So the IRS has sent you an audit notice. What now?
Last year I wrote a column offering eight tips for avoiding an IRS audit. This year, I want to give you some advice on what to do if you receive an IRS audit notice.
First, deal with the problem immediately. Don’t let the problem fester. Too often business owners do not open IRS letters or fail to pick up IRS certified letters. Worse yet, some owners ignore automated IRS phone calls or calls from a revenue officer. Ignoring the IRS greatly increasing the chances that the government will resort to collection actions (liens, wage garnishments, levies, seizures) in order to force taxpayer compliance.
Second, understand what the IRS wants. You have been selected to be audited for a specific reason. Being audited doesn’t mean you have done anything wrong. Your circumstances may be atypical. Your business may be cash intensive or you may have an unusual deduction that the IRS wants to review in more detail.
The most important explanation of what the IRS is looking for is contained in the Information Document Request (IDR). You will receive the IDR when you are initially contacted by the IRS. By understanding what the IRS is looking for, you can prepare and organize your documents, providing the most complete substantiation possible. The more complete your substantiation is, the less likely the IRS is going to challenge the information stated on your return.
Third, decide on professional representation or self-representation. If you are well-organized and have nothing to hide, there is nothing wrong with representing yourself in an audit. However, if you have a complex return, failed to report income, overstated expenses, failed to keep accurate records or reached an impasse with the auditor, then you should seek professional help.
Since your ultimate goal is to secure the smallest final bill or to obtain a “no-change,” on your tax return, hiring a tax attorney or a CPA firm to represent you has significant advantages.
Often tax attorneys and CPA firms have good working relationships with the IRS. They are knowledgeable about the IRS audit procedures, know the right time to elevate an issue to appeals and can often move through the audit process quicker than a taxpayer can alone.
An advantage to engaging a tax attorney is the attorney-client privilege, which offers a greater level of protection than a CPA. In cases where wrongdoing has occurred, a tax attorney is essential.
Fourth, limit the scope of the audit. Typically, the IRS has three years to request examination of a return. They will normally start auditing within one year. The exceptions are cases of late/no filings, significant errors or omissions in reporting income or expenses, and fraud. Do not offer up previous tax returns as it might trigger the opening up of other tax years, or an examination change. The IRS has the right to make adjustments on additional tax years even though it wasn’t covered with the initial IDR.
Fifth, control the flow of information. If you are representing yourself, you have the distinct disadvantage of having to answer the auditor’s questions immediately when asked. Never lie or make material misstatements to the auditor. Doing so is a federal crime that carries possible jail time. However, during an audit, make every effort to control the flow of information. Carefully listen to each question the auditor asks and answer only that question. Be brief. Keep your answers short. Answer as follows: “Yes,” “No,” “I don’t know.” “I will have to research that.” Too much “off-the-cuff” information gives the auditor more ammunition to make examination changes and potential additional assessments.
Sixth, remain personable and cooperative. Often, it is difficult for many taxpayers to keep their emotions in check during an audit. Many feel afraid, angry and inconvenienced and resent the costs of the audit. It is true that some auditors can be very difficult. However, the best audit outcomes are gained by working with the auditor rather than butting heads with him or her. Auditors are human, too. They will often favor those taxpayers who are personable and genuinely trying to work with them. Being well prepared and organized demonstrates sincerity to resolving tax issues. Cooperate. Do everything you can to move the audit process along quickly.
Seventh, pick your battles. Tax attorneys and CPAS tell me that they try to handle audits from a big-picture perspective. It doesn’t make sense to fight tooth and nail for every little deduction when it may lead the auditor to open up returns from other years. You may lengthen the audit and you will surely jeopardize your working relationship with the auditor. Conceding deductions in some areas or only taking a percentage of the claimed deduction when you do not have adequate receipts or records may ultimately be the best strategy. Auditors tend to respond positively when taxpayers are reasonable with them. Small concessions may lead the auditor to be more lenient in other areas. Keep focused on the big picture goal – minimizing your tax obligation.