IRS Tax Audit Guide for Expats Taxpayers

IRS tax audits are something that every taxpayer dreads and hopes doesn’t come knocking on their door. But while terrifying, tax audits serve an important purpose. Knowing how they work and how to deal with them can make this otherwise scary endeavor less daunting.

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From different types of taxpayers to how expats can avoid being audited, this will serve as your ultimate guide on how IRS tax audits are conducted and how to prepare for them.

What are the Different Types of Taxpayers?

Knowing which type of taxpayer you are can help you determine your options when dealing with tax audits. According to the Internal Revenue Service (IRS), international taxpayers can be classified as either of these three types:

1. U.S. citizens and resident aliens abroad

The IRS categorises you as a resident alien of the United States if you meet one or both requirements for the calendar year: a substantial presence test or a green card test.

If you’re a resident alien, the rules for filing estate, income, gift tax returns, and paying estimated tax typically correspond with U.S. tax standards. Whether you’re abroad or in the United States, your worldwide income tax is subject to U.S. tax income, much like a U.S. citizen.

2. Foreign persons

The IRS classifies the tax information for foreign persons as the following: resident aliens who passed the green card test or substantial presence test in the current calendar year and nonresident aliens who did not meet the green card or substantial presence test.

Aside from resident and nonresident aliens, dual-status aliens, individuals who changed residency status in the same calendar year, and international students who temporarily live in the United States to study are classified as foreign persons.

3. U.S. territory taxpayers

If you work or live in U.S. territories like American Samoa, Guam, Puerto Rico, the Commonwealth of Northern Mariana Islands (CNMI), or the U.S. Virgin Islands, you must file a tax return with the territory’s tax department.

Certain situations may prompt you to verify whether you’re a resident or nonresident of the territory. If you receive income from one of the U.S. territories, you may need to file a U.S. tax return, a territory tax return, or in some cases, both, depending on if you’re a certified U.S. territory citizen.

Tax Audits: Why Does the IRS Conduct Them?

The primary purpose of tax audits is to determine whether reports, such as income or deductions, filed with the proper taxing authorities are accurate. Being audited does not necessarily mean you’ve committed an offense against the IRS; the appropriate tax authority has the right to conduct a closer examination of your returns as they see fit.

Fast Facts and Statistics

According to the IRS Data Book of 2020, the taxpayer’s chance of being audited is a measly 0.6%, meaning the IRS only audits one out of every 166 tax returns.
The IRS typically audits less than 1% of all filers.
Around 150 million total federal tax returns are filed annually
Close to 90% of audits result in a tax return change.

Tax audits are more common than you thought. Eventually, all citizens will be subjected to audits, as it’s customary for a responsible citizen to go through.

Read: What Triggers a Tax Audit?

How are tax returns selected for audit?

Tax returns are selected for examination using a variety of methods, including:

Random selection and computer screening – sometimes returns are selected based solely on a statistical formula. When returns are filed, they are compared against “norms” for similar returns. The “norms” are developed from audits of a statistically valid random sample of returns. These returns are selected as part of the National Research Program, which the IRS conducts to update return selection information.
Document matching – when payor records, such as Forms W-2 or Form 1099, don’t match the information reported, generally a correspondence audit is initiated in the form of a CP2000 notice.
Related examinations – returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for audit.

4 Types of IRS Audits

1. Correspondence Audits

A correspondence audit refers to an IRS tax audit process conducted by phone call or conventional mail.

The correspondence audit process entails the IRS sending the organization a written request, or the IRS Letter 566, to gain additional information about a particular issue or item on their tax return.

This type is the lowest level of audit. Aside from a Letter 566, receiving a CP2000 notice usually entails that you may undergo a correspondence audit.

A CP2000 notice, otherwise known as an underreporter inquiry, will be sent to the taxpayer if their returns do not accurately mirror what the IRS has on record. Additionally, a CP2000 notice is sent to propose an adjustment for under or overpayment of tax obligations.

2. Office Audits

If the IRS has inquiries that are too complex or vast for a correspondence audit but not at the level of a field audit, you will be sent a letter asking you to appear in person at an IRS office for an audit.

In an office audit, you will be asked questions about the issue under examination. This may include generalized questions about your financial position, employment, and lifestyle to find other causes for concern, like the possibility of underreported income.

It’s best to bring a CPA or a tax professional to accompany and represent you. These professionals will ensure that your answers and actions won’t expand the IRS’s inquiries beyond those specified in the audit letter.

3. Field Audit

A field audit is the most extensive type of IRS tax audit. This entails IRS revenue agents visiting your home, place of business, or your accountant’s office to see information outside of certain records, not wanting to limit themselves to a particular item.

If you’re a business owner, your typical field audit will consist of reviews regarding your financial records, employee interviews, and a business facility tour. These interviews will ensure an overview of internal controls, accounting procedures, and management structure.

As for individual taxpayers, the field audit only entails a review of financial records and an interview with the taxpayer. Depending on the complexity of the matter, field audits may last from one day to a week.

Field audits are considered the most intrusive type. Any information you may divulge may be used against you to broaden the scope of an audit, so it’s best to enlist the services of a tax professional like a tax attorney to aid you in these proceedings.

4. Line-by-Line Audit

Line-by-line audits are the most unpredictable, as the IRS chooses a taxpayer at random. If selected, the IRS will extensively analyze your tax return to establish norms or benchmarks that can trigger future audits of this nature. Some taxpayers subjected to a line-by-line audit may owe additional taxes, penalties, and interest.

Practice Your Right to Representation

Before going through a tax audit, you must be aware of your rights as a taxpayer. The IRS provides a “Taxpayer Bill of Rights,” which serves as a cornerstone of the 10 fundamental rights of taxpayers. It was created to inform taxpayers on what to do when resolving tax matters. It discusses the procedure for examination, collection, refunds, and appeal processes.

The IRS actively highlights these rights while constantly reminding its employees to apply taxpayer rights in every encounter with taxpayers.

Once familiar with your fundamental taxpayer rights, the next best course of action is to exercise your right to be represented by an authorized tax expert. Practicing this right with the help of legal counsel can increase your chances of favorable outcomes in your IRS audit.

How Different Types of Taxpayers Can Resolve Tax Audits

Now that we’ve identified the different types of taxpayers and audits, let’s discuss actionable steps to keep in mind when resolving tax audits.

1. Identify what type of audit will be conducted

Identify the audit type you’ll undergo, then prepare the necessary information or file for a postponement if you require more time. Whether in-person or by correspondence, dealing with the IRS requires the expat to be honest, accurate, polite, and courteous; reply to notices issued within the allotted time.

Additionally, it’s essential to keep all records related to your foreign income, taxes, and expenditures for at least three years to ensure that an honest error isn’t misinterpreted as tax evasion if audited.

2. Know why you’ve been selected for an audit

It’s imperative to know why you’ve been selected for an audit. For foreign taxpayers like expats, failure to submit necessary forms like the Foreign Bank and Financial Accounts Report (FBAR) could be one of the causes.

The FBAR or FinCEN Form 114 must be submitted yearly by qualified taxpayers. This foreign bank account report exists to combat tax evaders by requiring U.S. citizens to report money and assets in non-U.S. bank accounts.

Expats who fail to comply can be subjected to an audit and incur heavy penalties. Keep in mind the regular submission of your FBAR to avoid troublesome audits.

3. Submit your IRS Form 8398

IRS Form 8398, a more comprehensive reporting of foreign assets, is one of the most important requirements to fulfill as an expat. It is used to report an expat’s specified foreign financial assets due to their total value exceeding the appropriate reporting threshold.

The expat reports their savings deposits, checking, and brokerage accounts. Additionally, stocks or securities issued by a non-U.S. citizen must be reported. Submission is mandatory to avoid an audit and incur penalties of up to $50,000 for severe offenses.

4. Involve your tax professional throughout the process

Tax matters are complicated, and an ordinary citizen will find it challenging to deal with this process alone, making it best to hire a competent tax professional for help.

It’s recommended to sign a power of attorney that allows the IRS to talk directly to your tax professional. But even without a power of attorney, your tax professional should be present in any proceedings concerning your audit as they can properly guide you in resolving your tax audit issues.

Preventive Measures to Avoid an IRS Audit for Expats

While an IRS audit isn’t something to panic about, it’s still beneficial to learn some helpful tips, best practices, and actionable recommendations to keep your taxes up to date.

1. Account for all your income

While some may be tempted to underreport income on their tax return, it’s not a good idea. Report all income to the IRS regardless of the method of payment. Failure to report all income may result in having to pay back taxes with additional penalties.

2. Double-check your tax return before you file

Math errors and missing signatures are two of the most common mistakes taxpayers make. Even a simple miscalculation or oversight can trigger an audit. Review your return carefully, making sure the totals add up, deductions are accurate, and all required signatures are included before submitting.

3. Keep your financial records organized and updated

Tax compliance problems can be easily avoided by keeping your financial records up-to-date. Creating an accurate financial report will be much easier if you set aside time to extensively review payments, invoices, and other essential things to consider. This includes saving receipts for deductions and charitable donations, as missing or incomplete records are among the first things the IRS looks for during an audit.

4. Consult with a tax professional

Whether you’re dealing with a tax audit or trying to prevent it, consulting with a tax professional is always recommended. Receiving help from certified tax professionals can boost your tax compliance efforts.

Tax professionals possess a wealth of experience in helping corporate and individual taxpayers become tax compliant, as well as an understanding of tax requirements and laws.

FAQs About IRS Tax Audit

1. I’ve never faced an audit in over a decade of filing taxes. What are the chances of the IRS auditing me in the future?

Most taxpayers have less than a 1% chance of being audited. The odds increase if you’re self-employed or have higher income. Red flags, such as excessive deductions, underreporting of income, or holding cryptocurrency, can also trigger scrutiny.

2. I got audited before. Could the IRS audit me again?

Yes, the IRS can audit you more than once, but not for the same year. This could happen if you make the same mistake as in your past filing. Also, if you involve yourself in things the IRS sees as suspicious, like the examples above.

3. I received a letter from the IRS. What should I do?

Open the letter immediately and read it carefully. It will explain the year under review, the reason, and the required documents. If you’re unsure how to respond, reach out to a tax professional. Remember, the IRS will never notify you of an audit by email, so avoid phishing scams. If you’re in doubt about any communication from the IRS, check here first.

4. What should I expect during the audit?

The IRS may conduct the audit by mail, phone, or in person, depending on the instructions in your letter. The IRS auditor who reviews your tax return will examine your income, deductions, credits, and documents. The auditor will also ask questions to make sure that what you say matches what’s on record.

5. Should I handle the audit myself or consider hiring a tax professional?

You can represent yourself before the IRS. If your taxes are simple and you understand tax laws well, you might manage the audit alone. But you also have the option to hire a professional to represent you. Because the audit process is complex, we generally recommend seeking professional help. You can hire a tax attorney, CPA, or enrolled agent to handle your case.

6. What will happen next after the audit?

You will receive a report outlining the auditor’s findings. If you can support the information under review, the IRS won’t make any changes. They’ll accept your return as filed. If you owe more taxes, the report will detail the proposed changes to your tax return. You can agree with the findings and pay the taxes. If you disagree, you can file an appeal.

7. I agree with the decision, but can’t afford to pay the taxes. What do I do?

The IRS offers options if you can’t pay in full, such as installment agreements, offers in compromise, or temporarily pausing collections. These programs help make repayment manageable. A tax professional can guide you to the best solution for your situation.

Knowing is Half the Battle

Being subject to tax audits is one of the most stressful endeavors citizens could ever encounter. Tax laws are complex, and processes are arduous. However, arming yourself with the knowledge regarding audits, their types, and why they are done gives you valuable insights to deal with this situation if you’re ever faced with it.

Additionally, you can seek help from tax professionals. They’ve dedicated their professional lives to this cause, helping the uninitiated resolve their tax-related issues.

If you require excellent tax preparation services, look no further than Tax Samaritan. Serving expats since 1997, Tax Samaritan provides professional-quality tax resolution services to aid in intricate tax-related matters. Get a free tax quote today with Tax Samaritan and start your tax return efforts.