Posted by Dean Alexander on Mon, Aug 30, 2010
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.
Posted by Dean Alexander on Fri, Aug 13, 2010
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.
Posted by Dean Alexander on Wed, Aug 04, 2010
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.
Posted by Dean Alexander on Fri, Jul 30, 2010
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
Posted by Dean Alexander on Mon, Jul 19, 2010
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.
Posted by Dean Alexander on Thu, Nov 12, 2009
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.
Posted by Dean Alexander on Mon, Nov 02, 2009
The IRS has the power to summon taxpayers to appear before its representative along with their records. This is contrasted with a tax audit where your representative will meet with the IRS without your physical presence. In IRS summons, if you decided to comply with the summon you will have to appear personally before the IRS.
The question is: Do you have to comply with the summon when you receive the notice? The short answer is not necessarily. The court held that the summons is not self-enforcing, meaning that you don't have to voluntarily submit to the summon without a court order? Does the IRS have the power to enforce the summons through the court? The answer is yes.
For the IRS to enforce the summon, it has to comply with its administrative procedures among which is that it must not inconvenience taxpayer as to the date and the time (it cannot be on weekends for example.) Also the IRS should issue summons for records that it cannot obtain without the summon. So if you submit records to IRS you may render the summon as not needed.
The courts also held that the summons cannot be issued as a tool of harassment of taxpayers. Summons must not be also a means of criminal investigation. You must consult your tax attorney or representative before you respond to summons issued by IRS.
Posted by Dean Alexander on Thu, Oct 08, 2009
The IRS examines (audits) tax returns to verify that the tax reported on that return is correct. Almost everyone cringes when the word "audit" is introduced in conversation, formal or not. Although I am classified as the latters I just mentioned, selecting a return for examination does not always suggest that the taxpayer made an error or was dishonest. In fact, some examinations result in a refund to the taxpayer or acceptance of the return without change.
The overwhelming majority of people file returns and make payments timely and accurately. As such, they have a right to expect fair and efficient tax administration from the IRS, including verification that taxes are correctly reported and paid. Below describes some fundamental rights taxpayers have when dealing with the IRS. We'll move to the "meat & potatoes" afterwards.
Taxpayer Rights
The IRS trains its employees to explain and protect taxpayers' rights throughout their contacts with taxpayers. These rights include:
-
A right to professional and courteous treatment by IRS employees.
-
A right to privacy and confidentiality about tax matters.
-
A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
-
A right to representation, by oneself or an authorized representative.
-
A right to appeal disagreements, both within the IRS and before the courts.
The purpose of throwing the above points in this article before discussing anything else is because many of you reading this are currently dealing with a tax problem or debt and may even have been selected by the IRS for examination. These points also serve as key things to remember when dealing with the IRS.
Should you decide to discuss your tax issue directly with the IRS, no matter how intimidated you get and regardless of how difficult it is to produce documentation their requesting, ultimately, the system is built on ethical grounds. Of the hundreds of publications the IRS have, those bullets can be found in the first publication. Publication 1: Your Rights as A Taxpayer.
Before ending the article, as the title states, below is how the IRS selects tax returns to audit.
How Returns Are Selected for Examination
The IRS selects returns using a variety of methods, including:
-
Potential participants in abusive tax avoidance transactions - Some returns are selected based on information obtained by the IRS through efforts to identify promoters and participants of abusive tax avoidance transactions. Examples include information received from "John Doe" summonses issued to credit card companies and businesses and participant lists from promoters ordered by the courts to be turned over to the IRS.
-
Computer Scoring - Some returns are selected for examination on the basis of computer scoring. Computer programs give each return numeric "scores". The Discriminant Function System (DIF) score rates the potential for change, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. IRS personnel screen the highest-scoring returns, selecting some for audit and identifying the items on these returns that are most likely to need review.
-
Large Corporations - The IRS examines many large corporate returns annually.
-
Information Matching - Some returns are examined because payer reports, such as Forms W-2 from employers or Form 1099 interest statements from banks, do not match the income reported on the tax return.
-
Related Examinations - Returns may be selected for audit when they involve issues or transactions with other taxpayers, such as business partners or investors, whose returns were selected for examination.
Other - Area offices may identify returns for examination in connection with local compliance