The Ten Commandments
of an IRS Audit
Jim Buttonow, CPA CITP
Updated on: April 9, 2019
Behold, the IRS audit. They are rare these days. Only one out of every 184 taxpayers experienced an IRS audit in 2017, and less than a quarter of these audits are conducted in person by the IRS.
For many, navigating an IRS audit looks as simple as parting the Red Sea. Fortunately, most IRS audits are done by mail and are much less intrusive than the dreaded audit where the taxpayer personally meets with the IRS at their office (called an “office” or “desk” audit) or at the taxpayer’s home or place of business (called a “field” audit).
Nine out of 10 audits end in a change to the tax return. In mail audits, the additional amount owed averages around $6,790. For face-to-face audits, the cost is much higher — taxpayers owe an additional $77,309 on average from these audits. Mail audits are fairly simple — taxpayers simply need to respond timely, in writing, to prove a few line items on their return. For office and field audits, or if the taxpayer is disputing the IRS determination in an audit, they should ask a professional to intervene.
In the meantime, for the chosen few who must deal with an IRS audit, there are some do’s and don’ts to follow to successfully navigate an IRS audit — the Ten Commandments in handling an IRS audit.
1. Thou shall not ignore thy auditor
Ignoring an audit will not make it go away. In fact, it will do the opposite — the IRS will just proceed and assess additional tax on the areas that they want to audit on the tax return. In face-to-face audits, the IRS may ask third parties for information about the taxpayer, such as a bank to get information about the income the taxpayer receives or, if they are a small business, a vendor that supplies them with materials for the business. When the IRS requests information from a third party, they are usually trying to determine if the taxpayer is hiding income.
2. Thou shall not bear false witness to the IRS auditor
Never, never lie to the IRS. Lying to a federal agent is a crime. The taxpayer should present their facts to the IRS and their tax return position. If a taxpayer feels like they need to lie, that is a sure sign that they need to hire a tax professional to help.
3. Contest thy wrath
The IRS auditor does not have the final say. If there’s a disagreement on the facts or the application of the tax law, the taxpayer should exercise their right to appeal, and appeal the determination to the IRS Office of Appeals. A few months after the audit concludes, they will get to present their case to an independent person, called an Appeals officer, at the IRS and get a second opinion. If they don’t agree with the Appeals officer, they can take their tax dispute to court.
4. Thou shall file all thy past-due tax returns without haste
For taxpayers under audit, it is the IRS’s procedure to make sure that they have filed all required returns. It is never a good start with the auditor when they have not filed all required returns. The IRS will review, at a minimum, the past six years of filing history. If the taxpayer doesn’t file, the IRS auditor can file for them — called a substitute for return — and include no deductions, credits, or dependents.
5. Thou shall come prepared to thy audit
If the taxpayer is not prepared for the audit, they should be prepared for auditor skepticism and a long audit. For office and field audits, it is best to do a mock audit and know that income is properly reported and the auditor’s selected audit areas are properly reported. If the taxpayer cannot advocate for their tax return position from the start of the audit, they may get many more questions and requests for information from the auditor. The audit may even prematurely expand into other years because the auditor is suspicious that there is a problem.
6. Thou shall elevate issues to thy auditor’s manager
Audits should not feel like wandering the desert for 40 years. If the taxpayer doesn’t like how the audit is progressing, they should ask to speak to the auditor’s manager. In fact, they should always get the auditor’s and their manager’s contact information at the beginning of the audit in case they need to contact them. At any point that there’s a disagreement with the auditor, the manager is the first line of appeal. For example, if the auditor believes penalties apply, the taxpayer can ask the manager to hear their side of the case and intervene on their behalf. Few take advantage of the manager, and as a result, do not get a second opinion or intervention that could speed up the audit and get better results.
7. ‘So let it be written, so let it be done’
This is not a commandment, but in the 1956 movie “The Ten Commandments,” the pharaoh makes this proclamation many times. The rule in an audit is to get all requests for information in writing. Why? Auditors can get confused about the facts of the case if the taxpayer does not have a clear audit trail. Unclear facts lead to long audit. Take the lead in the audit, demand requests for information in writing and reply in writing. It will eliminate confusion and focus the audit on the issues in hand. Also, it will leave a written record of the facts that will be needed if the taxpayer wants to appeal the findings of the case.
8. Remember and obey thy deadlines
There are many deadlines in an audit — the audit appointment, deadlines to provide information, deadline to respond to the initial audit report, deadline to petition IRS appeals, and a deadline to petition the tax court, among others. When the taxpayer misses early deadlines in an audit, they put the auditor in a tight place. It is OK to delay one or maybe two meetings, but many missed deadlines and incomplete information means that the auditor will proceed to the next step: proposing adjustments to tax based on the taxpayer not meeting their burden of proof.
It is important to know that auditors have deadlines too. For face-to-face audits, a good rule of thumb is for the auditor to finish within one year. An open audit or an audit that is within a year of the statute of limitations expiring (three years from the due date of the return, or filing date, whichever is later) can mean trouble. Auditors and their managers like to close cases within two years after the filing of a return.
It is important to know that auditors have deadlines too. For face-to-face audits, a good rule of thumb is for the auditor to finish within one year. An open audit or an audit that is within a year of the statute of limitations expiring (three years from the due date of the return, or filing date, whichever is later) can mean trouble. Auditors and their managers like to close cases within two years after the filing of a return.
9. Contest thy penalties
Too often, taxpayers do not argue whether penalties apply. IRS auditors have been criticized for arbitrarily assessing penalties — namely the 20 percent accuracy penalty for negligence — in audits. Taxpayers should closely examine the facts and prepare to argue that penalties do not apply, and be prepared to explain the circumstances and prove to the IRS that they made a reasonable attempt to comply with the tax law, but were not able to because of unforeseen circumstances. For example, if they used a tax pro to file and their tax return position is being contested in the audit, they should highlight their reliance on the tax pro’s advice. In any event, they shouldn’t just concede — they should access the auditor’s manager and the IRS office of appeals if they need a second and third opinion.
10.When in doubt, seek a higher authority
Face-to-face audits require that the taxpayer “speak IRS.” They must know how to navigate the audit, their rights as a taxpayer, and how to advocate their tax return position. Unless they have experience and knowledge in handling an audit, they should seek the advice of a tax professional.
Professional representation in complex business audits can cost thousands. However, for most office audits, the tax pro will spend about two or three days in total in preparing for the audit, meeting with the IRS, and finalizing all matters of the audit. If the audit gets into multiple years, the time will increase. Tax pros should be able to offer a reasonable range of fees to expect before the taxpayer engages their assistance.
Professional representation in complex business audits can cost thousands. However, for most office audits, the tax pro will spend about two or three days in total in preparing for the audit, meeting with the IRS, and finalizing all matters of the audit. If the audit gets into multiple years, the time will increase. Tax pros should be able to offer a reasonable range of fees to expect before the taxpayer engages their assistance.
This article has been reprinted from Accounting Today. The Ten Commandments of an IRS audit | Accounting Today