How to Handle an Audit

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After all the time you spent filing your taxes, you just found out you're being audited. Don't panic... With a few practical tips, you should be able to emerge relatively unscathed on the other side of this ordeal from Uncle Sam. This guide to how to handle an audit will help you in managing this stressful experience.
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The content of this page is intended for general informational purposes only and is not a substitute for professional financial advice.

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After all the time you spent filing your taxes, you just found out you're being audited. Don't panic... With a few practical tips, you should be able to emerge relatively unscathed on the other side of this ordeal from Uncle Sam. This guide to how to handle an audit will help you in managing this stressful experience.
Disclaimer

The content of this page is intended for general informational purposes only and is not a substitute for professional financial advice.</note>
Introduction
- The IRS audited almost 1.4 million tax returns in 2007, which represents approximately 1% of all returns filed. There are essentially four types of audits undertaken by the IRS: Correspondence Audits, Office Audits, Field Audits, and NRP (National Research Program Audits). Whenever you get a letter from the IRS, it's bound to make you anxious. You may want to familiarize yourself with IRS Publication #1, Your Rights as a Taxpayer as well as IRS Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund.
The Three Most Important Rules of How to Handle an Audit
- These rules apply to any communication you receive from the IRS:
1. Don't Panic.
2. Don't ignore the notice.
3. Don't volunteer information that the IRS didn't ask for.
Handling an Automated Inquiry
- More formally known as an "Automated Adjustment Notice", the automated inquiry is not technically an audit, although it can lead to further examination if not handled properly. These notices are typically triggered when a document that the IRS received, such as a W-2, a 1099, or a 1098, does not match information you reported on your tax return. Automated inquiries can also result from a math error on your return. Along with the notice, you'll receive a recalculation of the tax the IRS believes you owe, and a response date.
1. Review the notice.
  1. Is the notice addressed to the right person?
    The IRS can make mistakes. Check to make sure that the name AND social security number on the notice are both correct. If they are not, return the notice to the IRS with a note explaining that you are not the person the notice was intended for.
  2. Has the statute of limitations expired?
    In most cases, the IRS must assess any additional tax due within three years of the return's due date (usually April 15 of the year following the tax year), or three years from whenever you filed, whichever was later. If this notice is dated after that, a note to the IRS referencing the relevant dates should end the matter.
  3. The notice will include a detailed explanation of the IRS's reasons for the adjustments. Compare the items on the notice to the tax return you filed, making sure you understand where each number came from.
2. Decide whether you agree or disagree with the IRS.
  1. If you agree with the adjustment, sign the forms, and return.
    There is usually an option for an installment payment, so even if you can't pay it all now, complete and return the forms.
  2. If you disagree with the adjustment, complete and return the response form, summarize your rationale in a letter, and include copies of any documents that support your position.
    For example, the IRS notice states that you did not report interest from ABC Bank. Upon looking at your return, you see that you listed the interest as coming from ABC Bank of Anytown USA. A copy of your schedule B, showing the interest as reported will probably be sufficient to end the matter.
3. Make sure you respond by the date indicated.
  - Return the form return receipt requested, so you have proof you responded in a timely manner.
Handling a Correspondence Audit
- A Correspondence Audit (sometimes known as a "Letter Audit") is the most common form of IRS audit, making up more than half of the audits the IRS does in any given year. It differs from an automated inquiry, because in this case a decision was made that a particular item on your return warrants further examination. Perhaps your charitable deductions were out of line with your income, or they don't believe you drove 80,000 miles for business last year? Or maybe they question your assertion that you have 16 children? In any event, they're making a request for information about an item on your return. In addition to making sure you read and understand the notice, as you do for an Automated Inquiry, there are some additional things you need to do.
1. If you had your taxes professionally prepared, contact your tax preparer.
  - They will be able to guide you through the process. In many cases, the initial consultation about a correspondence audit will be included in the price you paid for the preparation of the return.
2. Organize your records, making sure there is a clear "trail" from your documents to the amount reported on the return.
3. Include copies of documentation with your response.
  - For example, if the IRS is challenging your charitable contribution deduction, you'll want to send a schedule of each individual contribution you made, totaling to the amount you claimed on the return, backed up by copies of receipts.
  - If they're questioning your mileage deduction, you'll want to send them copies of your mileage log.
  - And for the 16 kids? Copies of the birth certificates!
  - Do not send the originals.
4. Be prepared for follow-up from the IRS, and negotiation.
What If I Can't Find my Documents?
- The best way to avoid this is to make sure you keep everything you used to prepare your return in a large manila envelope with a copy of the return. That way if you're audited, you just pull out your envelope, and you're all set. However, if you're reading this section, you probably didn't do that.
1. Some deductions, like that for business mileage, require that you keep a mileage log in order to claim the deduction. The log needs to be kept "contemporaneously" (i.e. noting down each trip as you make it), and you need to state that you've done this when you claim the deduction on the return. Some tax professionals suggest that in this type of situation, if you no longer have the documentation, you provide the IRS with a sworn affadavit supporting the deduction.
2. Other deductions, such as charitable contributions over $250, require letters of acknowledgment from the charity. In this case, you can go back to the charity, and ask for another letter. As long as they certify they received the deduction for the tax year in question, the fact that the letter was provided after the fact should not be an issue.
3. Information can also be reconstructed after the fact. Credit card companies and banks should be able to provide you with statements, receipts, and copies of checks. Town offices can give you duplicates of property tax bills.
Handling an Office Audit
- An Office Audit (also known as a Desk Audit), which is an audit conducted face to face in an IRS office, is more detailed than a Correspondence Audit, generally addressing either more complex or more numerous issues. In order to handle a desk audit, you need to do everything listed for the Correspondence Audit as well as the following:
1. Call a professional.
  - The IRS gives you an option to have a representative attend the audit in your place. This is an excellent idea, as if you're not in the room, you can't unknowingly volunteer information that might cause them to expand the audit.
  1. The American Accounting Association did a study in 2004, showing that taxpayers who had professional representation during an office audit payed less in taxes and fines.
  2. If you had a professional prepare your return, you'll want to contact that individual immediately. Most CPAs have relationships with the IRS office in your area, and it's possible that a phone call from your accountant to the IRS could resolve the matter without your ever having to go any further.
  3. If you prepared your return yourself, you'll want to engage a professional at this point. They can review your return and the IRS letter, and help you develop a strategy to respond to the IRS.
2. If you choose to attend the meeting with the IRS agent anyway, there are a few additional tips:
  1. Bring only the documents asked for.
  2. Be polite and respectful, never argumentative.
  3. Never give the IRS your only copy of a document.
  4. Don't leave your original records with the IRS.
    The IRS may insist on examining an original, but make sure that your originals are returned to you before you leave the office.
3. Don't sign anything without reviewing it with your preparer.
4. If additional tax is assessed, request that any interest or penalties be waived. Agents have some authority in this regard, but you probably won't be offered a waiver unless you request it.
Handling a Field Audit
- A Field Audit is usually initiated by the IRS when they anticipate complex issues that would require examining the books and records of a taxpayer onsite. The agents assigned are usually very experienced, and you can expect extensive interaction between the auditor and the taxpayer, and perhaps the taxpayer's staff. As with an Office Audit, stay calm, organize your records, and contact a professional. There are some additional things you should do if faced with a Field Audit however:
1. Try to switch a Field Audit to a Desk Audit.
  1. Have your preparer draft a letter to the IRS offering to bring all requested books and records to the IRS office, essentially shifting the audit from a field audit back to a desk audit.
  2. The agent will probably agree to at least an initial meeting in the IRS office, rather than your place of business
  3. If all their questions are answered, you've avoided a field audit
  4. If they still want to visit your place of business after the initial meeting, they'll probably spend less time there.
2. Before any onsite visit by the IRS to your place of business:
  1. Perform a pre-audit review of your books and records
    You can hire your accountant to do this, or do it yourself. The key is to look at your books the way an auditor would, identifying possible areas of exposure.
  2. Brief your employees.
    Make sure they understand to be polite and respectful, and not to volunteer information.
    Advise them to avoid chatter or casual conversation with the agent.
  3. Your preparer or a representative should be onsite during the audit.
    Just as with an office audit, you'll be better off having a professional manage your communications with the IRS.
Handling a NRP Audit
- Formerly known as TCMP (Taxpayer Compliance Measurement Program), the NRP (National Research Program) Audit is designed to assist the IRS in identifying areas where tax payers are apt to be out of compliance, so that they can focus future audit efforts on areas which have the potential to produce the most revenue. To achieve this end, they select approximately 13,000 returns, and audit 100% of the information on them. In an NRP audit, every item on the return will be examined, and every item must be supported by documents and receipts. It is time consuming, and will usually result in adjustments to your return. It is essential that you have professional representation during a NRP audit.
Conclusion
- The odds on being audited in any given year are small. If you are one of the fortunate few, however, it helps to be prepared. Get organized, stay calm, and make sure you don't volunteer any information that isn't asked for!
Resources and References | Add a Link
IRS Resources | Add a Link
- IRS: Publication 556 , Examination of Returns, Appeal Rights, and Claims for Refund
- IRS: Publication 1, Your Rights as a Taxpayer
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How to Handle an Audit

Table of Contents

Disclaimer

Categories

Disclaimer

Introduction

The Three Most Important Rules of How to Handle an Audit

Handling an Automated Inquiry

Handling a Correspondence Audit

What If I Can't Find my Documents?

Handling an Office Audit

Handling a Field Audit

Handling a NRP Audit

Conclusion

Resources and References | Add a Link

IRS Resources | Add a Link

Related Pages on Mahalo

References

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