You just received a letter in the mail, informing you that you have been selected for an audit. Now what? Here are some things to understand about an IRS audit.
Currently, audit rates for individuals hover around 1 percent for all filers, according to the IRS’ latest report. So at first glance it would seem that your chances of being audited is rather slim, but do not let the low audit rate lull you into a false sense of security.
The IRS does not just throw darts at a list of taxpayers. Rather, the IRS selects returns that have a good potential for generating additional money for the Treasury. Some returns are identified using information obtained from third parties, think jilted wives or business partners.
Most tax returns, however, are identified using sophisticated software which compares the taxpayer’s return to the “norm” for similarly situated taxpayers. The higher the deviation from the norm, the greater the potential of being selected for audit.
Once a return has been selected for audit, the IRS will mail an audit letter to the taxpayer, laying out the areas the IRS intends to examine, such as charitable deductions or business expenses. Very rarely does the IRS examine everything on a return but it can happen. Normally, the IRS has selected several areas to examine and the IRS agent will confine his or her work to those issues.
Be careful, though: If the IRS agent feels that there are other errors or omissions on the return (or returns, if covering multiple years) the audit can be expanded to cover those areas or years.
The audit letter will also lay out the type of audit being conducted. Depending on the complexity of the audit, the IRS will conduct either a correspondence audit, or a field audit for more complicated tax matters. Correspondence audits are the most common and are handled largely through the mail, whereas field audits are face to face meetings with an IRS agent at your home or office, where the agent may request to view your supporting documents.
Once the IRS agent is finished with the audit, you will receive a letter telling you the results of the examination. The best result is a no-change letter, meaning the audit ends with no change to your return (in some rare cases, the audit may uncover that the IRS owes you money).
Otherwise, the results are additions to your tax liability. The IRS agent will list his or her reasons for assessing the additional tax and you can agree or dispute it. If you agree then you merely sign the letter and the IRS will assess the additional tax. If you disagree with the additional tax you have the right to appeal the agent’s decision.
If you disagree with the audit results, you can appeal to the courts or to the Appeals Office, an independent administrative arm of the IRS. The Appeals Office is a cheap and quick way to resolve the matter.
Most cases brought to the Appeals Office are resolved through settlement. If, however, you are not satisfied with the outcome at the Appeals Office or you did not bring your case to the Appeals Office, then you can appeal your case to the U.S. Tax Court, a specialized court for tax cases only, or to the Federal district court or Federal Court of Claims.
Appealing your case through the court system can be expensive and time-consuming but it provides you with the right to have your case heard by a judge where you can put on witnesses and introduce evidence to support your position.
If you lose on appeal, you will be responsible to pay the additional taxes assessed. The IRS will provide you with an opportunity to make payment arrangements. If you find yourself unable to pay your tax liability then you may be able to compromise the tax or seek forbearance from the IRS.
Being audited is not something anyone looks forward to, but if you understand the basics it can help put yourself in the right frame of mind to deal with it. Here are some tips on handling yourself during an audit:
1. Don’t panic! You have rights which protect you from being harassed or abused by the IRS agent. If you feel that you are not being treated fairly or that the IRS agent is unreasonable you can request to speak with the IRS agent’s supervisor or report the agent to the Treasury Inspector General.
2. Be prepared. The best defense is a good offense. Save all documents, such as cancelled check, bank or credit card statements and receipts that support any income and deductions you claim on the tax return.
3. Be honest with the IRS but do not volunteer information. Honesty is always the best policy when dealing with the IRS. Do not give the IRS any reason to believe you are trying to impede the audit as this can have a devastating impact on your case. Provide the IRS what it wants but nothing more. If you made a mistake and you know it — concede it if raised by the IRS agent. Don’t fight over a lost cause as you will likely lose credibility in the agent’s eyes which may make the agent less willing to settle other issues in your favor. If your position has some merit then make a good argument for why it should stand. You may find the IRS agent is willing to settle the issue in your favor.
4. Treat the IRS agents with respect. If you are rude to the IRS agent, or you are difficult, you run the risk of the IRS expanding the audit to explore other issues and other years. Simple common courtesy will go a long way in making the audit go smooth.
5. Go to irs.gov and use the search feature. The site has a wealth of information regarding how audits are conducted. The IRS even produces audit technique guides for certain tax issues or types of taxpayers. A review of these guides can give you an idea of what the IRS is looking for in your type of business and why.
6. Finally, get help if you need it. If you find yourself in over your head then you should consider hiring a tax professional to represent you, whether that be an attorney, certified public accountant or enrolled agent. This is especially true where you need to meet with an IRS agent or you have a complicated tax matter.
James Wade is a Maine attorney practicing in Portland, ME. His firm, the Law Office of James D. Wade, offers services to individuals and small businesses statewide. Jim offers a variety of services, such as tax planning and preparation, business start-up consulting, contract drafting and business succession planning. Jim is also admitted to the Maine Bankruptcy Court and U.S. Tax Court, which allows him to assist clients who find themselves in financial trouble. Jim can be reached by phone at 207-299-0515 or email at firstname.lastname@example.org.