Federal tax law gives the Internal Revenue Service authority to examine a taxpayer’s books and records to determine the correct amount of tax due. The IRS also has the right to summon taxpayers and to make them appear before the IRS and produce necessary accounting records. Taxpayers are required by law to maintain accounting records to facilitate an IRS audit.

The IRS may also issue a summons of taxpayer records from third parties such as banks, brokers, and CPAs. The IRS must notify the taxpayer within three days of serving a third-party summons to allow the taxpayer to intervene in any proceeding involving the summons. If a taxpayer receives notice the IRS is summoning records from a third party, he or she should seek immediate professional tax advice.

Types of IRS auditstypes of IRS auditsCorrespondence, office, and field.. A primary function of the IRS is to audit taxpayers’ tax returns. After the service centers have checked the returns for accuracy, the returns can be selected for audit. Most individual income tax returns are unlikely to get audited, and a traditional sit-down audit happens in less than 1% of all tax returns filed.

There are three major types of audits: correspondence, office, and field. In a correspondence audit, the taxpayer is asked to submit documentation on one or two items, usually small dollar amounts. Of the nearly 1.4 million audits done in 2007, 78% were done via correspondence. The audits and other enforcement actions yielded almost $60 billion in 2007.

An office audit is one in which the taxpayer is asked to come to an IRS office and sit down with an auditor to review limited (again, one or two) items with little or no business income and deductions. The taxpayer is simply required to substantiate deductions, credits, or income items that appear on the tax return.

An individual who owns a business could be subject to a field audit where an IRS agent comes to the place of business to conduct an audit. This type of audit is generally used when the accounting records are too extensive to take to the Internal Revenue Service office. Field audits are usually used for taxpayers with substantial trade or business activities. If a taxpayer can present a valid reason, he or she may have an office audit changed to a field audit.

Selection of returns to audit. A tax return is usually selected for audit within a three-year period after the due date of the tax return, and the process to select is based on mathematical formulas and statistical sampling. The mathematical formula yields a Discriminant Inventory Function (DIF)Discriminant Inventory Function (DIF)Mathematical formula used by the IRS in assigning a score to tax returns and selection for audit. score assigned to tax returns based on the likelihood of errors and other factors. The formula is based on past tax return audits. In addition, tax returns may be selected for audits based on

If an audit results in an amount due and the taxpayer does not agree, there are steps the taxpayer can take. First, the taxpayer can appeal the decision within the IRS, and an appeals division hearing can make a settlement. The next step would be to take the issues to court.