What is Tax Audit? Definition, Advantages, Characteristics

What is Tax Audit?

A tax audit is an examination conducted by a financial agency that oversees the compliance of all tax-paying entities. A tax audit may be triggered by a tip-off, an annually scheduled analysis, or at random.

Statistically, Bloomberg notes that audits happen in fairly small numbers. Recently, the number of tax audits has only ranged between 0.01% to 0.00004% of all tax returns filed. Furthermore, the Internal Revenue Service highlights that the higher the income, the greater the chances of a tax audit. This means that individuals and small businesses are less likely to be audited. Though the chance is always there.

Tax Audit Definition

“Examinations (audits) of most types of tax returns, information reporting and verification, math error notices, and criminal investigations are critical tools for determining if income, expenses and credits are being accurately reported and to identify and resolve taxpayer errors and identify fraud.” — Internal Revenue Service

“Tax audits are usually triggered by unusual or unordinary deductions or forms of income listed on a tax return, but taxpayers can also be selected at random.” — Carol Nachbaur

“A tax audit is a complete investigation into a taxpayer’s finances, income, and taxation conducted by the Internal Revenue Services. It’s a double-checking of a person or corporation’s tax filings, and generally means the IRS goes through financial records, taxes, and more with a fine-tooth comb to make sure everything was reported correctly.” — Liz Knueven

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Characteristics of Tax Audit

Audits can be done internally or by third-parties

When people hear “tax audit”, government entities and financial watchdogs are the first groups that come to mind. In actuality, tax audits can also be rolled out internally or by third-party consultants.

In many companies, internal auditors (IA) are employed to review financial records and activities regularly. This is meant to be a proactive method of avoiding further investigation by regulatory agencies.

Alternatively, some companies choose to hire a third-party auditor. This certified public accountant (CPA) will objectively double-check all financial reports without needing to study each action’s rationale.

There are several types of audits

There are various ways financial agencies can audit. Most are dependant on their region or country’s mandates and protocols.

In the United States, for instance, the four main types of tax audits are

• Mail audits
• Office audits
• Taxpayer compliance
• Field audits

The main difference between these is that they vary in intensity and scrutiny.

To illustrate, if you’ve just filed a questionable but not notably large discrepancy in your taxes, then you may just receive a more “casual” mail audit. This only requires you to send up documents for clarification.

But if you have filed dubious facts and figures, you’ll likely be escalated to a field audit. On this occasion, you’ll need to produce comprehensive documentation with assistance from your CPA or tax attorney. This is done over a face-to-face meeting with the auditor in your place of work or home.

Most audits are resolved without further issue

Most audits are resolved fairly quickly. In fact, recent data states that over 72% are resolved at the preliminary mail audit stage. That said, finance experts advise entities against taking tax audits lightly.

Rather than trying to handle it solo, onboarding a CPA or tax attorney is preferable. AskMoney has a published a number of helpful guides on tax do’s and don’ts. And in an article on tax-filing services, the online publication highlighted how CPAs are capable of handling all tax-related concerns, including those that deal directly with agencies like the Internal Revenue Service.

In some cases, tax-filing services can even connect clients with in-house audit guidance centres. With these professionals’ expertise, the audit’s resolution can be hastened.

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Advantages of Tax Audits

In the long run, tax audits can provide clarity to strengthen your finances:

• It can highlight any financial discrepancies in your cash flow.
• It can help you and your organisation discover better ways to be tax-compliant.
• It can prove an entity’s transparency, truthfulness, and financial credibility.
• It can thoroughly test the efficiency and efficacy of an entity’s current financial management system.

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Qualities of Tax Auditor

• The tax auditor must be able to decipher nuanced data.
• They must be able to understand the stories that each financial report paints.
• They must be able to translate their findings into actionable data.
• They must be able to pinpoint any discrepancies in large amounts of financial data.
• They must be clear in how he communicates with the employees of the organisation. This is to ensure that nothing is misconstrued.
• They should have a pleasant and dynamic personality.

A tax audit is something most hope never to experience. Although the likelihood of being audited is slim, these chances are further whittled with proactive financial preparation. That said, competent auditors are a useful human resource, especially for businesses.

In fact, the profession is currently in huge demand, especially following the pandemic’s economic effects. This is reflected in the United States’ recent efforts to outsource auditing jobs to countries like India, as a result of stimulus packages being released. This only goes to show how essential auditors are in any entity’s tax-related processes.

For more information on financial literacy, management, and the like, please check the blog on Geektonight.