If you are singled out for the IRS audit, it is important to understand that not all inquiries are formal audits. Some are only the letters asking routine questions about math errors or data mismatches, while other inquiries – even if they are conducted by mail – can dig deeply into the return. Be on your guard, however, if the IRS sends two agents, because it could mean a criminal investigation, that something serious is going on, and it could mean the matter may wind up in court. Moves that could trigger IRS scrutiny:
Here are some tips on how to survive an IRS tax audit:
- Reporting high income. Audit rates have risen for those earning $200,000 to $1 million or more.
- Forget to claim reported income. The IRS automatically matches report of different types of income against the reported income on tax returns. Omitted items raise red flags.
- Take outsized deductions, especially for charitable gifts or travel and entertainment. The IRS is aware that many people don’t know about tough rules requiring taxpayers to have paperwork in hand before taking a large deduction.
- Hide offshore accounts. Penalties can be severe: up to half the value of the account or more.
- Claim certain items on small-business returns. Declaring negative gross income can catch the IRS’s eye, as can claiming to have paid independent contractor, deducting expenses related to bad debt or claiming large expenses for repairs.
- Use suspiciously round numbers. Occasional rounding is ok, but a return with many strings of zeroes call attention to itself.
- File an amended return. Scrutiny is especially likely if a large refund is claimed on such returns.
- Use an incompetent tax preparer. When the IRS finds such tax professional, it may follow up by examining his/her client’s returns.
- Provoke a whistleblower. The IRS has two programs that can pay rewards to people who provide conclusive evidence against tax cheats. Often the whistleblowers are former spouses or employees.
- Fail to claim cancelled debt as income. Some types of forgiven debt are taxable, while others aren’t, and experts say the IRS often is quick to challenge taxpayers. It is taxpayers burden to prove IRS wrong.
- Fail to file. If you don’t file a tax return, the IRS may file one for you, using information from W-2 forms and other income reports, and without considering any applicable deductions. Be prepared for further IRS attention in such cases.
Some inserts were taken from the Wall Street Journal article "The Sum of All Fears: How to Survive a Tax Audit" dated March 15-16, 2014.
- Keep accurate records up to six years, except in the case of asset purchases such as a home or stock in a company. Keep those records for six years beyond the last date you own the asset.
- Know what you are facing. When the IRS does come calling, Ms. Jeanguenat, an enrolled agent in Virginia Beach, VA, said, ask yourself: What is it that they are questioning, and what can you provide to prove your case? Receipts, canceled checks and other documentation give you more leverage in being able to negotiate.The IRS, for instance, often challenges mileage claims. Even if the taxpayer has not kept the best mileage log, it is possible to reconstruct one. One tip: Use receipts from oil changes that show mileage at that time. But the burden is still on you to prove your case. If you don't have the documents, you're going to lose.
- Don’t panic. Never lie to the IRS. On the other hand, don’t rush to pay whatever the agency asks. Often the IRS is wrong.
- Don't ignore the IRS. Whenever you receive an IRS letter, respond – even if all you do is send another copy of a letter you sent previously. Communicate via certified mail and keep careful track of the receipts. Put yourself in the IRS agent's shoes. If you're an agent with a large stack of cases, your sympathy level drops off if you can't find someone, making it harder to negotiate later on.
- Stop talking. You need to communicate with the IRS, but that doesn't mean telling them everything. The more taxpayers say the more follow-up questions it brings that may lead to more issues for auditor’ review.
- Be humble. Treat the agent as an equal, don’t be rude.
- Don't rush to pay. Don't arrive at an IRS meeting ready to write a check and don't respond to an IRS letter by dropping a check in the mail. "Many times the taxpayer may not owe the money," said Cynthia Jeanguenat. She said one client received an IRS letter stating he owed back taxes because he failed to report income from a Form 1099. Ms. Jeanguenat gave the IRS a detailed explanation of where the income had been reported on his tax return. "Sometimes it's a matter of pointing [the IRS] in the right direction on the tax return," she said.
- Ask questions. Tap the agent as a resource in resolving the issue at hand, said Jim Camp, chief executive of Camp Negotiation Systems and author of "Start with No." "When you talk with the IRS, they will lay out for you every single thing that you can do," he said. "All you have to do is ask." Some questions he suggested: What am I allowed to do? What are the policies? Where can I find more information in writing? What are the rules for appealing this?
- Don’t forget your state. If you wind up owing the IRS more money, your state of residence will probably want its due as well. So, don’t neglect your state obligations – or yet more tax trouble could be in store.
- Think twice before representing yourself. While it might be fine to correspond directly with the IRS about a math error or computer mismatch, be careful about doing it along in a formal audit. An experienced professional may be able to save time, trouble and money. Consider hiring a pro—a tax lawyer, certified public accountant or enrolled agent—or, if you can't afford that, try one of the IRS' tax clinics for low-income taxpayers. If you believe the IRS has treated you unfairly, seek help from the Taxpayer Advocate Service, an independent organization within the IRS that represents taxpayers.