It’s not pleasant — but IRS audit is survivable
|Friday, April 3, 1998|
|Wichita Business Journal – by Eric Namee
April 15th is right around the corner, which means many people will be frantically trying to get their tax returns filed and hoping they won’t be audited. Generally, only 1 percent to 2 percent of tax returns are audited.
This percentage is deceiving, however, because the technology used by the Internal Revenue Service substantially increases its ability to detect returns with problems. If you’re one of those unlucky individuals whose return is chosen for audit, here’s what lies ahead.
Once a return is chosen for audit, audit classifiers determine which type of audit is appropriate: the correspondence audit, the office audit or the field audit. The correspondence audit is conducted by service center employees, who aren’t required to have any accounting background. Correspondence audits focus on relatively simple and easily identifiable problems that can be resolved by mail, such as mathematical errors or omitted schedules.
The office audit is conducted by a tax auditor, who is required to have some accounting background, but not an accounting degree. The office examination is generally initiated by a letter identifying the items to be reviewed and is generally limited to these items unless the auditor discovers another significant issue.
The field audit is more complex and is conducted by a revenue agent at the taxpayer’s place of business. Revenue agents have more advanced accounting skills and greater familiarity with the tax laws.
There has been some publicity about IRS’s use of “lifestyle audits,” which allow agents to gather information about the taxpayer from sources other than the tax return to determine whether the taxpayer’s expenditures exceed his or her income. These audits raise concerns because they allow the agent to engage in a “fishing expedition.” Although IRS internal procedures direct agents only to conduct lifestyle audits under certain specific or unusual circumstances, some agents continue to perform them.
The IRS also has developed the Market Segment Specialization Program, which provides audit guidelines for various business sectors, including law firms, financial institutions, and insurance and real estate agencies. These guidelines are intended to prepare agents for potential issues that may arise in certain industries, such as banking and health care, that have significant and complex tax issues.
From the perspective of the taxpayer, the goal of an audit should be to close it as quickly as possible. The longer an IRS audit continues, the greater the chances of issues being raised. Because of the IRS’s increased ability to identify returns with problems and its training of “experts” in specific industries, obtaining professional assistance at the beginning of an audit has become almost essential. The professional can:
• Act as your representative, limiting your contact with the IRS.
• Possibly host the interview at his or her office, preventing the agent from gaining extraneous information from the observation of your business.
• Ensure the audit does not become a “fishing expedition.”
Those who choose not to hire a professional or who cannot afford to do so, should observe the following guidelines:
• Be organized and prove support documents for deductions at issue.
• Support all responses with credible evidence to avoid further inquiries.
• If helpful, prepare summaries of documents, i.e. list itemized expenses rather than handing over all receipts.
• Avoid completing any form listing living expenses (taxpayers shouldn’t be required to prepare documents for agents during an audit).
• Never guess at answers. You’ll be bound by your answer and false answers could lead to a criminal investigation. If you cannot answer accurately, say so.
Although an audit will seldom, if ever, be a pleasant experience, abiding by these guidelines should help make the experience as painless as possible. Obtaining professional assistance early in the audit process can help resolve the matter quickly, possibly reducing exposure to liability.
Eric Namee is a member of Hinkle, Eberhart & Elkouri LLC. His practice primarily involves representation of taxpayers before the IRS and Kansas Department of Revenue.