TAX ALERT BULLETIN
Five Must Know’s
On Your IRS Audit
Say you are faced with an IRS Audit where the agent or his manager just won’t quit or maybe they’ve asked for everything under the sun and it’s not humanly possible to come up with enough paper and ink to give them what they want. And after three weeks of banging your head against the wall, two things seem very clear. First, IRS isn’t planning to go away anytime soon, at least if you leave things to chance. Second, your head will continue to hurt if you continue to bang it against the wall.
Meanwhile, you are at that point where the words are beginning to seem a bit unkind with “summons” and “deficiency” leading the pack and “penalties” or “willful misconduct” not far behind. Chants of taxes-taxes-taxes are all around. Preparer liability maybe. Penalties. Though you tried to nail down gross revenues with every penny being ticked and tied to the nearest decimal, you are now hearing that nothing short of an outright contact with a customer will get them to say “sure, fine – let’s move on”.
So … should you lock the doors and send them a few blank checks along with a “please-please-please” note, hoping and praying for a change of heart? Or what about a punchy threat from your attorney about the latest in civil rights and how they crossed that fine line as provided in a little known section so and so, the cite that always gets them in trouble.
Well, hold a sec and let’s keep hope alive. Here we go, our top five must know’s on how to handle your IRS Audit and what to do, when things get a bit sticky:
1. Engage a Qualified Representative and Identify the Issues and Areas of Exposure – It’s a guarantee that every case will have a theme and any number of issues, big or small – no matter how clean or messy the books and records may seem. You may not like the issues, but you’ll have to sort them out in order to strategize and defend. If it’s a simple correspondence audit where IRS just wants the back up for travel and entertainment on a self employed taxpayer to make sure that everything was paid during the tax year, then hey, maybe no big deal if you can send them credit card slips or paid receipts. One or two mailings and you’re done. But what if they get into the limits on how much you can deduct and what’s business or personal, almost like a Leona Helmsley thing where you can’t take write offs for renovations to your personal residence? What if the taxpayer didn’t keep a diary or he can’t recall who he met and how it relates to his business? What if it’s a cash basis taxpayer and one can argue, the amounts were really paid in a different year? Can a correspondence audit lead to something more? Perhaps they’ll call it a recurring item and look to another year.
And what about that field audit where IRS has made a written demand for the books of original entry together with back up doc’s for everything from interest expense to the sourcing of income on a foreign tax credit for income taxes paid in Japan, West Beirut or wherever.
Often on a correspondence audit, it’s quickest and easiest for the tax preparer to take the lead by reaching into his file and pulling out the source doc’s that he used when he did the return. Either the doc’s are there or they aren’t, but you have to respond no matter what. When it comes to field audits however, it’s almost always advisable to have a qualified representative appear on behalf of a taxpayer and act as a buffer since that can help keep the process structured in terms of information requests and responses, and allow you to keep your head straight as issues come up. At least initially, it’s most efficient to have the tax preparer act as taxpayer representative as long as he has the background and experience and there are no conflicts of interest due to preparer negligence or otherwise. Should any issues require an administrative appeal within IRS or a petition to Tax Court, then it’s best to hire a qualified professional that normally deals with all the research, drafting and courtroom skills that may become necessary on legal type matters.
2. Define the Scope of the Examination, Reduce all Demands to Writing and Respond Fully and Truthfully – Don’t even think about telling the IRS what they can or can’t do since the laws give them all kinds of authority to dictate the course of destiny on what they’d like to look at. Think of Darth Vader, power of the universe. The key will often lie in confirming all demands in writing and doing your best to build credibility with the auditor by responding timely and fully.
3. When Things Get Out of Control – Sure things can get out of control if you let the document requests go and if IRS doesn’t get what it wants – or if the agent has become downright hostile due to what he suspects or because he’s got no trust and faith in what the taxpayer or taxpayer’s representative has to tell him.
At this point the agent can reach out to third parties like banks, customers and business contacts by issuing a summons to demand the information which they claim they’re not getting, like for instance, customer checks to show that you received income that wasn’t reported or a creditor’s statement to prove that you actually owed a debt and the interest you deducted wasn’t a complete farce.
So, what to do?
Must you sit back like a punching bag and let them take your life and shove it down the drain? Relax … and go watch the NY Mets for cents on the dollar – or, are you better off with the summons perhaps?
Well, here’s our three step:
a) Change the Guard – Regardless of what the taxpayer representative has done – good or bad – chemistry can sometimes work wonders when it comes to getting along. Replace the taxpayer representative and move on.
b) Identify the Exposure – Let your mind wander for a sec and think of where the audit can go in terms of what was reported and the kinds of issues that may arise. Are you clean as a whistle? Something less? Exposure can run the gamut from nothing at all to outright criminal activity where the main concern should lie with privilege and the potential for a plea bargain.
c) Protect Rights of Privacy – Federal statutes prohibit IRS from freely giving out the information on a tax return, subject to limitations. Auditors who violate the rules can get in big trouble so if you have an agent who’s out of line, a well drafted warning can do wonders.
4. File Administrative Appeal by Submitting “Protest” in response to “Preliminary Deficiency” or “30 Day Letter” – The moment of truth will eventually arrive when you must either agree or disagree with the auditor’s findings. If you disagree and IRS serves a notice of “preliminary deficiency”, then you must file a written protest in a legal type format within thirty days after receipt and the matter will then go to IRS Appeals where the folks are generally a bit more savy on the technical details. The good news is, most cases tend to get settled in Appeals.
5. File Petition in U.S. Tax Court in response to “Statutory Notice of Deficiency” or“90 Day Letter” – As to those cases that are not resolvable either with the auditor or in Appeals, IRS will issue a Statutory Notice of Deficiency setting forth their findings, an allegation of the taxes and other charges being due and the legal backup. You’ll then have ninety days to file a Petition inthe U.S. Tax Court and seek relief. If you let the ninety days go, IRS will enter an assessment and then – all bets are off and collections will take over. Ouch.
Signing off till next time,
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Kenneth B. Schwartz Attorney, CPA, LLM
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The Jericho Atrium
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