What it means
Most audits are correspondence audits, because they are cheap for a tax authority to run. A computer flags a mismatch, such as reported income that does not agree with a third-party filing, and a standard letter goes out asking for evidence.
No officer visits your premises and no interview takes place. The scope is deliberately narrow, and that narrowness works in the taxpayer's favour.
A letter typically names the tax year and the specific line item in question, such as charitable donations or vehicle expenses, and asks only for records relating to it. Volunteering extra information beyond what was requested can widen the enquiry, so most advisers answer the question asked and nothing more.
The process runs on deadlines. A response is normally due within 30 days, extensions are usually granted if requested before the date passes, and silence is treated as agreement with the proposed adjustment.
Missing the deadline is the single most common way a manageable letter turns into an assessment plus penalties. Outcomes fall into three groups: no change, an agreed adjustment, or disagreement.
If the documents support the return you receive a closing letter, and if they do not the authority proposes additional tax with interest and possibly a penalty. From there you can pay, negotiate, or take the matter through the formal appeals process.
For a business, the practical lesson is about record keeping rather than about tax law. Correspondence audits are usually won or lost on whether receipts, mileage logs, invoices and bank statements can be produced quickly for a year that closed two years ago.
A company with clean digital records treats the letter as an afternoon of admin, while one without treats it as a crisis.
In practice
Real-world examples.
Example
A freelance graphic designer receives a letter noting that a client reported paying $18,000 while the return shows $12,000 of income from that source. Bank statements show the difference is a $6,000 payment received in January of the following tax year, the timing is explained in a two-page reply, and the file is closed with no change.
Example
A small logistics firm is asked to substantiate $52,000 of fuel and vehicle expenses. Its telematics system produces a complete mileage log by vehicle and journey within a day, the claim is accepted in full, and the finance manager notes that the same request would have been unanswerable three years earlier when logs were kept on paper.
Example
A charity shop chain is queried on the value of donated stock recorded as income. It replies with its written valuation policy and a sample of the monthly stocktake records, and the authority accepts the policy but adjusts one quarter where the records were incomplete, resulting in a modest agreed adjustment rather than a wider examination.
Formula
Calculation
Formula: Additional tax due = Disallowed amount x Marginal tax rate; Total payable = Additional tax + Interest + Penalty
Worked example. Harborline Design Ltd receives a correspondence audit letter questioning $40,000 of claimed contractor costs for a year that closed 24 months ago. The company produces invoices and payment records for $30,000 of the total, but $10,000 relates to a supplier whose paperwork was lost during an email migration, so that amount is disallowed.
Additional taxable profit: $10,000.
Tax at a 25% marginal rate: $10,000 x 0.25 = $2,500.
Interest at 6% a year for the two years since the tax fell due: $2,500 x 0.06 x 2 = $300.
Accuracy penalty at 20% of the underpayment: $2,500 x 0.20 = $500.
Total payable: $2,500 + $300 + $500 = $3,300.
Had the missing invoices been retrievable, the letter would have closed with no change and no cost beyond the couple of hours spent replying.Case study
Seen in the real world.
This illustrative and fictional case involves Larkspur Interiors, an invented interior design partnership with revenue of about $2,400,000 a year. Two years after filing, it received a correspondence audit letter querying $85,000 of subcontracted installation costs and giving 30 days to respond.
In the fictional scenario the office manager who had handled supplier records had left, and invoices for that period were split between a shared drive, an old accounting package and a filing cabinet. The partners spent nine working days reconstructing the file and eventually supported $71,000, leaving $14,000 unsupported. At a 25% rate that produced $3,500 of additional tax, plus $420 of interest and a $700 penalty, a total of $4,620.
The direct cost was modest, but the partners calculated that the nine days of lost billable time were worth roughly $11,000, which made the exercise far more expensive than the tax bill suggested. They moved to a system where every supplier invoice is captured digitally against the payment at the point of approval, so that any future letter can be answered from one place. That is the usual lesson of an illustrative case like this: the audit is cheap, disorganisation is not.
Watch out
Common mistakes.
- Ignoring the letter in the hope that it goes away. Non-response is treated as acceptance of the proposed adjustment, and the assessment then becomes far harder and more expensive to challenge.
- Sending the entire general ledger to appear cooperative. Supplying material outside the stated scope invites questions on items that were never under examination.
- Assuming a correspondence audit means the authority suspects fraud. The overwhelming majority are automated document-matching queries with no allegation of dishonesty attached.
Questions
People also ask.
Should I involve an accountant for a correspondence audit?
For a single straightforward item with clean records you can often reply yourself, but anything involving valuation judgements, several years or a large sum is worth passing to an adviser.
Can a correspondence audit become a full audit?
Yes, if the replies raise wider concerns the matter can be escalated to a field examination, which is another reason to answer narrowly and accurately.
How long should records be kept to be safe?
Most businesses keep supporting records for at least six years, because enquiry windows are commonly three to six years and longer where a return is judged careless or deliberately wrong.
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