What to do When the IRS Comes Knocking

With the IRS’s recent efforts to close the so-called “tax gap,” the chance of being selected for audit are higher than ever for many individuals and businesses. In fact, President Obama’s fiscal 2011 budget request includes an increase of $293 million for IRS enforcement programs. When you are on the IRS’s audit radar, it’s important to be well informed, well prepared, and well advised.  Here are some tips to make sure you’re ready with your best defense.

Know what type of audit you have been selected for.  There are four kinds of IRS audits:

  • Correspondence audits begin with a letter from the IRS Service Center requesting that you send in copies of your cancelled checks and/or receipts to substantiate your deductions.  This type of audit is for small, simple tax returns or individual tax returns, and your business will most likely not be audited in this manner.  Approximately 45% of all 2009 audits of high-income taxpayers earning $1 million and above were conducted in this manner.  This type of audit is conducted by an IRS tax examiner.
  • Office audits also begin with a letter from the IRS Service Center. The IRS will request that you bring your documentation to the local IRS office.  Sole proprietors with less than $500,000 in sales are usually subjected to this type of audit.  This type of exam is conducted by tax compliance officers who generally have more experience than tax examiners.
  • Field audits may begin with a call to the owner/president of the company to notify him/her that the return has been selected for audit.  The IRS will likely request to perform the audit at the place of business and may want to conduct onsite interviews and see the business first hand.  This type of audit is conducted by IRS revenue agents with advanced technical training and degrees in accounting and taxation; many are Certified Public Accountants.
  • Taxpayer Compliance Measurement Program (TCMP) audits are the most intensive and time consuming, and involve a comprehensive audit in which every part of the return must be substantiated by documentation.  This type of audit is also conducted by IRS revenue agents.

Know who you are dealing with and how best to deal with the situation.    The IRS makes the final determination as to when, where, and how the examination will take place.  An IRS appeals officer has more experience and knowledge under his/her belt than an IRS agent.  It’s important to know how to deal with both.  Don’t attempt to outmaneuver either with an argument that is not supported by the tax law.   Even if the issue is supported by tax law and court cases, you must be prepared to substantiate your case.  Because the tax code is extremely complicated, your best course of action is to immediately retain the services of an HLBGC tax advisor.  A professional who deals routinely with these matters can make sure you are prepared and can argue your case most effectively.

Stay calm, get organized, and do not delay.   Once you have determined that your IRS notice is valid, respond! The notice will dictate what is being examined and what records you will need to produce.  Your HLBGC advisor can guide you in the right direction and respond on your behalf.  Organize your records so that you can substantiate your deductions in a manner that is easy for the IRS to follow, and bring all documentation to the examination.  It is your legal responsibility to prove your deductions.  If you are missing records, obtain duplicates from the source party.  Otherwise, the deduction will be denied.  Provide only duplicates, and leave your original documents at home.

Inquire why your return was selected for audit.  It is within your rights to know.  The bulk of returns are selected because of a high numerical score established by the IRS.  The IRS Discriminate Function scoring system is a secret, but we know that certain criteria lead to a higher score:

  • Low gross profit margin and/or little or no profit from business operations
  • Number of autos used in business
  • High auto expenses and/or high business use of autos
  • High travel and entertainment
  • High interest expense
  • Income in excess of $1 million

The higher the number, or the more your deductions vary from the IRS calculated norm, the greater the chance of error on the return, and the higher your chances are for audit.  Other criteria for selection include informants, your relationship to another taxpayer or business entity that is being audited, your inclusion in a special IRS target group (such as employers of contract labor), or random selection.  IRS matching programs designed to correlate amounts reported on Forms 1099 or other tax documents with amounts reported on tax returns may also result in audit selection if amounts do not match.   The IRS announced the Global High Wealth Industry Group initiative in late 2009 to examine the tax returns of wealthy individuals in the totality of their financial and business arrangements, rather than on an individual taxpayer basis.

Do not provide anything that has not been requested and answer questions succinctly.   This is not the time to impress the IRS with your document collection.  The last thing you want to do is pique the auditor’s curiosity about other tax matters and expand the audit. Allow your HLBGC advisor to accompany you and field questions for you whenever possible.  If you are asked a direct question, answer as briefly as possible.  Elaborate only when asked to do so.   What may seem like friendly conversation can increase your exposure and risk. Keep your emotions at bay, and maintain a respectful and polite demeanor at all times.  Remember that the IRS representative is a trained professional, and he/she has a job to do.  Courtesy counts and can only help your case, even if you feel the IRS is making unreasonable requests or demands.

Know all your rights.  The IRS must explain and protect your rights as a taxpayer throughout the audit.  This includes confidentiality and professional and courteous service.  If you feel that the individual handling your case is not satisfactory, you should write to your area IRS director.   The Taxpayer Advocate Service can help with unresolved tax problems, and if you disagree with the IRS about the amount of your tax liability or certain collection actions, you have the right to an appeal and a judicial review.  You are responsible for paying only the correct amount of tax due under the law – no more, no less.  If you cannot pay all of your tax when it is due, you may be able to make monthly installment payments.   Interest and penalties resulting from certain IRS errors or delays can be waived if you can show you acted reasonably and in good faith, or you relied on the incorrect advice of an IRS employee.

Contact Us!

Contact Us