Audits Chapter 13
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Audits Chapter 13
Audits are selected based on IRS programs.
One program looks for compliance and another tries to find errors. They have not examined your return yet. Are you afraid? These days, auditors tend to be nicer. They tend to be more educated than the collection officers. They do not want to send your case to the criminal division unless they have to. I have represented people who have taken phony deductions, and have left out income on their tax returns. During my career I have never had an auditor accuse my client of criminal fraud. In each case they were happy to make the adjustments and charge the taxpayer additional tax, interest and penalties.
Of course, you have to say things like…I forgot, or I guess I make an error, or I can’t find the proof for the deduction. You can’t say, “Oh yeah, my friend the accountant said I should put down a lot of expenses because there is less than 1% chance of being audited”. There may actually be a less than 1% chance of being audited in your case, but you have to be careful not to say you ‘willfully’ did anything you know was wrong in the preparation of the tax return. Got it? To this day I don’t know of anyone foolish enough to admit to ‘willfulness’. If you follow this manual, you will have very little to fear, unless of course you can’t document the items on your return and don’t want to deal with the increased tax liability.
There are two main types of audits…
Correspondence and face to face. If any of these produces a tax liability, then the IRS sends you an examination report. You have 30 days to appeal it. In a face to face audit, the letter will ask you to provide information to backup certain items on your return. I suggest that you prepare two sets of proof. One directly responding to the letter, and another proving all the other items on your return. Be mindful of things like depreciation, loss carryovers, etc. that affect other years. Make sure that you are prepared to defend ‘all’ deductions, including carryovers to other years under audit. Purchase an audit guide from the book store to supplement the info I am giving you if you wish.
In my experiences, you will fare best by being able to support your deductions with receipts, proof that the payment was made, and by also explaining the business purpose! Part of explaining the business purpose is knowing the tax law pertaining to the deduction, so take the time to look it up. If you can’t convince the auditor, then get a list of what would be acceptable proof, and have it by the due date the auditor gives you. Remember: Do not assume that it was received on time. If mailing, copy everything and send it certified return receipt. Call the auditor to make sure that it was received on time. Our you can have hired a representative to help you from this point. You always have the right to hire a representative at any point in the any IRS matter! Don’t ever forget that.
I have represented people in audits from other states without any problems. It is not necessary, or better, for the tax payer to sit face to face with an auditor to prove your income and expenses. You should not let the auditor into your home or office to conduct the audit. If representing yourself, set up the audit at the IRS, or get the auditor’s agreement that you will promptly mail the information and that you request that it be handled that way. Tell the auditor you will put it in writing along with a signed notarized affidavit so the manager can accept or deny the request. If they deny it, then meet with them. This not a battle to fight. Winning it doesn’t directly reduce your liability, so save the battles for when it counts. As a representative, I have yet to have the IRS refuse to have me send the information by mail when I have an out of town client. Locally, I don’t mind appearing with my client. We have a pretty decent audit group here in Houston.
As in all dealings with the IRS, collections or audit, never adopt a guilty posture, or any posture for that matter. Treat the audit as a routine examination of documents and explain the business purpose. Remember that the auditor has no collection power and can’t anything against you, other than making up an examination report against you. So don’t be intimidated, but be nice and cooperative. Never admit to any wrongdoing, even if you have a good excuse. You do not want the auditor to document that you willfully left out income or put down expenses that you did not incur. This is the beginning stage of fraud and criminal cases against taxpayers. It is really o.k. to say that you forgot, or don’t remember, or that you don’t have a reason or doing something. Maintain your innocence! Be persistent in your response no matter how much the auditor my push you for reasons.
Always pull the 3rd party payer information or get it from the auditor ahead time. If there is incorrect W-2, 1099, or K-1 information filed against you it’s best to resolve this prior to the audit.
If at any time during the audit you feel uncomfortable, just get up and say that you don’t feel well. Tell them that you will call later or the next day to reschedule. Do this if you need time to think. If you decided that you want representation, inform the auditor and reschedule the appointment. Request a rescheduling if you demand time to get additional proof when your currant proof is not accepted. You are entitled to this. You can make request to record the audit if you do so at least 10 days prior to the audit. However my discussions with auditors over the years show that this is not very wise. If you start out not trusting the auditor, they won’t trust you, and will be more hardnosed in accepting your proof. If you start quoting IRS publications and taxpayer rights, that may not go over well, and you may gt an examination report that gives you no choice but to go to appeals to have your proof reviewed properly.
When gathering your proof, if you don’t have a mileage log for your business miles, create one. Don’t try to make it look like you did it during the year being audited. You are allowed to create it now for the year under audit. If you are missing receipts or need to swear to a condition or circumstance that makes an expense deductible, prepare an affidavit swearing that you actually spent money and what the reason was. Use an affidavit to swear what your income is, in cases where the auditor wants to add income, but he/she doesn’t have 3rd party payer (W-2 or 1099 etc.) to back it up. If the auditor has 3rd party payer information to back it up, but the information is not yours or higher than you actually received, you need to prove that it is not your income. Go to the issuer to resolve it by having them issue a correct one, or do an analysis of your income and expenses to show you didn’t receive that money if you can. Now you see why it is important to get the 3rd party payer information first. Remember, when doing an affidavit to give a lot of detail, simple logical explanations that will lead anyone clearly to your conclusions. Leave no room for doubt.
If you disagree with the examination report from the auditor, get your documentation together and discuss it with the auditor again. If you don’t get satisfaction, go to the manager for their opinion. If still not resolved, you can go to the taxpayer advocate and prove what a hardship it would be if you suffered a large tax burden, or unfair one, from the income caused by disallowing expenses of which you have proof. Don’t forget to file an audit appeal before the due date, even if things seem to be going well with the manager or taxpayer advocate. They may not resolve your issues timely enough for you to be able to appeal it, so the appeal extends your time to challenge it at appeals.
You may avoid an audit by explaining any items that would be a red flag. If any deductions look too large to you in relation to your income, just attach your evidence as part of the tax return. Even if the IRS disagrees with your proof and wants to disallow the expense, they probably will not charge the negligence or substantial understatement penalty. They really shouldn’t charge any penalties, but fighting the late payment penalty may be more time and trouble that it’s worth. Make sure your evidence is very specific, just like the detail as required in an affidavit. Show that your deductions and positions have a reasonable basis in law and in fact.
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