IRS Tax Audits: One Person's Story and Tips from Tax Experts
How one person kept her cool and won a tax audit with the IRS
My friend Susan (not her real name) was recently audited by the IRS. Here's her story:
When I received a legal size envelope in the mail from the IRS, I opened it immediately. We were being audited. I called the office mentioned in the letter and scheduled a time to meet. An IRS auditor was coming to my office. I had heard the horror stories – you know, people losing their income after going through an audit.
Why does the IRS always seem to come out on top when bad things happen to people?
I got ready for the audit by pulling out all my documents. The IRS had sent me a list of what they wanted to see, mentioned in an Information Document Request, which was included in the packet they mailed to me. I usually keep tax returns and documents in the filing cabinet. And for this year I also went through the extra effort of scanning all our documents onto our hard drive. So I had two places to dig through documents. Out of the filing cabinet came a copy of the requested tax return, 1099s, and profit and loss statements for our businesses. We have multiple Schedule C's for separate businesses. I had prepared the returns myself, always have, and decide to work with the auditor on my own, without representation. I can do this. I know I can.
I spread the papers across my work table. I reviewed all the profit and loss statements and compared them to the tax return, line by line.
I found a few entries in the wrong place, and its position did make a difference to the bottom line.
What to do?
Others said I shouldn't mention it to the auditor. I knew the errors would probably be obvious, and I wanted to put it out there.
When the auditor showed up at my office for our first meeting, I gave him a brief tour of the office and then we went into a conference room we use for meeting with clients.
I told the auditor upfront about the mistake I found on our tax return.
The auditor noted the errors and went on. He acted very business-like. Like it wasn't a big deal.
After the auditor looked over the documents I had organized, he gave me my next project. I would have to total up every bank deposit and compare it to my declared income. His tone of voice was pleasant, and he wasn't intimidating. I told the auditor, "sure."
So after the meeting was over, I pulled out all my bank statements for the year. Some of them were in my filing cabinet. Some I downloaded from my bank’s Web site. I created a spreadsheet. I don’t remember exactly how long it took, but it was a few weeks. We have multiple bank accounts, and we flip money back and forth between the account I use most of the time and another account. I looked at each deposit on each bank statement and typed the information into my spreadsheet; going through it, again and again, flagging all transfers from one account to the other.
The purpose of this spreadsheet was to explain how the totals on the bank statements were over the amount of income we claimed on our tax returns. This deposit was a loan paid back to me. That deposit was from a garage sale.
A few years down the road some deposits were hard to remember without a bit of research. Now I flag every deposit that's not income with a complete explanation.
The auditor had a list of deductions he was to look at specifically, so I had to find receipts. Some of the receipts were gone. Luckily, I did find many of the missing receipts – and some were for things I did not claim on our tax return. Maybe the deductions I didn't claim would balance out the deductions I couldn't find receipts for?
In the meantime, it was tax time. We didn't file our current tax return while we were being audited since that opens the door to scrutiny of the return. And there was no time to do it anyway. So we filed an extension.
The audit had been going on for a few months. All of that time I spent looking for documents, organizing them, and explaining what was going on to the auditor.
Eventually, we received another letter from the IRS in the mail. No changes were going to be made to my return.
I was relieved. The auditor could have charged us tax and did not. I felt like I had my life back. I have finally worked through an IRS audit.
Keeping your cool, treating the auditor with respect, and showing the auditor you are trying to obtain things to the best of your ability makes a big impact.
Our next return will be perfect and easy to examine if an audit occurs.
What Susan Did Right
Susan is "very business savvy," observes Mike Habib, an enrolled agent and fellow of the National Tax Practice Institute. She was "honest with auditor, good thing. Gave a tour of the business, so he got an idea of the operation. Gave him bank statements, so he had proof of payment even though the receipts were lost." If a client asks for representation in an audit, the first thing is to prepare a new tax return from scratch, so we can show the auditor "how the return should have looked like," Habib said. "She did almost that," Habib went on to say, by comparing her documents to the tax return line-by-line.
"She may have established credibility with the auditor as an honest person," says Frederick Daily, a tax attorney and author of Surviving an IRS Tax Audit, "or the auditor had determined early on that she was a credible taxpayer, I tell my people look, how is this going to turn out? Well, you know, I could take this audit in front of 10 different auditors and get 10 different results. [It's an] art as well as science. [IRS agents have] a lot of discretion. She must have been credible enough to accept explanations without documentation."
What to Do First When You're Being Audited
- Read the letter from the IRS and the accompanying Information Document Request.
- Get out your copy of the tax return for the year in question.
- Read the IRS letter again.
- What does the IRS want you to do?
- Look over your tax return.
"First thing I look at ... is … the letter and take a look at the tax return, figure out why they got audited, then zero in on that," says Fred Daily.
Next, identify what type of audit the IRS is conducting. You can identify the type of audit by what the IRS wants you to do.
- Does the IRS want you to mail receipts and documents for them to review? That's what we call a correspondence audit.
- Does the IRS want to schedule an appointment for you to come into their office and bring your documents with you? This is an office audit.
- Does the IRS want to send an agent to visit you at your office? This is called a field audit. "You should ... be really concerned with [a] field audit," says Fred Daily. This is the highest level of seriousness.
Identifying the type of audit lets you know two things straightaway:
How serious the IRS is, and how you're going to communicate with the IRS agent.
"[The] most common audit now ... are correspondence audits. Usually pretty cut and dried," says Daily. In a correspondence audit, you mail copies of your receipts or other documentation to the IRS, along with any notes or explanations. An IRS agent reviews your documentation and lets you know by mail whether there's an adjustment to your tax return.
An "office audit is a dying thing, they were going to eliminate it altogether," says Daily. In an office audit, you bring in your documentation and receipts to a local IRS office, and you sit down with the auditor and go over everything in person. You find out right away what the auditor is thinking, and what adjustments they are proposing.
A field audit is where an IRS agent comes to visit you at your business or at your accountant's office. "That's a different animal," Daily says, "They use their best auditors." He went on, "almost always [the target is a] self-employed person."
Tips for Success in a Tax Audit
- "Be prepared and organized before meeting with the auditor."
- "If there is an audit technique guide published for your situation, read it. It will tell [you] what specific questions the auditor will ask."
- "Make the auditor's job easy."
- "If you look and act prepared the auditor's first impression will be positive rather than negative."
--Pat Michael, enrolled agent
- "Establish deadlines from the get go." The IRS is pushing agents to complete audits within 90 days, Habib told me. "If he really doesn’t have a case, close it and move on."
- "Don't be afraid to push back." Ask questions and seek clarification.
- Question your auditor about penalties. Some people just accept the penalties without question.
--Mike Habib, enrolled agent
Finding the Right Tax Professional to Represent You in an Audit
Assess your comfort level. Do you want to handle this yourself? Do you prefer to have someone else talk to the IRS for you?
If you decide to hire someone to help you with a tax audit, you should look for either an enrolled agent, certified public accountant or attorney. Professionals with these credentials are permitted to represent you before the IRS in a tax audit. Additionally, some professionals complete further training to become fellows in the National Tax Practice Institute. This is an educational program for training tax professionals how to handle audits and other types of tax problems.
One thing you might want to do is consult with a tax professional for an hour or two. Fred Daily said that during an initial consultation, he can get a "general feeling what the possible damage is in the case, and advise the people if they should get a rep to handle it."
Some reasons to hire a properly credentialed tax professional:
- They can meet the auditor with you.
- Or they can meet the auditor by themselves. You don't have to attend unless you want to.
- You don't feel comfortable dealing with the IRS.
- You need help organizing your documentation.
- "If you don’t have what they are asking for, ... see a tax pro," says Fred Daily. Tax professionals are trained in how to handle this situation and can advise you on what your options are.
Frederick Daily is the author of Surviving an IRS Tax Audit (Nolo Press) and a tax attorney in private practice. He can be reached through his Web site: taxattorneydaily.com.
Mike Habib is an enrolled agent and fellow of the National Tax Practice Institute in private practice in Southern California. He can be reached through his Web site: myirstaxrelief.com.
Pat Michael is an enrolled agent in private practice in San Diego, California.
- Your Rights as a Taxpayer, Publication 1, pdf, IRS.gov
- Examination of Returns, Appeal Rights, and Claims for Refund, Publication 556, IRS.gov
- The Examination Process (Audits By Mail), Publication 3498-A, pdf, IRS.gov
- IRS Audits (an overview), IRS.gov
- IRS Audit FAQs (frequently asked questions), IRS.gov
- Audit Technique Guides (industry- and issue-specific guidance), IRS.gov
- Cash Intensive Businesses Audit Techniques Guide, IRS.gov