IRS Examination (Audit) Procedures

Rule

IRS examines (audits) a small fraction of returns — under 1% of individual returns in recent years. Higher-income taxpayers and EITC claimants are audited more often. Being selected does not mean the return is wrong or the taxpayer was dishonest; the taxpayer bears the burden of proof to substantiate items on the return. IRS always notifies taxpayers of an audit by mail (never by email). Filing an amended return does not affect the original return's selection; the amended return goes through separate screening.

Three Types of Examinations

A taxpayer may request transfer of a field audit to a more convenient location (e.g., where records/representative are).

Centralized Partnership Audit Regime (CPAR / BBA)

Established by the Bipartisan Budget Act of 2015; applies to tax years beginning 2018+. Under CPAR, IRS assesses and collects any underpayment at the partnership level (not against individual partners) by default.

• Elect OUT of CPAR only if: (a) partnership has 100 or fewer partners; AND (b) all partners are "eligible" — individuals, C corporations, S corporations, estates of deceased partners (NOT partnerships, trusts, disregarded entities/LLCs, or bankruptcy estates). Must elect annually on Schedule B-2 of Form 1065, filed by the extended due date.
• A partnership with even one ineligible partner (e.g., a grantor trust) cannot elect out.
• A partnership that elects out can "push out" adjustments to partners under IRC §6226 via Form 8988 within 45 days of the Final Partnership Adjustment notice.

Selection Methods

• DIF (Discriminant Inventory Function) score — computer scoring of returns for audit potential
• Information matching — W-2/1099 mismatches with the return (often produces CP-2000 notices)
• Related examinations — pick-up from a related taxpayer's audit (partner, investor)
• Abusive tax shelter promoter/participant leads
• Third-party information — law enforcement, public records, individuals (assessed for reliability before use)
• Random selection (rare)

Audit "red flags": high income, self-employment with large Schedule A deductions, large charitable contributions, home office, rental losses, high meals/travel, 100% business vehicle use, hobby losses, cash businesses, unreported foreign accounts, currency transactions.

Taxpayer Rights During Audit

• Professional and courteous treatment
• Privacy and confidentiality
• Right to know why info is requested, how it will be used, and consequences of not providing it
• Right to self- or authorized-representation
• Right to appeal within IRS and in court

Representation During an Audit

A taxpayer may represent themselves or use a qualified representative with a Form 2848. Only Circular 230 practitioners (attorneys/CPAs/EAs) or those qualifying under limited-practice rules (AFSP for returns they prepared/signed; family members; fiduciaries; officers/employees) may represent. The taxpayer generally need not attend if a qualified representative is authorized. For a joint return, either spouse (or a representative) can meet with IRS. IRS cannot force a taxpayer to attend an interview without a summons, but can bypass a representative who fails to provide records, keep appointments, or respond to correspondence.

Examination Procedures

• Initial contact letter — notifies of exam, items under examination, documents needed
• Information Document Request (IDR) — Form 4564, formal request for specific records
• Third-Party Contact (TPC) notice — under the Taxpayer First Act (IRC §7602(c)(1)), IRS must give advance notice of intent to contact third parties, including a specified period (≤1 year), sent at least 45 days before first contact. Exceptions: pending criminal investigation; notice would jeopardize collection; notice could cause retaliation; contacts with other government agencies.
• Audit interviews can be recorded by either party, but the recording party must give the other party 10 days' written notice. If the taxpayer wants to consult a representative mid-audit, IRS must suspend and reschedule.

Audit Techniques

Interviews; inspection of books/records; bank deposit analysis; net worth method; source and application of funds; specific item review; statistical sampling.

Statute of Limitations During Audit

• Generally 3 years from the later of filing date or original due date
• 6 years if >25% of gross income is omitted
• No limit for fraud or failure to file
• Taxpayer may consent to extend (Form 872)

Examination Report and Closing

• Revenue Agent Report (RAR) summarizes proposed adjustments; taxpayer signs Form 4549 (Income Tax Examination Changes) if agreeing
• A closing agreement is a written settlement (rarely used) — finalizes liability or a specific transaction's treatment
• Three dispositions:
  1. No-change — taxpayer substantiated all items; no change
  2. Agreed — taxpayer understands and agrees to proposed changes
  3. Disagreed — taxpayer understands but disagrees; may request a manager meeting, fast mediation, or appeal, or go to court

IRS generally will NOT reopen a closed exam for an unfavorable adjustment unless: there was fraud/misrepresentation; a substantial error based on an IRS position existing at the time of exam; or reopening is needed to avoid a serious administrative omission.

Audit Reconsideration

A taxpayer who disagreed with a prior exam may request reconsideration if: new information not previously considered is submitted; the taxpayer filed their own return after an SFR was prepared; IRS made a computational/processing error; or liability remains unpaid/a credit was denied. NOT accepted if: the taxpayer signed a closing agreement; or a court has made a final determination. IRS has discretion to grant or deny.

Duplicate Examination

IRS tries to avoid auditing the same items twice. If a return was examined for the same items in 2 prior years with no change proposed, the taxpayer may request IRS discontinue the exam (IRM 4.10.2.13.2). Approval is at IRS discretion. Does NOT apply if the new exam covers different items.

Authority

• Publication 556 — Examination of Returns, Appeal Rights, and Claims for Refund
• Publication 3498 / 3498a — Examination Procedures (general / correspondence)
• Publication 3598 — Examination Reconsideration Procedures
• Publication 3605 — Fast Mediation
• IRC §7602(c)(1) — third-party contact notice (TFA amendment)
• IRC §6501 — assessment statute (3/6 years; no limit for fraud)
• Bipartisan Budget Act of 2015 — CPAR (centralized partnership audit regime)
• Form 4564 (IDR), Form 4549 (examination changes), Form 872 (consent to extend assessment statute), Form 8988 (CPAR push-out)

Edge Cases

• CPAR elect-out partner eligibility: An S corporation IS an eligible partner, but a grantor trust, a disregarded LLC, a partnership, or a bankruptcy estate is NOT. One ineligible partner kills the election.
• 100-partner CPAR limit: Counts partners, not entities; the threshold is 100 or fewer.
• Third-party contact 45-day notice: Does not apply to contacts with other government agencies (e.g., DOJ), or when a criminal investigation is pending, or when notice would impair collection or risk retaliation.
• Audit recording: The 10-day written-notice rule applies to whichever party initiates recording (taxpayer OR IRS).
• Reopening a closed exam: Only for fraud/misrepresentation, substantial error based on existing IRS position, or serious administrative omission — not simply because the taxpayer's income rose.
• SFR (Substitute for Return): When a taxpayer won't file, IRS prepares an SFR using available documents — which does NOT give the taxpayer the deductions/credits they'd otherwise get. The taxpayer can later file their own return and IRS will adjust.
• Audit reconsideration vs. appeal: Reconsideration is a separate process (new info, error) — distinct from the 30-day letter appeal path.

Common Traps

• Three audit types: Correspondence (mail, most common), office (IRS office, moderate), field (taxpayer's location, most thorough). Candidates sometimes add a fictitious "TCMP" or "company" audit type. TCMP is a random selection method, not an audit type.
• Correspondence audits are the most common: ~78% of audits are by mail. Do not assume field audits are most common.
• Field audits are conducted only by Revenue Agents: Trained, experienced agents — not customer service reps.
• CPAR elect-out: The partnership must have 100 or fewer partners AND only eligible partners. "Trust" is the classic ineligible-partner wrong answer in exam questions.
• Duplicate-exam relief requires 2 prior no-change years for the SAME items: A third exam on different items (e.g., education credit after two EITC exams) does NOT qualify.
• DIF score does not mean the return is wrong: It identifies audit potential; many high-DIF returns are correct.
• CP-2000 is not a formal audit notice: It's an information-mismatch proposal, but it can lead to an audit. Employment-related identity theft often surfaces via a CP-2000.

Connected Rules

• irs-collections — what happens after assessment (lien, levy, IA, OIC, CSED)
• irs-appeals-tax-court — 30-day letter, 90-day notice of deficiency, Tax Court
• poa-disclosure-privacy — Form 2848 for audit representation; Form 8821
• irs-authority-practice-requirements — who can represent; AFSP limits (examination level only)
• penalties-refund-professional-responsibility — accuracy-related §6662, fraud §6663, SFR consequences
• identity-theft-data-protection — CP-2000 as an identity-theft warning sign; Form 14039

Scenarios Worked

None yet