A tax investigation is a structured evaluation of the finances and tax returns associated with a specific taxpayer. The taxpayer in question may be an individual or a business entity. There are several reasons why this type of investigation may take place, ranging from random selection to suspicion of some type of attempt to engage in tax evasion and defraud the tax agency conducting the investigation.
During the course of a tax investigation, a process known as a tax audit takes place. This is simply an examination of all the available financial records related to one or more filing periods. The idea is to make sure that the information provided on a tax return is supported by financial records such as income reported from different employers or contractors, the amount of taxes paid on that income prior to filing the return, and the range and type of deductions and other claims made in calculating the total amount of taxes due for a given period. Depending on the complexity of the individual or company’s finances, the tax investigation may be completed in a short period of time, or take several weeks or months to finish.
While many people assume that a tax investigation or audit is only conducted if there is suspicion of some sort of wrongdoing, that is not always the case. Most national and state tax agencies will select a few returns at random during each filing season and compare the data on the returns with the appropriate financial documents. At times, the audit or investigation may uncover some minor issues that are obviously oversights or miscalculations on the part of the filer. When this is the case, the agency may impose some type of small fine for filing the amended return, or maybe even waive the penalties altogether, depending on the nature of the discrepancies.
In other instances, a tax investigation is triggered by events that do raise some suspicions regarding the returns filed by the individual or business. This may come about because data reported to the tax agency does not match with information provided by the taxpayer. A tax investigation is also more likely to occur if the taxpayer fails to submit returns for certain tax periods, or if there is some reason to believe that deductions are being claimed that the taxpayer is not entitled to claim, resulting in lowering the amount of taxes due for a given period.
Many businesses secure what is known as tax investigation insurance, coverage that helps to protect the business from the cost of penalties and interests when an investigation leads to disallowing certain deductions and resulting in a much higher tax burden. Assuming that there is no evidence of intentional wrongdoing, the coverage will often offset all or a portion of the penalties and may even help with settling the additional amount of taxes owed.
Most tax agencies around the world are somewhat lenient when the tax investigation clearly shows that the taxpayer made an honest error, such as miscalculating a total or failing to understand the qualifications for claiming a certain exemption or deduction. Leniency is less likely to be granted when the investigation uncovers what appear to be intentional efforts to defraud the tax agency, with the punitive measures ranging from the imposition of stiff fines to the individuals responsible for the fraud spending time in jail.