How to Survive a Tax Audit
You managed to meet the tax deadline, but you may not be finished with Uncle Sam. Though it’s pretty rare, you never know when you might be called on the carpet and get audited. It’s not cause for panic though.
Here’s what you need to know about successfully navigating the audit process.
Don’t assume the tax authorities are correct
Larry Elkin, a certified financial planner and president of Palisades Hudson Financial Group offers much advice: Know that federal and state offices send out huge numbers of notices advising taxpayers that they owe money. Most result from simple data or reporting errors the tax authorities believe you made, says Elkin. However, if you carefully gathered your tax information and had someone competent prepare your return, there is a good chance the notice is incorrect.
Do not just pay the bill. Check the facts first, or ask your tax preparer to investigate. If the tax authorities’ figure is wrong and yours is correct, you should be able to clear up the matter routinely.
With field audits, where the IRS or your state agency goes through your records with a fine-tooth comb, the situation is far more complex. “Unfortunately, the tax agent may not fully understand the law, or even the facts,” says Elkin.
Field agents often lack a detailed knowledge of applicable tax law, or may seem to make up rules that are not in the tax code or regulations, he adds. “That’s because they are typically some of the least experienced and least trained personnel in the enforcement staff – those with greater knowledge tend to be promoted to review-level positions,” says Elkin.
Don’t go it alone
The audit process works best when it is limited to the issues the auditor raises. Your presence invites incomplete or incorrect off-the-cuff answers to the auditor’s questions. An effective taxpayer representative (usually a CPA, attorney or IRS-authorized enrolled agent) will find out what the auditor wants to know, gather the information and present it clearly and concisely without triggering collateral issues.
Skilled professional representation is expensive, and your representative does not control how many hours the audit will consume – the auditor does. Auditors do not care how much they cost you in professional fees, says Elkin. Sometimes, tax authorities seem to have a pretty good idea how much it will cost a taxpayer to appeal or litigate a dispute and offer to settle for about the same amount, he adds. “It may be worth accepting such an offer if the auditor raises a valid point.”
Once you hire help, get out of the way. “You have nothing to gain by participating in the process,” says Elkin.
Do not extend the statute of limitations
You have a few months after the end of the year to file your tax return. The authorities generally have three years thereafter to examine it and ask anything they want. Auditors have heavy caseloads, however, and they like to manage them by asking taxpayers and their representatives to waive the three-year limit. Taxpayers usually grant such request. “Just say no,” warns Elkin.
Waiving the statute allows the agent to drag out the process, inflating the taxpayer’s cost for representation and increasing potential interest and penalty charges. It gives the agent more time to raise more issues. It lets the agent raise additional issues if new legislation, regulations or court decisions provide support. “You get no benefit,” says Elkin.
Do not be bullied or intimidated
Most agents will not threaten, yell at or mistreat you, but an occasional miscreant will, says Elkin. If that happens, documenting the misconduct so that the agent’s supervisor or an appeals officer might learn about it, is one way to handle the situation. Another is to simply ask to speak with the agent’s supervisor.
Keep excellent records
If you can demonstrate that your tax return is correct and complete, and that you have taken positions that comply with the law, you should have no problems if you are audited.
Realize that even the best tax professional representing you must work with information you provide. It you don’t have a system to efficiently maintain the records you need, your tax adviser can help you set one up, or maybe even maintain the records for you.
You will get the best results through helping the auditor do his or her job well, by offering information that is credible, responsive and well organized.
Pay what you owe, promptly
Interest and penalties, including penalties for late payment, add up quickly. If you have the money to pay what you owe, pay it. It is possible to get installment plans and even compromises on tax debts, but the tax authorities do not cut great deals for solvent taxpayers.
If an auditor raises an issue in which you are clearly wrong, concede the point. Owning up builds credibility and shows the agent (and any appeals officer who reviews the case) that you are making a good-faith effort to comply with the law. That credibility might earn you the benefit of the doubt on other issues, such as minor gaps in your records.
Lastly, says Elkin, “Your goal in an audit should be to show the auditor that it is time to move. That’s the quickest, safest route through the audit minefield.”
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