IRS Help: Extending the Statute of Limitation in an IRS Audit

Congress imposed a time limitation on the IRS to assess taxes. Generally, the time limitation is three years.

After three years from the due date of the tax return or the filing of the tax return (whichever is later) the IRS cannot assess taxes on you. 

Think of assessing taxes as sending a bill. That is one of the reasons we stress the importance of filing all your unfiled returns. If you file returns, the IRS has no right to audit you and assess new taxes after three years from filing. If you don’t file the return for a specific year, the statute is open to an IRS audit for eternity. The statute of limitation of three years will also work against you when you want to claim a refund on prior years for which the statute of limitation lapsed.

When you have an IRS audit, and you disagree with the audit findings and decided to appeal, the IRS typically will ask you to waive the statute of limitation on the older year which may be getting ready to expire. That will allow the IRS time to prepare and consider the appeal.

The IRS will send you a letter asking you to extend the statute as soon as you file the appeal if the time on the oldest year under audit is running out. They will tell you that you have the right to refuse extending the statute, but one practically must need to sign it in order to get on with the audit appeal. You will also be advised that you can limit the scope of the statute of limitation extension.

There are two ways to limit the scope of the statute. The first is when you disagree with particular items in the IRS audit. If that is the case, you may extend the statute only to those items that you have tax problems with and that you care about. The second is that you can limit the time to extend the statute of limitation. Some contend that you can limit it to six months but a typical extension of the statute is one year. The IRS will add a few months to the year to make the date a calendar year thus you may end up extending the statute of limitation to say fifteen months instead of one year.

The IRS will send you a statute of limitation consent form (Form 872). Also they will attach Publication 1035, Extending Tax Assessment Period, which discusses in detail the nature of statute of limitation extensions, your rights and your options.  We typically recommend that our client signs the extension and we usually extend the statute to one year. It shows a good faith effort and we believe it will enhance the potential of a favorable IRS tax settlement.

IRS Audit: A Shoe Box of Receipts vs. Detailed Analysis

You get a notice of an IRS Audit.  Your first instinct (hopefully) is to prove your case. Proving your case entails looking for receipts, checks, tapes, invoices, contracts, statements and schedules that you may prepare to present your case. This evidence will be submitted to an IRS agent either by you or your tax representative; a CPA, a tax attorney or an enrolled agent who is trying to offer you the best tax help.

Our question here is how should you present your evidence to the IRS agent? 

There are two ways to do this: the first is to shove everything, chaotic as it may be, in envelopes or shoe boxes to the IRS and let them have at it. The second approach is to make sense of the documents first and do some fancy work, a rather professional approach before you present it to the IRS.

Shoe Box of Receipts

Advocating the shoe box approach may be easier but it it is not the best. For one, when you throw everything in a shoe box without going methodically over every receipt it may not give you the best tax relief and could undermine your audit should you present a document that should not be there. That may destroy your chance of winning the audit and possibly compound your tax problem.

Secondly, if you follow this approach, you may not be able to determine your own weaknesses and strengths. You may not have the knowledge of the dollar amount that you have evidence for versus the amount that you may concede.

Finally those advocating this approach are hoping to distract the auditor by adding additional burden to his already crowded desk.  Each agent has his share of IRS audit workload. They have pressure from their managers and maybe the CPA or tax attorney is adding more pressure to make the IRS agent compromise. This really does nothing but antagonize the IRS agent who has your tax audit and the auditor may not be as amenable as they would have been if you were cooperating and hoping to reach a quicker IRS settlement.

Detailed Analysis

The other approach is to go to another extreme and do all the work for the auditor. If you do that your tax audit may go a lot faster but you may run the risk of giving the auditor extra time that he would not have otherwise had to munch and ponder on the issues that may not have been available to him due to time constraints. 

The reasonable thing to do is to organize the work papers in a logical sequence, identify each expense and summarize the evidence and the dollar amount for each expense. We even like to do a table of contents to present to the auditor so they may cross reference our work paper and make it easier on the auditor to follow the evidence trail. In many of the tax audits that we have, we get compliments on the way we send the work paper. 

That will start us on a good faith beginning. This is a good approach to tax resolution you may do on your own. Remember, there will be a penalty abatement issue coming as soon as the auditor finalizes his report. There may be other items that can be waived at the discretion of the auditor as well.

There are things that you may not want to get out of your way to accommodate so much, such as the case of sending bank statements. Should you summarize the deposits by revenue versus non revenue deposits to the auditor when it is an intimate analysis schedule they have to perform? The answer will depend on my benefit as a taxpayer. We will summarize those deposits if it is important to direct the IRS auditor to specific issues in the deposits. Only then we will do that.

Generally speaking if we have to choose sides, we will always opt for a professional and organized package that is easy to read and less time consuming to the auditor on your case. This may go a long way for a favorable audit tax settlement.

Tax Help: The Gift of Per Diem As a Tax Relief

Many taxpayers travel frequently because of their business or job.  Most people are burdened by keeping receipts, credit card bills and other travel expense substantiation. The tax relief offered by law is in the flat rate allowance for travel while you are out of town on business. 

The IRS will allow you a rate that covers both meals and lodging.  Those meals and lodging rates vary from one city to another in the USA. There is also a per diem rate for international travel that varies from country to another and from city to another in the foreign country.

When you decide to use the per diem rate you do not have to keep receipts for substantiation (keep your receipts anyway just in case but do not submit to the IRS.) Instead claim the flat rate and that is it period.

A tax problem pops up every once in awhile in an IRS tax audit.  If the travel time is extended the IRS may contend that the taxpayer should change his tax home and he should be considered as to have lived in the area where most of his travel is and thus disallows the per diem expense. 

The answer to that is the one year rule. This rule means that as long as your travel did not exceed one year, then you are considered to be travelling from your original home to the place of business. Thus you can claim your per diem rate.

How do you calculate per diem expense?  Simply, find the rate for the city where you traveled from the IRS per diem guide (See publication 1542) and then multiply the amount per day times the number of days you stayed in the city. For information that is more pertinent to your case, consult a CPA or a tax attorney.

Tax Problem in the Making: Employee vs. Independent Contractor

If you have people who work in an organization on a permanent or semi-permanent basis, you will be faced with the issue of classifying them as either independent contractors or employees.  We are not exaggerating when we say that this issue alone can close a thriving million dollar business down by the IRS. The tax debt that may result from the wrong classification can be huge.

 

How do we know that the help you hire should be contract labor or be treated as an employee? There are several criteria that we can look at. 

 

1) If the hired help has to clock in and out everyday according to your rules, he is probably an employee. If he comes whenever he likes, he may be classified as contract labor.

 

2) If you tell him how he should paint the wall starting from the left upper corner with a larger brush, he is most likely your employee. If he were an independent contractor you would have told them you wanted this room to be painted period without any details.

 

3) If they have to furnish their own tools, that is another parameter that indicates they are an independent contractor.

 

4) If they work for you and for other customers that they serve, as opposed to being exclusively working for you, then they are contract labor.

 

What can happen if you decided to classify all your hired help as contract labor? You may need tax help soon as well. 

 

About 25 years ago I acquired a client who had about 150 persons working for him. He treated all his help as contract labor instead of employees. He had been doing this for years. I calculated that he may owe a tax liability of $1 million if he were subject to an IRS audit for the years on which the statute of limitation is open. 

 

I advised him that he should immediately convert all his help into employees instead of contract labor which he did. Sure enough he received an audited notice three years after he became clean. All his payroll taxes were in order. He would have to shut his business down for the back taxes had he had an IRS audit three years earlier. So before you make the decision, take the time and think about the future IRS debt that you may be accumulating without knowing. Also think that the tax relief may not be as readily available. If you need tax help with regards to contract labor issues consult Publication 1779 or just talk to your CPA or tax attorney.

Tax Audit Interview: Attend Alone or With Your CPA or Tax Attorney?

As a matter of policy, short of a summons, we usually do not let our clients be interviewed in an IRS audit. Why do we do that? First off, we believe one of the core tax help is to save the taxpayer from this interview.  Clients are typically nervous. They are not aware of the tax law and no one knows what a client may say to complicate the tax problem. Clients, out of fear, may also say something that could lead to criminal investigation. Who needs all that trouble?

 

Some argue that clients should not be interviewed except in the presence of a tax practitioner such as his CPA, his tax attorney or his enrolled agent.  We argue that because of the complication we mentioned that this should not happen…period.  Those who are open to let their client show up in the interview say that it may be beneficial if the client appears to be credible to take the client along to establish creditability. 

 

Granted, credibility cannot be minimized, but what will happen if the client is hit by a question he is not ready for and he started to stutter? The CPA may come in to the rescue, but why chance it? They also argue that there may be oral evidence that has to be submitted only through person to person and therefore they may need their client to present that evidence orally. In situations like this we ask our client to write a statement about the issue. We have the leisure to review the statement before the meeting and it is presented to the IRS auditor.

 

Whether a Field Audit or an Office Audit we alone sit in the interview. In a field audit, we ask that the IRS auditor conduct their audit in our office. In an office audit we send a package to the auditor and we also do not attend. The IRS auditor typically argues that he has to ask personal questions or in a case of business audit he may say something like he has to know the accounting procedures and the records they keep etc. Our typical response in this instance is to ask the IRS auditor to please write all his questions and we will get the answer and they usually end up doing.

 

As we have mentioned before if the tax audit is a business audit, IRS auditors usually would like to visit the premise. We accompany them in the tour.  They ask no questions of the taxpayer during that tour. We just introduce the taxpayer if he is available and a nod of heads and everyone will go to his business. Any conversation is considered to be an interview which we have already argued and mutually agreed that the IRS agent would not do.

IRS Audit: Correspondence Audit vs. Office Audit

IRS audits are the concern of everyone. People wonder why their tax returns are selected for an IRS audit. There are many reasons as to why the IRS selects a return for an audit. Briefly, the IRS has a scoring system for each return. They call it Discriminant Function (DIF). It is basically a computer program that is able to identify which returns have the potential to be audited. They score these returns, the higher the DIF the more the potential for a tax audit. No one precisely knows what the ingredients in this program or the formula are? It may contain relationship between the numbers on your tax return such as travel expenses to your gross income on schedule C. It may assign certain skewed weight to certain items on schedule C such as office at home and so on. 

Your chances of an IRS audit are usually higher as your reported income gets higher. Also, if your deductions do not conform to certain ratios for your size of income. Some items may be especially looked at such as employee business expenses, travel and meal, repairs and maintenance and office at home on schedule C. Amended returns may increase your chance of audit especially if you are requesting a large refund. Also errors mathematical or otherwise may cause the return to be audited.

What type of IRS audit will you be subjected to?

The IRS may send you a notice to send proof of items such as interest and tax on your home. You just send the evidence to them. Being Mr. Anxious you send the required documents quickly. You agree in the end with the IRS. You may pay a few dollars more. Case is closed. You have just gone through an IRS correspondence audit. It is an audit that the IRS thinks that it can usually be resolved through correspondence, no need for your presence. This type of audit is usually performed through the Service Center not the Area Office. It is usually used for an audit of individual returns and the amounts looked at are smaller.  Perhaps the IRS employee performing that audit is less experienced than the other types of audit.

The second type of IRS audits is Office Audit. In this type of audit you take your files and your shoe boxes and go to the nearest IRS Area Office. You present your case and you argue your evidence (we usually don’t even attend the IRS Office Audit.  We send our document to the IRS as if it is a correspondence audit.) As in correspondence audit you may have to present original documents such as cancelled checks and invoices. The items chosen for an office audit may require some explanation as to why an item by way of example was expensed instead of being capitalized or the calculation of an asset basis or whether income should be treated as capital gain or ordinary income. 

So the difference between these audits may be looked at through the nature of the items examined and the dollar amounts that may be subject to the audit. We will discuss Field Audit in later blogs. 

As always we welcome any comments or experiences anyone has had.

IRS Audit Responsibility and Taxpayer's Rights

It may be advisable before you start submitting your data to an IRS Agent in an IRS audit to know taxpayer's rights:

1) You are entitled to IRS representation. You can have a CPA, a tax attorney or an IRS enrolled agent to represent you in your tax audit. If it is an individual tax audit, you do not have to face the IRS auditors and answer their questions. It is your right. Your CPA or representative can answer on your behalf after interviewing you. If you are a business entity, you can avoid the personal interview but the agent has the right to tour the place.

Touring your place of business is significant.

The IRS Auditor is sniffing and observing. He looks at your inventory; he sees how many people you have and so on. This observation can help him determine the level of activity and perhaps the level of income and the type of expenses he will expect to see in your financial statements. Obtaining tax help in this regard will be a good idea. A competent CPA is valuable IRS help in this regard.

It must be said that that IRS representation is not absolute right. If your tax attorney, CPA or enrolled agent unnecessarily delay dispensing of the information requested to conduct an IRS audit, the IRS has the right to contact you directly. The auditor must however, obtain his group manager’s approval before he takes this step.

2) IRS audit should not be more than once for the same tax year.  They should not look at the books several times. They can handle the same year relating to an assessment of some tax problem such as assessment of additional tax deficiency, correcting mathematical errors or a claim of refund by the taxpayer.  Taxpayer should not be audited on the same item more than once if the audited items did not result in any adjustment against taxpayer.

3)  You also have the right to obtain taxpayer information about you in the IRS records under Freedom of Information Act. The IRS may have the right to withhold some information that it deems exempt from FOIA but generally you are entitled to see your records and identify any tax problems you may be facing or may be brewing. This right also applies to any IRS settlements relating to tax collections. 

4) Taxpayer in a tax audit is entitled to an explanation of the tax audit process including tax audit appeal. Typically the agent will hand you a brochure explaining the taxpayer's rights and the tax audit process.

5) Finally, the taxpayer is entitled to what is called Taxpayer Assistance Order (TAO). This order is issued by the Taxpayer Advocate. Many times the issues that you cannot resolve through the normal channels can be resolved by the Taxpayer Advocate.  The Advocate knows how to navigate the IRS and can solve the IRS tax problems faster and perhaps more equitably.

IRS Audit: Tax Audit Selection

In our minds tax audits mean tax problems. Many ask why my return? How did I fall prey to a dreaded tax audit? There are several reasons that cause one's tax returns to be selected for an IRS audit. Let us just say that if we have done everything by the book and we have mitigated all the reasons for the tax audit that we will talk about, our return still may be selected through random selection.

Now let us talk about tax audit reasons other than random selection. Let us start by saying that the amount of income and tax liability may be a reason for an IRS audit. The larger the amounts on the tax return the better the chance for a tax audit.  Why? It makes sense from the IRS point of view. The reasons go as follows: we will invest time and money for the IRS agent and we would like to recover our money. The higher the amounts reported (or not report or underreport) on your tax return the more handsome the chance they will recover money from you for their investment.

Let us speak about tax audit reasons that we would like to put them under the banner of self induced tax problems. It is a tax problem that you could have avoided but you either asked for it or mistakenly caused. Arithmetical mistakes on the tax return can cause your return to be selected for a tax audit. So check your math as they always say. Among other reasons are tax exemptions. Many taxpayers claim the wrong exemptions especially divorced taxpayers. Both parents sometimes claim same exemptions or more exemptions than they should.

For self employed people, the favorite items for an IRS audit are excessive car expenses relative to the income; meals and entertainment and the ever favorite office at home raises tax audit flags as well. Schedule C is one of the prominent schedules we see that cause tax problems to taxpayers. 

The return can be selected for an IRS audit because you report high income on the schedule C. We recommend to our clients that if their income goes over $100,000 on schedule C, to consider incorporating. The opposite is true about income on schedule C.  If you reported too little an amount and claim a lot of expenses, that may be a sure tax audit trigger. Some even deduct substantial expenses with $0 income on Schedule C. That may invoke the issue of hobby losses.

IRS audit can also be caused by taking deductions for expenses that do not suit the activities such as say liquor and beer purchase for an office supply store or say large office supplies expense by a truck driver.

One of the reasons that may cause you a problem and a tax audit is an amended return. This is true especially if you are claiming a large refund. They want to look at this return before they send you say $10,000 that you did not ask for to begin with. So be careful but always remember there is tax resolution to any problem. Next blog we will talk about the IRS audit and Taxpayer Rights

Back Taxes: The Case Against Not Filing

The simplest argument for filing taxes in time is that it is the law. You must comply with the law. If you are not a tax protestor, and we hope that you are not (tax protestors usually end up on the wrong side of the bed) then you have no qualms with the legality of filing.

There are many benefits of filing in time besides being in compliance with the law. The most obvious benefit is getting your refund. If you are entitled to a refund and you don’t file, you may lose your refund because you are barred by the statute of limitations when you eventually file. We have seen people losing $7,000 or more of money in some cases that were coming to them and when they filed late they got nothing. Never mind that the IRS will ask you to pay the tax debt even if you don’t file. You guessed it. They file for you and now you owe back taxes (more on that later.)

One of the benefits of filing is that you may be able to wait out the IRS on you tax debt. The law states that the collection statute of limitation is 10 years.  If for example you owe taxes and disappeared from the radar of the IRS for ten years, the IRS may have lost the amount of tax you owed forever. In this case you have got yourself a nice tax settlement.

One of the disadvantage of not filing your taxes is that the IRS will file on your behalf. IRS calls that SFR or substitute for return.  Needless to say, in preparing your unfiled taxes, the IRS will not look after your best interests. The IRS will assume the worst against you. They will do a return for you as married filing separate even if you are single because filing separately causes you a tax liability higher than the latter.  In an SFR, you will not get any deductions for your expenses. 

For example, if you sell a house, the tile company will give you a 1099 for the proceeds and sends the IRS a copy of this 1099. The IRS records the total sale price as your income even if you were upside down on the house and they will not record the cost of the house. That is why we have many clients who come to us for $70,000 or even $100,000 of tax liability because of the sale of their residence when in fact they lost money. Unless you file, the tax liability remains on the book. The IRS had one of our clients owing over $250,000 in 2003 because of this exact issue. Guess how much he would have owed? Zero.

Because the amount of taxes owed is usually high you may even have a revenue officer appointed. When you have a revenue officer, that spells bad news. And to make things worse, we do charge more for revenue officers. So, that is another reason that you should file your taxes earlier.

Audits is another reason.  If you don’t file, the IRS can select any return regardless how old it is for an audit. On the other hand if file in time and you happen to have a year in the past that you made a lot of income and you think if you get audited on that year you will pay a lot of money, this year cannot be audited after three years. So, here you may have gotten away with murder.

We have seen other benefits to filing your taxes in time that particularly come in handy when you have a bank levy or wage garnishment or even when you want to do an installment agreement or an offer in compromise.  If you have unfiled returns, there will been no tax settlement for your tax debt unless you are in compliance. Tax compliance in this instance means filing all your back taxes. If have not filed, that may delay the process of IRS negotiation when you need it most.

Finally the IRS may even look sympethatic on your case if you have been filing on time.

Tax Audit Help

What IRS Does After the Audit Notice:

1. Typically they will look at the year they are auditing plus one or two years (before or after) if the year in question produced more taxes for them.

2. They will usually audit income and some expense items such as travel, mileage and number of claimed exemptions.

How To Prepare For Your Tax Audit:

For Income:

1. Examine the returns for the year they specify and have the other two adjacent years available as well. 

2. Order bank statements for the years that are under audit.

3. List deposits by month and get a total for the year.

4. Make sure to identify non-revenue deposits such as loans and account transfers

5. Order all transcripts for income and wages for the three years.

6. Compare the income per the transcripts to income claimed on the tax returns and the total deposits for every year.

7. Obtain support for non-revenue deposits such as documentation of loans, gifts or account transfers.

For Expenses:

1. Among the popular expenses audited by the IRS are travel and car expenses.

Car Expenses

2. To prepare a car defense, it is good to have a car log.

3. If you are a sales person, or courier for example, your log should be daily and should show how many miles you have on the car every morning and how many driven each day. Should include stops in between.

4. Just three or four months of that log is sufficient.

5. Get a reading of the odometer by a neutral party such as a repair shop or an oil lube shop.

6. Taking the mileage route may be easier than documenting each and every car expense.

Travel

1. Travel usually relates to out of town travel; you may need evidence with receipts (such as hotel receipts, meals and flights).  There is a per diem amount allowed by the federal government that changes from one local place to another and may range anywhere from $150 to $250 per day.