Audit issues may arise after IRS' computer compares your tax return (or your business') to a programmed “norm” and finds that some of the expenses or deductions claimed fall outside of that norm. In some cases, the Examination Division of the IRS may get involved if it obtains information from W-2 forms, 1099s, or other sources which reveal that you or your business have not filed tax returns to report federal income, employment, estate, gift, or excise taxes. In any event, once you or your business have been targeted for an audit, your tax return is forwarded to either a revenue agent or an office auditor who may be located in the District Office which has jurisdiction over your tax return or at one of IRS' Service Centers.
THE LETTER FROM THE I.R.S.
The initial contact from the IRS' Examination Division is usually a letter. Receiving an IRS letter which informs you that one or more of your tax returns have been selected for an audit is a jarring experience. It's akin to having a rug suddenly pulled out from under you. Though it may be a cliché to use that phrase, it's an apt metaphor to describe the sudden and unexpected impact such a letter may have. The reaction to it varies with each person. Some respond with anger while others put the letter away to avoid dealing with it. Some experience guilt, while others feel remorse. Some busy themselves with other facets of their life in an effort to reaffirm the familiar over the unknown. Most of us experience fear.
THE PROCEDURE
An IRS audit usually involves a meeting with a Revenue Agent or an Office Auditor who asks you to bring records to substantiate your income and expenses. You may have to go to the IRS' office to meet with the Agent or the Agent may come to your place of business, if the audit is on a business. In smaller cases, the audit may be conducted out of an IRS Service Center, in which case it is conducted by mail, fax and/or telephone.
THE RESULTS
Once the audit is completed, the Agent will either accept the return as filed, or – more likely – send you a letter with the proposed changes. More likely than not, the proposed changes will mean more tax, plus additional interest and penalties. At that point, you can either accept the proposed changes or request an informal conference with the manager. If agreement cannot be reached with the manager, you have a right of appeal to IRS' Appellate Division. As a last resort, you may file a suit in the Tax Court or the U.S. Court of Claims in Washington, D.C.
THE RECOMMENDATION
When you get that initial letter, we recommend that you retain counsel to represent you. While it will mean additional costs to you initially, it may save you money in the long run. In addition to the costs involved, you should consider the following:
- More likely than not, you are not familiar with the complete tax laws and IRS' administrative procedures. If that is true, you are at a distinct disadvantage in dealing with the IRS without a knowledgeable representative. The Agent may gloss over the issues that favor you and emphasize those that favor the IRS. While IRS purports to be fair and impartial, the reality is that the Agent is being paid by the IRS and the goal of the IRS is to assess additional tax. IRS does not like to expend time and effort on a case which will result in no additional tax.
- Even if you are familiar with the law and IRS' procedure, it is a good idea to get someone that is personally removed from the issues involved. As the taxpayer whose pocket is being picked, you are not in a good position to distance yourself from the situation. This may result in poor judgment calls on your part, or worst yet, anger at the Agent. If the professional relationship breaks down, the Agent may become polarized and entrenched in factual or legal minutiae that could result in a less conciliatory stance.
- Some Agents are more difficult to deal with than others. The more difficult ones may make unreasonable demands for evidence or may want to probe beyond the narrow issues involved in the audit. Without representation, you may not know how far the Agent's inquiries may go and disclose information that may lead to a broader audit or even a referral of your case to the Criminal Investigation Division.
- Some issues, such as penalties, may be negotiated. Sometimes the Agents assume a quid pro quo stance and propose to concede some penalties in exchange for concessions on the part of the taxpayer. Without a competent representative you may not be able to judge how strong the IRS' position is or which offers are worthy of consideration. In addition, you may not know all your legal and administrative rights, such as your right to legal opinions from the IRS, or the right to a written closing agreement. These rights may have important consequences, including what audits IRS may conduct against you in the future.
- Having a legal representative adds psychological clout to your side. It tells the IRS that you are taking this audit seriously and have hired a professional to deal with it. The Agent is less likely to assume a patronizing attitude towards you and less likely to take short cuts or gloss over certain formalities. It's true that some Agents like to deal directly with the taxpayer rather than through the representative. Without a representative, the Agent has the dominant negotiating position. The Agent may shift the burden on the taxpayer to prove that he or she is innocent. If the taxpayer fails to do so, IRS has the administrative power to enforce its decision. A representative tends to level the playing field.
- Some Agents, on the other hand, prefer to deal with a representative. In most cases a representative knows how the game is played and the Agent does not have to spend time and effort explaining the procedure. Agents often find dealing directly with the taxpayer results in communication problems. The Agent usually assumes the abstract stance of an audit, with all the rules and regulations that go with that. The taxpayer, on the other hand, brings a different perspective, one that involves personal issues of no immediate concern to the Agent, such as hardships, business failures, explanation for lack of records, etc. The result is often the Agent talking apples while the taxpayer is discussing oranges. In those situation, polarization is again more likely to set in resulting in a protracted audit and a diminished likelihood of an amicable settlement.