Preparing for an IRS Audit
By Tim Buell, ACI
Director, ASHI Education Inc.
November 2012, I received a letter from the IRS telling me I was going to be audited….my first time.
No doubt some of you have been audited while most have not. Fortunately for me, my accounting education and background proved worthwhile.
According to Jeremy Kisner, president of Surevest Wealth Management, there is an overall 1% chance of getting audited. However, he says, for those bringing home more than $200,000 in 2013, their chances jump to 3.26% and 10.85% for those making more than a $1 million.
There are very few totally random audits. What IRS computers are looking for, in general, are a number of red flags. For example, someone making $60,000 a year with $30,000 in charitable donation claims might raise some eyebrows at the IRS. A small business owner writing off 100% of his car as a business expense can also lead to an audit.
So, what do you do if you are audited by the IRS?
1. First of all, do not panic. Most situations are handled easily provided one has good financial records. The IRS usually gives you 30 days to respond. A letter from the IRS doesn’t always mean you are being audited; sometimes the agency is looking for more information or clarification. The vast majority, or 76%, are correspondence audits, meaning the IRS requests information by mail instead of questioning a taxpayer in person. For example, they may want documentation confirming your medical expenses or income. If you do get an audit letter, the first thing is to determine what part of your tax return is being audited.
2. The IRS uses a system called the discriminate information function to determine what returns are worth an audit. The DIF is a scoring system that compares returns of peer groups based on similar factors such as job and income. If a person’s financial data differs significantly from those established by his peers, the system gives that return a high DIF score. A high DIF score raises the chances that the filer will be audited.
3. The IRS abides by a statute of limitations of three years after the due date of the return. For “substantial errors,” the IRS maintains it can go back six years and recommends you keep most records at least that long. The experts agree: If an audit is going to happen, it will occur in the latter half of the three-year time frame. Audits generally always happen two years after you file.
4. If you are using an Accountant or CPA (recommended) send them a copy of the letter received and let them handle it. If not, get one that specializes in IRS audits. There are Accountants/CPA’s who used to work for the IRS and understand how the system works.
5. If they want to schedule an in-person review, start collecting documentation that is requested in the letter.
6. Keep tax-related documents for seven years from the date a return was filed; however, the IRS usually only goes back three years. In my case, they audited 2010 and 2011. If you can't find the documentation you need, you can usually get another copy elsewhere. If you're missing the bill for a medical expense you claimed, for example, you can contact your doctor's office. If you donated money to a charity but lost your receipt, the charity will probably be able to send you a duplicate. If you're unable to get the proof the IRS is asking for, any unsubstantiated claim or deduction on your return will be disallowed. If you think you have made an error, don’t cover it up. Honesty is the best policy. Remember, the burden of proof is on you, not the IRS, and by law they have access to all your banking, mortgage and investment documents. They have the right to subpoena documents even from your clients.
7. Organize your records. Making the auditor's job easier will win you some points. The auditor will at least believe that you're an organized person and that all of your items are documented and justified.
8. If you are required to have an in-person review, be polite, courteous and professional. Remember, the agent has chosen this as his/her career and has a family to support just like you do.
9. If you end up owing extra money, you'll get a bill in the mail that's typically due within 30 days, unless you ask to set up a payment plan. If your federal return ends up being changed, you'll typically have 90 days to amend your state return as well. If your error(s) were “an honest mistake” and not on purpose, the IRS may forgive the interest but not the penalty.
10. Disagree with the outcome of an audit? Ask to talk with a manager, who can conduct an internal review. If that doesn't help, you can request assistance from the Taxpayer Advocate Service, the IRS's watchdog arm. As a last resort, you can appeal the audit in U.S. Tax Court, a federal court specializing in tax cases; however, this can be costly and time consuming.
11. Manage your expectations. Don't expect to come out of the audit without owing something -- the odds are against you. Don't try to compromise on the amount of taxes to be paid; instead, negotiate the tax issues with the auditor.
12. Know your rights. Browse IRS publication 1, explaining the Taxpayers' Bill of Rights, prior to your audit. If the audit is not going well, demand a recess to consult a tax pro. Ask to speak to the auditor's manager if you think the auditor is treating you unfairly. If the subject of tax fraud comes up during an audit, don't try to handle it yourself.
Again, your best bet if you're audited is to retain the services of a qualified and experienced tax professional who can argue your case without passion or prejudice. Such a person already knows the most effective ways to help you quickly resolve a conflict with the IRS. Hiring such a person is not cheap, but quality services never are, and you could pay a lot more if you don't hire a professional and the audit doesn't go well. The tax code has become so complicated that you're unlikely to know the law as it applies to your tax return and your rights as a taxpayer. That's why a qualified tax professional can be worth every dollar of his or her fee.
Strongly consider using QuickBooks interfacing to your bank so you can download checking and credit card information posting the entries to the proper account…accounting made simple. QuickBooks interfaces with TurboTax making the filing of your Federal and State returns simple and easy, allowing you to keep both a soft and hard copy of your returns. A few dollars invested in proper software can save you a lot of headaches down the road.
Tim Buell, ACI
Director, ASHI Education Inc.
Board Liaison, ASHI Finance Committee