Dealing with IRS - what to do when being audited
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If you are called in for a standard office audit, you will probably have at least two weeks after being notified to get your records and arguments together. However, if you need more time, you generally can get at least one reasonable extension.
If you are unable or unwilling to appear in person, you may mail in your records. A word of warming, though: An audit conducted by mail can be much more costly than one done in person. Unless your records are perfect and self-explanatory, you stand a good chance of losing the deduction, because you won’t be present to answer the auditor’s questions.
Usually, once an audit is started, it cannot be stopped. There is one exception, though: the repetitive audit. If you went through a non-business audit for the same issues in either of the two preceding tax years, emerged without owing tax, and still get audited again on them, you can alert the IRS and tell the agency that it can’t audit you about these write-offs this time.
Assuming there’s no way out, though, you need to prepare. First, get a copy of the tax return under audit and pull together all the documents that support the items being questioned. Try to reconstruct any missing records. Get copies of cancelled checks from your bank, duplicate receipts from your credit-card company, church, synagogue, or doctor, for example, or letters from people who can back up your claims. For instance, if you deducted business expenses, get your boss to write a letter verifying their legitimacy.
Your records do not have to be perfect. If you cannot dig up roof, try to prepare a convincing argument. The auditor usually must give weight to your oral testimony, except for disputes over business entertainment expenses.
If record keeping fails, the following guidelines may save the day:
Don’t volunteer information. What you do not know about the tax law can hurt you. Answer the auditor’s questions, but do not feel compelled to elaborate.
Leave your emotions and hostility at home. Be courteous and cooperative. That does not mean you have to automatically give in when the auditor disallows your donation to Goodwill or your trip to Miami. In fact, being too eager to agree can raise suspicious.
Look for areas of compromise. The auditor will probably be willing to bargain in order to close your case. If you are flexible and know the auditor may come away from the audit satisfied with the final bill.
Should you brave the IRS by yourself or, if you hired a tax pro to prepare your return, have him or her do the talking? It all depends on what the IRS wants to know. If you had a preparer fill out your return, when you get an audit letter from the IRS, show it to your adviser. Then ask for his or her guidance. If the issue is a simple one, you may be able to handle it on your own and save another fee to your tax preparer, either by sending back a letter to the IRS or meeting with the auditor. However, if the IRS wants to ask a lot of questions, you’re being audited on a gray area of the tax law, or you took a write-off you shouldn’t, it’s best to let your tax adviser handle the audit for your. In fact, you’ll probably be better off not even going to the audit, since you could inadvertently say something to the auditor that could be held against you.
After all the evidence has been presented, the auditor will make a decision. This judgment may come at the end of the audit or after you have provided more information at the auditor’s request. If you are in the IRS office, the auditor will give his or her ruling and explain any proposed changes to your tax liability. Otherwise you will get an audit report by mail. Call the auditor if there is something you do not understand.
Three outcomes are possible: (1) no extra tax due; (2) additional tax due; or (3) a refund. In four out of five cases, the wheel of fortune lands on more tax due.
If you agree, fine. What if you don’t have a cash to pay the extra taxes? The IRS says that if your audit bill is $10,000 or less, you can get a three-year installment payment plan. Figure on owing annual interest and penalties at about 14%, however. You’ll need to fill out Form 433 to get the installment plan. If, however, you think you’ll never be able to pay the full amount, try to work out a settlement with the IRS. Fill out Form 656, known as the Offer in Compromise form, and type in: “Doubt as to collectibility of the full amount of tax, penalty, and interest.” On average, the IRS accepts 15c on the dollar from people who get such offers. It can take six months to a year to find out what kind of deal the IRS will make, however.
But bear in mind that the auditor’s findings are not necessarily final; you don’t have to accept them. You have 30 days after you receive the audit report to decide what action to take. During this period, you may submit additional information you believe might change the auditor’s mind.
If you have no information to help your cause, you may either agree or disagree with the audit report. If you decide to agree, sign a copy of the report and mail it back. Keep the other copy for your records. You may send the IRS a check for the tax due with signed report or wait for a bill for the extra tax, plus interest and penalties, from the IRS Service Center.
If you decide the audit report is unfair or incorrect, tell the auditor within the 30-day period that you want to appeal. The IRS gives you several choices if you want to keep fighting. You can ask for an informal appeal to the auditor’s supervisor. If you go that route and are still unhappy or you prefer to skip this stage, you can go to the IRS Appellate Division. This is called a formal appeal. Then, if you lose at the appellate level, you can take your case to court. This decision should be made with the help of an experienced tax professional, however, since going to court can be extremely expensive and time-consuming.
Most tax disputes are settled in the U.S. Tax Court, although you can also take your case to the I.S. District Court in your area or the U.S. Court of Claims in Washington, D.C. The tax court, which hears cases at sites around the country, has a special procedure for so-called small cases, in which the disputed amount is $10,000 or less. With relatively informal procedures, you can represent yourself in these suits. Unlike regular tax court cases and those in the district courts and court of claims, however, the ruling in a small tax case cannot be appealed.
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