A Tax Audit Success Story and Tips From Audit Experts

How One Person Kept Her Cool and Won an IRS Tax Audit

Documentation Is a Crucial Factor in Winning Any Tax Audit
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"Susan," not her real name, recently received a legal-sized envelope from the IRS, telling her that she and her husband were being audited. Like any other red-blooded American, she panicked. She'd heard the horror stories of people losing their entire incomes after going through an audit. Fact or fiction? Does the IRS always come out on top? 

Susan called the IRS office designated in the letter and scheduled a time to meet. An IRS auditor would meet her in her office. 

Getting Ready for the Audit 

Susan prepared by gathering documents. The IRS had sent her an Information Document Request listing what they wanted to see: copies of tax returns, 1099s, and profit and loss statements for their businesses. Susan had multiple Schedule Cs for separate businesses. She'd prepared all the returns herself and she decided to work with the auditor on her own, without representation. 

She reviewed all the profit and loss statements and compared them to her tax returns line by line. And she found a few entries in wrong places. The positions of the erroneous entries did make a difference to the bottom line.

The First Meeting 

When the auditor showed up at Susan's office for their first meeting, she told him upfront about the mistakes she'd found on one of the tax returns. The auditor noted the errors and went on like it wasn't a big deal.

After the auditor had looked over the documents she'd organized, he gave her another project. He wanted her to total up every bank deposit and compare it to her declared income. His tone of voice was pleasant, and he wasn't intimidating. 

Sorting Through Bank Statements 

Susan pulled out all her bank statements for the year and she created a spreadsheet.

She and her spouse had multiple bank accounts, and they were in the habit of flipping money back and forth between the account she used most often and another one. She looked at each deposit on each statement and typed the information into her spreadsheet, reviewing everything again and again and flagging all the transfers from one account to the other.

The purpose of the spreadsheet was to explain how the totals on her bank statements were more than the amount of income they'd claimed on their tax returns. A few years down the road, some deposits were hard to remember without a bit of research. 

Identifying Receipts 

The auditor also had a list of deductions he specifically wanted to look at, so Susan had to find receipts as well. Some of them were long gone. Luckily, she did find many, and some were for things she hadn't claimed on a tax return. Maybe the deductions she hadn't claimed would balance out the deductions she couldn't find receipts for. 

The Outcome 

The audit ended up going on for a few months. Susan spent all that time looking for documents, organizing them, and explaining them to the auditor. Eventually, she received another letter from the IRS. No changes were going to be made to her returns. The auditor could have charged her additional tax and even penalties, and he had elected not to do so. 

What Susan Did Right

Susan is "very business savvy," observes Mike Habib, an enrolled agent, and a fellow of the National Tax Practice Institute. She was "honest with the auditor, a good thing. She gave a tour of the business so he got an idea of the operation. She gave him bank statements so he had proof of payment even though the receipts were lost."

"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 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 a science. IRS agents have a lot of discretion. She must have been credible enough for him to accept explanations without documentation."

What to Do First When You're Being Audited

  • Read the letter from the IRS and review 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?

Next, identify the type of audit the IRS will be conducting. You can identify it 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.

Correspondence Audits 

"The most common audits now are correspondence audits. They're 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 will be an adjustment made to your tax return.

Office Audits 

"An office audit is a dying thing, and they were going to eliminate them altogether," says Daily. You bring your documentation and receipts to a local IRS office and you sit down with the auditor and go over everything in person. You'll find out right away what the auditor is thinking and what adjustments he's proposing.

Field Audits 

A field audit is where an IRS agent comes to visit you at your place of business or at your accountant's office. "That's a different animal," Daily says, "They use their best auditors. The target is almost always 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. 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, look for either an enrolled agent, a certified public accountant, or an attorney. Professionals with these credentials are permitted to represent you before the IRS in a tax audit. Some professionals also complete further training to become fellows in the National Tax Practice Institute. This is an educational program that trains them on how to handle audits and other types of tax problems.

You might want to at least consult with a tax professional for an hour or two. Fred Daily says 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 representative to handle it."

A properly credentialed tax professional can meet the auditor with you, or he can meet the auditor by himself. You don't have to attend unless you want to. You might not feel comfortable dealing with the IRS, or you might need help organizing your documentation.

"If you don’t have what they're asking for, see a tax pro," says Fred Daily. Tax professionals are trained in how to handle this type of situation and can advise you on what your options are.

Sources:

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.