“The only two certainties in life are death and taxes,” a famous quote from Benjamin Franklin and later attributed to Mark Twain, is more appropriate today than ever due to the almighty IRS. And perhaps the most powerful weapon available to the IRS today is the tax audit. In this article, learn what to do (and not do) when confronted with the IRS audit machine.
The basic premise here is that no one understands all of the complex and confusing tax laws; not the elected officials who wrote and voted for these laws, not the IRS employees hired to enforce these laws, not the tax professionals earning a living trying to assist others with the tax laws, and certainly not the taxpayers themselves (to whom these complex laws apply). While some tax law is black and white (meaning it is relatively easy for all private tax professionals and the IRS to agree on how an issue must be handled), most is a vast shade of gray. In many instances, it is in this gray zone where the tax audit game is won or lost. You are not bound by the IRS auditor’s interpretation of the law (or facts) and you must be willing to challenge the IRS at every step of the process. You should never give in to the IRS simply because the IRS will not give in to you.
The IRS will identify which issues are subject to examination, such as looking at business expenses on Schedule C and charitable donations on Schedule A. You should look at each issue as a separate “mini audit” and organize all records around each mini audit. This will permit you to focus in on each issue and make sure you are organized with the appropriate records and documents to support the position taken on your tax return. You should make sure you use all of the time that the IRS gives you to complete any tasks and remain patient during the process. The more you appear to want to end the audit, the longer they seem to take and the more detail the IRS explores. If your responses are organized, detailed and timely, and you are patient with the IRS, good results will often come.
The IRS relies upon its agents to handle a sufficient number of audits at the same time and expects each audit to be resolved within a certain timeframe (often depending upon the type and complexity of the audit). If you use all of the time available to you, this will allow the audit to proceed at an appropriate pace and may also give you a negotiating advantage if the audit starts to go too long from IRS management’s perspective. For example, if the IRS gives you 30 days to get documents to its employee, use the entire time. If you need more time (legitimately- not to stall), you can often request an extension of time and these extensions, if used legitimately, are routinely granted. While the time element may seem like a small advantage, all advantages, however, small, should be utilized when your opponent is the IRS.
Many taxpayers are afraid to ask the IRS any questions during the audit process and this generally is a major mistake. The purpose of an IRS audit is to make sure that the filed tax return was/is substantially correct. This works both ways in that any mistakes, either in the taxpayer’s favor or IRS’ favor, can be corrected at an audit. As such, an audit can produce a refund to the taxpayer just as easily (but not nearly as often) as an amount owed to the government. You are permitted to know why the IRS is asking any questions to determine if the information is even relevant to your audit. You are permitted to ask the IRS any questions about your audit at any point in the audit, including questions concerning the audit process (what happens next?), the facts associated with your case, and how the IRS auditor plans on applying any tax laws to your return in question.
Taxpayers have rights- the IRS does not. While the IRS may have the authority to do certain acts, only taxpayers have rights. However, if you are not aware of your rights, you are not going to be able to exercise these rights. For instance, taxpayers have the right to be represented by professional counsel at any/all stages of the audit process, can tape record the audit proceedings (with notice to the IRS), can appeal any and all findings to IRS management and the Appeals Division, and are permitted to ask questions, including the reason the tax return was selected for an audit. In addition, IRS employees who abuse their authority can be subject to civil sanctions.
Prior to the first meeting with the IRS agent, you should make sure you read IRS Publication 1 (which explains your rights), along with reviewing the Taxpayer Bill of Rights I, II and III at www.irs.gov. Know your rights or proceed at your own peril.
The IRS has some information about you prior to the audit, including your tax returns being examined, where you live, your income and some other basic financial documents. It does not have much information, and in fact has much less information than most taxpayers suspect. IRS agents often use an audit interview to gather as much additional information about the taxpayer as they can. The more information that the taxpayer discloses, the more opportunities the IRS agent will have to find tax issues to examine. Going against taxpayers here is the fact that most taxpayers are very nervous when they are sitting in an IRS agent’s office (this is the nature of the interview and does not imply any wrongdoing). When people get nervous, they typically talk too much, especially in the silence of an IRS audit. Do not give in to this temptation and answer only the questions that are asked and nothing more.
While it may be tempting to alter receipts or other documents or provide the IRS with information that you know is not accurate, do not do this under any circumstances. If you are caught, it will turn the civil audit (only money at issue) into a criminal case (where your freedom is at issue along with your money). It is not important in most audits that your receipts may not match precisely with your tax returns. For instance, your tax return may claim $2,300 in charitable contributions but your receipts only total $2,200. In many cases, the $100 difference will not be an issue and may not even result in any adjustment.
Contrary to what the IRS publicly claims (“provide American taxpayers with quality service”), the IRS is in business to collect tax revenue. Thus, the IRS and its employees are not charged with looking after your interests. Instead, your interests as a taxpayer often directly conflicts with the IRS employees’ goal of assessing and collecting additional tax revenue. In addition, unrepresented taxpayers are often misinformed about the tax laws, to their financial detriment. Fortunately, many IRS employees are very honest and not at all interested in cheating taxpayers. However, it is often difficult, if not impossible, for the average taxpayer to know which employees to trust and which should not be trusted. Given the nature of the stakes involved in an audit, it is best to not make any mistakes here and simply assume the IRS employee cannot be trusted. Instead, treat the IRS employee with the utmost professional respect and research every proposed adjustment before agreeing to any changes to your tax returns.
Many tax audits today are done via correspondence/mail with the IRS and thus you would not need to meet with an auditor in person under these circumstances. However, when the IRS conducts a field audit, they will want to meet with you and/or your representative. You have the opportunity to choose the location and you should not choose your personal home. Instead, offer to meet the IRS at the IRS agent’s office, your business location (if private), or best yet in the office of your representative. A visit to your personal residence will give the IRS agent information about your personal lifestyle, which can be matched to your tax return to see if the income reported matches your apparent lifestyle. Please understand, however, that if a visit to your home is necessary for one or more issues in the audit, such as business inventory in the home or a home office deduction, the IRS is permitted to request a scheduled visit to that portion of your home.
It is often difficult to beat the IRS in an audit, even with the most experienced professional. However, it is often impossible to beat the IRS by handling your case by yourself. Unless the issues are very straightforward (it happens but is somewhat rare), it is often necessary to have a tax attorney, CPA or enrolled agent represent you during the examination. All taxpayers are allowed to have a professional represent them during the examination (done by filing an IRS Form 2848- Power of Attorney). If you decide to represent yourself, make sure that you believe you have the competence in your ability to research the tax laws, deal with the legal and bureaucratic complexities of a tax examination, and otherwise handle all phases of the audit. Finally, if you decide to represent yourself and later determine that this was a mistake, you are permitted to ask the IRS to stop the examination to allow you time to secure a representative; this is your right.
An IRS tax audit can be won, but only if you know your rights and know how and when to assert them. By following the simple rules outlined in this article, you too can handle many aspects of your audit and also understand what should be done (and not done) to give yourself the best chance for success. Best of luck with any IRS audits, now or in the future.
More expert advice about Taxes
Photo Credits: Considering The Tax Shelter by Flickr: JD Hancock; Check Man, Cross Man and Jump Man © ioannis kounadeas - Fotolia.com