US expats: What is IRS audit?

By ZM Ishmurzina

What is IRS audit? US citizens and green card holders become terrified after receiving a letter from the IRS. US expats face even a more challenging situation because if the IRS letter is sent to a foreign address, it might arrive late or even be lost. Consequently, it is essential for every taxpayer to understand the IRS audit reasons and the types of IRS audit letters.

This is an email from one of our clients, US expats living abroad and green card holders. “I am a American expat living in Ireland. I filed a prior year tax return on overseas taxes by myself. However, a week ago I received the form 4564 from the IRS. I am scared. I would like to understand what is IRS audit for US expats and form 4564.”

Let’s review the key issues about what is IRS audit and IRS letter.

What is IRS audit?

The USA tax system is one of the most complex tax systems in the world. The IRS is the nation’s tax collecting agency that has been created by Congress in 1862. Due to a budget deficit it is even more pressure on the IRS to enforce the tax laws and to collect taxes. One of the ways for the IRS to accomplish its tasks is through IRS audits. The IRS audited approximately 1 percent of individual income tax return in 2012 per the IRS website. Next step is to understand what is IRS audit.

What is IRS audit reason?

Actually, there are multiple reasons that US expats can receive the IRS audit letter. We mentioned expatriate tax audit reasons earlier. For example, a failure to report all income, multiple red flags, excessive charity donations and multiple errors. The number of IRS audits among US expats is growing up to the latest FBAR and FATCA requirements. For example, US taxpayers are not only required to indicate the existence of foreign financial accounts but also to file the FBAR report TD F90.22.1 and FATCA form 8938. A failure to report foreign financial accounts can result in significant penalties and even a jail time.

What are IRS audit chances?

The chances of the IRS audit increase as the income grows. However, the IRS assigns to every tax return a score that is called the Discriminate Function Score. The IRS has never disclosed the formula behind this score, however, it admitted that a higher Discriminate Function Score increases the chances of audit. Next step is to understand what is IRS audit procedure.

What is IRS audit procedure?

There are 3 main types of IRS audit.

  • What is IRS Audit – Correspondence audit

As a part of correspondence audit, the IRS requests US taxpayers to verify some information on a tax return by mail. Specifically, the IRS might request a cashed check, receipts, brokerage statements and other documents to confirm some numbers on the tax return. US expats might be required to submit the foreign bank account statement to verify the account balances. It is important for US expats to promptly reply to the IRS request and return all required information.

  • What is IRS Audit – Field audit

The IRS visits the office or home of taxpayer to verify the information.

  • What is IRS Audit – Office Audit

The office audit happens at the IRS office. US expats, a taxpayer or its representative is required to bring all required documents to the appointment.

What is IRS tax letter?

 

  • IRS audit notices are Letter 566, Letter 2201A, Letter 2205, Letter 2205A, Letter 3572.

Letter 566 is the initial letter sent by the IRS. The purpose of this letter is to inform a taxpayer that his/her tax return has been selected for examination with the list of items to be verified.

Letter 2201A provides the information about various boxes on page 3. It will help determine Schedules that are questioned.

Letter 2205 and 2250A identifies the type of audit, the IRS agent’s name, address and phone number.

Letter 3572 informs a taxpayer about the audit. Usually this letter is sent to initiate an audit in person. It might happen at a taxpayer’s office, home or the IRS location. This letter is usually accompanied by Form 4564 or Form 886A to request the information from a taxpayer.

  • IRS information requests are form 886A and form 4564.

Form 886A is very important because the IRS expects a taxpayer to reply to all questions on this form. If a taxpayer has not filed his/her tax return but the IRS has taxpayer’s year-end tax documents like 1099, W-2 etc on file, then the IRS will file a return for a taxpayer. The return prepared by the IRS does not have any deductions or exclusions that a taxpayer is eligible to claim. The IRS will send Form 886A to a taxpayer to inform about all findings and any tax due. A taxpayer must file a tax return to claim all appropriate deductions and to minimize US tax liability.

Form 4564 is the Information Document Request that is usually labeled “Request Number 0001”. This form is one of several requests for records by the IRS.

  • IRS determination letters are form 4549, Letter 3219, Letter 531-T.

Form 4549 is used by the IRS to report the results of their findings per the examination of a tax return. The letter identifies a list of proposed changes by the IRS and any tax liability or refund. A taxpayer must sign this form and return it to the IRS. A taxpayer must indicate whether s/he agrees with the proposed changes. If s/he does not agree, then a taxpayer must provide the records to support his case.

Letter 3219 is a Notice of Deficiency that is also called a 90-day letter. This letter provides the amount of interest and penalties assessed by the IRS. A Notice of Deficiency must be provided to a taxpayer by law and a taxpayer has the right to appeal to the U.S. Tax Court.

Letter 531 is a Notice of Deficiency too that is sent to a taxpayer to inform about any tax due for a certain tax period.

Conclusion

US expats should act proactively and reply to the IRS requests. A failure to do can result in substantial penalties and jail time. US taxpayers with foreign income and foreign financial assets are advised to work with a CPA that specializes in US taxes for expats. International tax experts at Artio Partners are here to help you.