October, 2006 Tax Tip
Don’t Panic Over a Tax Audit
A couple of experiences in the past year with clients have prompted me to write this month’s Tax Tip.
It is true that many people would rather have multiple root canals than get the dreaded audit notification from the IRS. In short, they panic. However, assuming you have filed an honest return and have documentation to support your income and deductions, there is no reason for alarm. The following tips provide sound advice, based upon my many years of experience, on how to deal with an audit without over-reacting.
The Audit Notice - The audit notice is a very serious letter that must be responded to within 30 days. Believe it or not, I have known taxpayers, including clients, that ignore the notice thinking that the issue will disappear. There are cases where the taxpayer has moved without notifying the IRS of the new address and, since most IRS mailings are not forwarded, he does not receive the audit notice. It is not the IRS’s responsibility to track down where you moved, it is yours! All the IRS is required to do is send the notice to the last known address it has of record. There may be many months (sometimes well over a year) between the time the notice was sent and the time the taxpayer files his next return which first puts the IRS on notice of the new address. In the meantime the IRS has prepared a substitute for return (“SFR”), based upon information it has received from third parties. You can be sure this SFR won’t be in your favor. Therefore, don’t ignore a notice, and be sure to let the IRS know when you move. IRS Form 8822 is a notice of address change and can be used for federal and state purposes, although some states have their own form.
Content of the Notice – The notice will advise you of the items that are being questioned and what you need to bring to the audit. Bank statements and copies of relevant cancelled checks are almost always requested, as are invoices relating to the deductions at issue. On business audits, you can expect that three areas that will be questioned are automobile expenses, telephone expenses, and travel and entertainment expenses. In addition, if depreciation has been claimed, you no doubt will be asked for the purchase invoices of the assets. The reason for these is perhaps obvious. They are usually among the largest deductions on the business schedule.
Providing Information Not Requested – In an effort to display their honesty, it is common for taxpayers to bring too much or talk too much. The danger here is that you may provide a document or make what you believe to be an innocuous statement which may open the door for an alert auditor to expand the audit to areas not previously at issue. Bring only what is specifically requested and answer any questions as briefly as possible without straying beyond what is asked. To save time and, I have found, to impress the auditor, provide adding machine tapes showing the total of the checks and related invoices and reference them to the item on the return in question.
Anticipate the questions – No one knows more about the items on your return than you do. Therefore, when asked a question you are expected to answer it directly and forthright. If business deductions are being questioned, it is reasonable to assume that the auditor could ask you any questions about the business and how you conduct it. Hemming and hawing could give the impression that you are hiding something, whether you are or not. Therefore, it is very important that you go over all items on your return in preparation of the meeting.
Avoid Confrontation – In an office audit, it is pretty much the luck of the draw as to the personality, temperament, and reasonableness of the auditor you are assigned to. If you believe the auditor to be unreasonable you have the right to speak to his supervisor. If you do so, maintain your composure and explain the situation as briefly as possible, again remembering not to offer any extraneous information. Unlike the auditor, the supervisor has the authority to expand the audit beyond the issues in the notice.
Honesty – Deliberately lying is a criminal offense. With that in mind, if you are asked a question that you can’t handle, end the interview at that time, (see final item below) )but don’t lie! Auditors have been known to test your honesty by asking a question to which he already knows the answer.
Documents – Never provide original documents to an auditor or leave original documents with him. I had a recent incidence where an auditor misplaced an entire box of documents that were provided to him. Make photocopies or have the auditor make photocopies of any requested documents.
Scheduling the Appointment – It has been said that there is no one as impatient as a hungry auditor. To the extent possible I try to schedule audits for late morning or late afternoon. Knowing that it is almost lunch time or quitting time, an auditor may be more inclined to short cut the audit. Always try to close the audit in one visit.
Be Friendly – This is clearly where most taxpayers and tax practitioners as well drop the ball. Believe me, the old proverb that it easier to catch a fly with honey than with vinegar was never more true than in dealing with the IRS. Leave the attitude at home! Whether you feel that way or not, the more respect you show the auditor the better off you will be. A little levity and apple polishing here can make a big difference.
Know Your Rights – You do not have to accept the auditor’s determination. If you believe it to be incorrect, you have appeal rights to the IRS Appeals Division. It has been my experience that, once I see that the audit is going nowhere, I cut it short and advise the auditor that we are not going to agree. I tell him to close the case and send it along. In virtually all cases, I have reached satisfactory conclusions with the Appeals Division without having to go to court.
Better Yet, Stay Home – It is said that a taxpayer who represents himself at an IRS audit has a fool for a client. I am not suggesting that you engage a tax practitioner, but I am cautioning you to know the downside of representing yourself.
As mentioned earlier, the taxpayer is expected to know all the answers to the questions asked. It is difficult to evade them, buy time, or say you don’t know. Your representative, on the other hand, is not expected to have all the answers at his fingertips. Therefore, if an uncomfortable question arises, there is a legitimate opportunity to buy time to reflect on the question. Tell the auditor that you didn’t anticipate the question and that you don’t have the answer but will get back to him. As often is the case, the auditor will want to complete the audit during this meeting and will not pursue the matter, especially if he knows he can get an agreement right then and there.
The second reason why professional assistance is strongly advised is, as also mentioned earlier, taxpayers, more often than not, will stick their foot in their mouth by talking too much. It is difficult to avoid this even if consciously attempting to do so. There is absolutely no upside and plenty of downside. Eventually they are apt to say something that they will regret and sharp auditors will engage them in friendly conversation while setting the trap. When I represent a client at an audit, the first thing I tell him is that he will stay home.
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