“Gasp!” That might be your first reaction to seeing an envelope with an eagle on the upper left corner and the dreaded words next to it: Internal Revenue Service. But fear is not an emotion that should flow through your body. Why not? Well, if you’ve accurately recorded what properly belongs on your tax return, you have nothing to fear from the IRS if they contact you about an audit.
Documentation is your friend and it can prove invaluable in any examination. So what exactly is an audit? An audit (or more frequently called “examination”) is simply a means for the IRS to discover what may be missing or irregular on a return. The IRS usually has three years from the due date to verify the accuracy of your return. However, if certain situations are present it can be longer. The IRS relies heavily on what is known as third-party reporting. This is basically the verification process to ensure you’ve reported everything you should be reporting on your return. The concept of third-party reporting is simple. The IRS receives a form from the party that paid you. You report that amount on your return. It matches what has been reported. Case closed.
For example, your employer simultaneously provides you with a W-2 in late January and sends a copy to the IRS. When you report your W-2 on your tax return, the IRS is expecting to see the same numbers that your employer reported to them. What ends up generating a letter from the IRS is in areas on your tax return where they don’t have the luxury of third-party reporting. In the case of performing artists, this would be on a Schedule C (self-employment income) or on Form 2106-Unreimbursed Employee Business Expenses (suspended until the end of 2025 under the Tax Cuts and Jobs Act of 2017). It could also involve proving you made a contribution to your retirement program.
The formula that the IRS uses to determine just who will get that letter examining your return is…