Surviving a Tax Audit

Surviving a Tax Audit

Since the beginning of the new millennium, tax audits have increased to higher levels than was seen during the last decade of the previous century. In light of the recent and still lingering serious economic downturn, further increases in enforcement will almost certainly occur under the Obama administration.

Whether the number of audits is increasing or decreasing or will do so in the future is somewhat unimportant because the probability of the average business owner being audited is actually quite low. However, no matter what it is, the probability is not anywhere near as low as the probability of winning the lottery. Accordingly, we will all want to minimize the probability of a tax audit and maximize our survival condition if there is an audit.

In the unlikely event that you do receive an audit notice from the IRS you should not automatically panic. Most IRS notices are simply requests for some specific item of clarification and/or verification. Sometimes notices simply tell you that you miscalculated taxes owed by a relatively small amount and that (1) you need to send an additional amount or (2) you will be getting a refund or credit.

Even when there is an audit, it isn’t always a tense, face-to-face encounter with an agent. A letter from the IRS saying you added wrong also counts as an audit, at least in the eyes of the Treasury Department. There are basically three types of audits:

•  Correspondence Audit – The IRS requests a mailed reply to relatively uncomplicated issues. For example, the IRS may request proof of one or more deductions. Under many circumstances, taxpayers have a right to do the audit by mail rather than meet an auditor face-to-face.
• Office Audit – The IRS requests that the taxpayer bring documents regarding specific issues to an IRS office. For example, the IRS might want to see all the taxpayer’s bank account statements.
• Field Audit – The IRS agent comes to the taxpayer’s home or office.

In the event you do face an audit, you should consider hiring professional help. Obviously, if an accountant prepared your tax return, he/she should be your first choice if experienced in dealing with the IRS. If you don’t have an accountant, pick a CPA or tax attorney who is experienced in dealing with the IRS. If possible, find one who has previously dealt with the local auditors.

There are a number of advantages in being represented by a professional. One issue is that the IRS backs down in at least one-third of disputes and this is much more likely the outcome when a taxpayer is represented by a professional who has at least the same knowledge of tax law as the auditor.

It can even be further advantageous for the professional to meet the auditor without your presence if qualified to do so. A qualified professional will know what must be provided and what shouldn’t be provided the auditor. The professional won’t know and is not expected to know the answers to many questions and so can’t volunteer “incriminating” information. The professional can promise to provide answers after asking you.

If you will be attending the audit, remember the following DOs and DON’Ts:

• Do pick a time and place for the audit that is convenient to you and allows for adequate preparation – this is your right.
• Do consider recording the audit to prevent the IRS from changing the rules part way through – this is your right, but doing so gives the IRS the same right.
• Do limit the scope of the audit to those issues of the notice – this is your right
• Do answer as briefly and concisely as possible.
• Do remember that auditors can be wrong about tax law.
• Do ask to speak with the auditor’s supervisor if you feel that the auditor is being unfair or does not understand the issues.
• Don’t lie.
• Don’t guess if you don’t remember.
• Don’t volunteer information not requested.
• Don’t provide documentation that was not requested or related to the issue.
• Don’t hesitate to pause or postpone the audit if you feel that things aren’t going well so that you can consult with your professional before continuing.
• Don’t sign any forms at the audit that might take away your rights to claim deductions, appeal, or prevent enforced collection.

Expanding on some of the above points, if you choose to appear for an audit on your own, restraint is your best ally. Provide only the information the IRS specifically asks for and do so without going overboard. The more you talk the more risk of saying something that the auditor hadn’t even thought of and increasing the scope of the audit.

Just because the auditor asks about something doesn’t mean you’ve done anything wrong. If you don’t know the answer to a specific question, don’t guess. For example, if asked the source of funds for a particular bank deposit and you’re not sure of the source, simply answer that you don’t remember, but will research the matter and provide the answer as soon as possible.

Don’t consider an auditor to be infallible. In fact, some observers claim that auditors are wrong in more than half of cases. If you think that an auditor is wrong about an issue, ask to speak with a supervisor or get professional help.

The IRS has the legal right to look at your financial records, but, whether you will appear at the audit by yourself or with a tax professional, it’s advantageous to do the following:

• Talk with the IRS auditor ahead of time in order to understand the issue(s) and to determine exactly what documentation you need to bring with you.
• Take with you only the documentation being requested and organize it so that it’s easy for the auditor to find what’s needed. You don’t want the auditor looking through a lot of unrelated documentation and finding other things to question. For any missing receipts, use other documentation to provide the required information. For example, if an expense invoice is missing, use a canceled check or credit card statement to show the expenditure.

Finally, if you are being audited before filing a return for the most recent tax year, you can avoid that year’s return being included in the audit by filing for an extension.

Additional Information
For additional discussions regarding tax issue in considerably more detail than is provided by this series see our “9 Steps to Avoiding & Surviving a Tax Audit” Mini Training Guide and tax related lessons of our “Buying Income Property” and “Managing Income Property eCourses.

This entry was posted on September, 2010 and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.