How to Survive an IRS Audit by Andreea Cioara, CPA
The thought of an IRS audit can strike fear and loathing in any law-abiding U.S. taxpayer. As the recipient of an examination notice from the IRS, it is the taxpayer who shoulders the responsibility to prove that previously filed tax returns were both complete and accurate. This burden of proof does not lie with the IRS. To avoid significant penalties and even jail time for non-compliance, taxpayers must keep detailed and organized records to substantiate all the deductions, credits and income, estate and gift tax liabilities items they claim on their tax returns.
If you do fall under IRS scrutiny, you may feel overwhelmed by the countless hours and dollars you must commit to comply with information document requests and produce evidence to substantiate your claims. Do not panic. Cooperation, organization and professional assistance can go a long way toward a hassle-free examination and favorable audit outcome.
The IRS generally uses two methods to identify tax returns for examination. The first is the agency’s Discriminant Inventory Function (DIF) computer system, which looks for abnormalities in processed returns. The second relies on uncovering discrepancies between the entries on a taxpayer’s return and the information contained on 1099s and W-2s the IRS receives from third parties, such as a taxpayer’s bank and employer.
It is good practice for you or your tax accountant to obtain copies of your IRS transcripts prior to filing a tax return in order to prevent a mismatch of information and potential examination. An experienced CPA can help match transcript items with your records to expedite the process of identifying and resolving any discrepancies.
Do Not Handle It Alone
Considering the complexity of the tax code, taxpayers should never respond to IRS notices on their own. Rather, it is critical to engage the knowledge and expertise of experienced tax preparers or CPAs who understand the IRS’s rules of engagement and speak the same language as IRS agents. This is true even if you prepared and filed your tax returns without the benefit of a qualified professional. CPAs and qualified tax preparers can more easily identify the reason for an IRS exam and help you prepare documentary evidence to counter claims of tax deficiencies while avoiding ongoing complications and costs down the road.
When working with a CPA, it is important you complete IRS Form 2848, Power of Attorney and Declaration of Representative, giving that professional the authority to represent you before the IRS and speak and act on your behalf. This will help to ensure you do not make statements or provide to the IRS information that could foreseeably damage your case. Remember, a person who represents himself has a fool for a client.
IRS notices typically detail why tax returns are flagged and what additional information the agency requests. Failing to respond to these communications in the allotted time frame may result in additional interest and penalty charges, liens, levies and other unpleasant consequences for taxpayers.
Once an audit is underway, you typically have 30 days to comply with each IRS Information/Document Request (IDR). Should your response exceed that deadline, you will be granted an additional 10-day grace period, at which time you will receive a delinquency notice demanding a response within 15 days. Failure to respond to a notice of delinquency will result in a summons that will essentially force you to produce the requested information.
Due to the timely nature of examinations and audits, you should contact a CPA as soon as they receive any notice from the IRS. Not only do CPAs understand these time constraints, but they also are well-trained to make initial contact with the IRS and help you organize your documentation and present the information required in the IDR. You too should be mindful of this sense of urgency and make every effort to respond to your CPA’s requests for information in a timely matter.
No one, including IRS examiners, wants to spend time sorting through a shoebox of jumbled files and receipts. The onus is on you to locate missing records and produce items included in an IDR. The more organized you are in gathering required information, the easier it is for your CPA to present it to the examiner in the format and timeframe required by the IRS. This will further simplify the examiner’s responsibility to understand and review the audit trail, which in turn makes the entire process smoother for you.
Know Your Rights
Taxpayers facing an audit have certain rights, including the right to speak with a tax preparer before and during an audit or to have a CPA speak on their behalf. This right also allows taxpayers to refuse to be personally interviewed by an IRS agent unless the taxpayers received a summons compelling them to do so. With the benefit of professional counsel, you can help ensure all communications with the IRS stay on point, further helping you avoid the risk of self-incrimination, or worse, being referred for criminal investigation.
Although the number of tax returns audited by the IRS has decreased over the past decade to less than 1 percent, your chance of being audited increases based on factors that include the types and amounts of tax credits and deductions you claim, whether you operate a business and report losses, and whether you own interests in any foreign assets. Moreover, your risk of an audit increases as your income rises.
Coming under the scrutiny of the IRS is not a cause for alarm, but it should prompt immediate action. By understanding your rights, maintaining organized records, and retaining the counsel of experienced CPAs, you can manage an audit with confidence and walk away unscathed.
About the Author: Andreea Cioara, CPA, is a director of Tax Services with Berkowitz Pollack Brant Advisors and CPAs, where she provides corporate-tax planning for clients through all phases of business operations, including formation, debt restructuring, succession planning and business sales and acquisitions. She can be reached at the firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at firstname.lastname@example.org.