Posted on | December 11, 2009 | No Comments
The IRS is stepping up audits of taxpayers at a rapid pace. Each of the past several years there has been a significant addition of Revenue Agents (RA) and Revenue Officers (RO); those responsible for auditing returns and collecting taxes. In addition, the IRS has been improving its already sophisticated computer programs, resulting in much more thorough and accurate reviews of tax returns, including comparisons to documents forwarded to the IRS by third parties; W-2s, 1099MISC, 1099INT and many, many others.
The number of audits has increased steadily each year for the past eight years in all categories, both personal and business tax returns. Of significant concern is that the IRS recognizes that small business owners, especially those who file Schedule C are prone to making mistakes and keeping poor records. Guess what? This is one of the areas where they are focusing their attention. Over recent years the IRS has received a lot of money in additional taxes, penalties and interest by auditing small Schedule C businesses.
So, why does the IRS audit tax returns? The IRS wants you to comply with the tax code by filing and paying on time. The IRS wants you to be intimidated. Our U.S. tax system is a voluntary one. The vast majority of us play by the rules; we file and pay on time. But, in order to get us to do that, the IRS puts the “fear of God” in us by auditing tax returns and getting maximum publicity on those high profile cases where they throw a celebrity or ordinary citizen in jail. The result is that most of us fear the IRS more than just about anything else. We get an IRS letter in the mail and many of us are paralyzed. We don’t want to open it!
The IRS has a sophisticated system of computer programs that it uses to determine who gets audited. Obviously, they don’t have the staff to audit everyone, so they have to select the ones that they think will be the most fruitful, i.e., result in the largest amount of taxes, penalties and interest. All individual tax returns are computer scored by the IRS DIF system. Discriminate Function (DIF) is a highly secretive mathematical technique used to score income tax returns as to their examination potential. Generally, the higher the DIF score, the higher the potential for audit. Once the IRS selects returns to be audited, it then determines what kind of audit it will do. One thing I want you to always remember.
The first type of audit is a CORRESPONDENCE AUDIT. This is the simplest form of audit, but has proven to be very lucrative to the IRS in terms of return on investment. The taxpayer receives a computer generated letter from the IRS saying the IRS is proposing to make an adjustment(s) to their tax return unless the taxpayer can substantiate (prove) the expenses he/she claimed on their tax return. The letter gives you 30 days to do so. As I’m sure you all know by now, when you are dealing with the IRS, in the vast majority of issues, the burden of proof is on you. You must respond to the IRS with documents that show you actually incurred the expense. Common issues handled by correspondence audits include mortgage interest, taxes, contributions and many more. Correspondence audits are usually focused on a few specific items in your tax return and are limited to that.
The next type of audit is the OFFICE AUDIT. An office audit means that you are summoned to the office of a local IRS Revenue Agent who will look at your return in more depth. These audits are generally focused on specific areas of your tax return but a RA can look are the entire return and even open up other tax years if he/she feels warranted. Many times small businesses are selected for office audits. As with the correspondence audit, the burden of proof is on the taxpayer. These audits are generally completed in one visit, just a few hours, assuming the taxpayer is prepared when he/she comes to the office.
The final type of audit and by far the most comprehensive is the FIELD AUDIT. As suggested by the name, in this case the RA comes to your home or place of business. In a field audit, expect to have a very experienced Revenue Agent and expect he/she to look at all aspects of your return, your personal financial life and, if warranted, other tax years as well.
So, what should you do if you are notified your tax return is being audited? First of all, if your return is selected for an audit, that in no way implies that you made a mistake on your return. Selection simply means that the IRS has one or more questions about your return. If it is a correspondence audit and if the audit is focused on a specific issue and you have substantiation for your deduction, go ahead and handle the audit yourself by following the instructions in the letter. If, after you have done so, the IRS still says you owe money, I highly recommend you hire an Enrolled Agent, CPA or attorney to represent you; someone with experience in dealing with the IRS.
If you are facing an office or field audit, I recommend you immediately hire an Enrolled Agent, CPA or attorney to help represent you. They will generally attend the audit in your behalf, but will require you to supply the substantiation required to prove your deductions/income in question. Someone experienced in dealing with the IRS can save you a lot of money and give you peace of mind especially in office and field audits.