IRS audits (officially called "examinations") is a popular horror-story topic. Although it's true that they are far from pleasant experiences, there's no reason to lose your sleep - even if you are targeted. It's likely going to cost you some money, time, and nerves, but it's not a life-threatening situation. In fact, some people end up receiving money after an audit. The key is to be prepared and know the rules of the game.
#1 - Audits are usually limited to certain issues and a certain tax year. If they're probing into your moving expenses in 2008, chances are that you won't be asked about your investments or your 2009 income. Focus your preparation efforts on the specific areas they're interested in. Don't show them anything not specifically related to the items and year under audit, even if they ask. They can ask, but cannot force you to submit the materials. At worst, they would take the position least favorable to you. Still, it can be better than giving them documents that would lead to further questioning - especially if you have something to hide. On the other hand, not cooperating can be a risky tactic, from a practical point of view.
#2 - The burden of proof is on you. Unlike criminal system, where they have to convince the jury that you're a bad guy, in an audit you have to prove that you're clean. They may or may not agree with you. If they don't, you can either accept their conclusions or initiate an appeal process.
#3 - Documentation, documentation, and documentation. Audits are not such a big deal for organized people who keep the receipts and maintain regular accurate records. Well, not many of us do. For the rest of us, the only winning move is to gather as much written evidence as possible. Cancelled checks, bank statements, copies of bills, testimonies of other people, photographs – all can and should be used. Warning: provide the IRS with copies and keep all the originals, otherwise you risk losing your documents forever.
#4 - Knowledge of tax law is not required but is helpful. Most audits are about documentary evidence to support the numbers on your return and not about interpretation of the law. Besides, most IRS agents are skilled bureaucrats but not top experts in tax law. You may, in fact, know more than they do, so don't be intimidated. They're frequently wrong. Often, the most aggressive agents are the least knowledgeable.
#5 - Treat them nicely. No matter how unreasonable or harsh they are, getting emotional with the IRS people is hardly ever to your advantage. They're used to it and are likely to respond by making it even harder on you. Nobody likes to be abused. Remember – you catch more flies with honey than with vinegar. Some people claim that "PITA" (pain in the ...) tactics work well, but I personally wouldn't use them. Warning: don't go too far – offering any kind of favors to your auditor may trigger an instant criminal investigation.
#6 - Never lie. Take this advice seriously. You give your answers under penalty of perjury. Lying to an auditor is a crime and technically can be prosecuted if discovered. Not answering a question is not a crime and, in fact, is protected by the Bill of Rights. Politicians and celebrities are skilled at playing this game. The best response to a question that you don't want to answer is that you're not prepared and need to check your records or speak with your accountant. If you appear cooperative and sincere, your chances of winning the game are greatly improved.
#7 - Do not volunteer information. Don't answer questions that are not asked. Millions of people got themselves into unnecessary trouble by foolishly mentioning facts that were not solicited by auditors and would've never surfaced otherwise. Tax attorney Frederic W. Daily, in his excellent book Stand Up to the IRS by Nolo Press, suggests five best responses to a question posed by an auditor: --Yes. --No. --I don't recall. --I'll have to check on that. --What specific items do you want to see? as well as couple real bad ones: --I guess you caught me, ha, ha! --I didn't think you would find that account. By the way, the latter immediately invites criminal investigation.
#8 - Do not argue with the auditor too hard. Make your point and substantiate it. If the IRS agent wouldn't agree, move on. Avoid deadlocks. Remember: you can always take the issue to several layers of supervisors, appeal the audit, and/or enlist help of a tax professional.
#9 - Time generally works to your benefit. Auditors are frequently overworked and have deadlines. The longer it takes, the more pressure there is on the auditor to close your case. They do forget to follow up on the documents they requested, questions they raised, and problem areas they noticed. If you are real lucky, they may even quietly drop your case altogether, but don't count on this. Artificially delaying your audit may sometimes work to your advantage, but don't overdo it.
#10 - The IRS machine is very inefficient. Despite their multi-billion investments in information technology, the IRS still has hard time delivering timely and accurate information between various departments. Frequently, auditors opt not to go into the trouble of requesting additional data, such as previous years tax returns, internally and instead ask you to provide it. If you're slow to cooperate, the issue can occasionally be dropped.
#11 - Negotiating skills are useful in IRS audits. Technically, auditors are not supposed to negotiate, but in reality it happens all the time. Keep in mind that you can negotiate on "per issue" or "per adjustment" basis only. This means that you can't just offer to pay 50% of the auditor's total number; you have to refer to specific questionable items on the list.
#12 - Beat them in their own game. Bring up any areas in the return that can be adjusted to your benefit, such as previously overlooked or understated deductions. It can effectively offset some of the additional tax they're proposing and even discourage further review.
#13 - In extreme cases, you have the right to ask for a new auditor. It may sometimes relieve the stress of a real tense relationship. But be reasonable yourself. Repeat requests are unlikely to be honored. Try talking to a manager before requesting another auditor.
#14 - Do not sign any documents that you don't fully understand. Thoroughly read what you sign. Some of the documents may extend legal time limits that the IRS has, such as the 3-year deadline to complete the audit. Other documents may affect your rights, for example, right to appeal the audit. Always demand complete explanations and insist that all promises are in writing. Consulting a tax professional (before you sign!) is a very good idea.
#15 - Do not spread the word that you're being audited. Your friends are unlikely to be of help, but your enemies can easily add to your problems. Besides, you will get an earful of useless tips from people who heard it from a friend of a friend of a friend. The hearsay can do more harm than good.
#16 - Professional help is not necessary …. but may be worth it, especially if you're not a great communicator, too nervous, or too angry. When you don't have sufficient evidence, or your situation falls into "gray areas" of the tax law, hiring an expert can make a big difference. You may need to weight the benefits of using a good tax professional against the cost and risk of hiring a bad one. You can typically choose between a one-time consultation, full representation services, and anything in between. Warning: beware of "experts" who claim that they "guarantee" you a victory - or that the IRS actions are "illegal." These are sure signs that you’re about to be scammed. A true professional is likely to charge you an upfront retainer. However, charging you a percentage of future savings is a sign of trouble.
MICHAEL PLAKS, EA
Reprinted courtesy of Michael Plaks. Visit www.MichaelPlaks.com The information and opinions presented in the above article are general in nature, not intended to address specific tax situation and/or to substitute for professional consultation, and shall not be considered legal advice. Email: michael@MichaelPlaks.com 713-721-3321 The author is a Houston-based accountant, working exclusively with real estate investors. He is a federally licensed Enrolled Agent who can represent his clients in their dealings with the IRS.
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