Financial Focus: IRS Audit Cometh

Financial Focus: I got an IRS letter for an audit; what do I do?

On a scale of 1 to 10 (10 being the worst), being audited by the IRS could be a 10. Audits can be bad and can result in a significant tax bill. But remember – you shouldn’t panic. There are different kinds of audits, some minor and some extensive, and they all follow a set of defined rules. If you know what to expect and follow a few best practices, your audit may turn out to be “not so bad.”

A little background first. There are three types of IRS audits: mail, office and field audits.

*Mail audits are fairly routine. They require you to mail in documents responding to specific questions or requests for information from the IRS. Mail audits make up 77% of all audits.

On the other hand, office and field audits are much more serious. The IRS will not only ask for information to validate your deductions and credits, but it will also look closely at your lifestyle, business activity and income to see whether your tax return is accurate. Most tax evasion cases start from field audits. But don’t worry – the IRS prosecutes few taxpayers for tax evasion. The IRS saves criminal prosecution for the most egregious tax evaders.

There’s also another way the IRS questions tax returns, but it’s not technically an audit. It’s the underreporter inquiry, or CP2000 notice, and it’s very common. The IRS sends almost 4 million of these every year. The CP2000 is a discrepancy notice that proposes a specific increase in taxes on your return. The IRS automatically sends these notices when there’s a mismatch between income you reported on your return and information that your employer or other payer provided to the IRS through statements, such as Form W-2 and Form 1099. A common example is when taxpayers don’t report Form 1099-MISC income from work they did as an independent contractor during the year.

Here are some numbers that show how common – or uncommon – the different types of audits can be:

About 150 million total federal tax returns are filed each year. The IRS audits less than one percent of filers. Almost 90% of audits result in a change to the tax return. For mail audits, the average amount owed is more than $7,000. For office and field audits, the average amount owed is $65,000. The IRS sends underreporter notices to about 2.5% of filers. About 66% of underreporter notices result in additional taxes owed. For underreporter notices, the average amount owed is about $1,500

As unpleasant as an IRS audit can be, it won’t go away. It’s important to respond. If you don’t, you will get a tax bill for additional taxes, and perhaps even penalties.

Here are a few things you should do to get the best results in an audit:

Consider hiring a tax professional immediately, especially if you are not fluent in “tax.” Unless you can “speak IRS” and can clearly articulate your tax return position to the IRS, you shouldn’t try to handle it yourself and hope for the best. Tax professionals trained in IRS audits will provide the response needed to clearly communicate your tax position. If there’s an adjustment, a tax professional can help address proposed penalties.

Most audits and all underreporter inquiries require corresponding by mail with IRS processing centers. There is no specific person assigned to your case, so the person viewing your response will rely on the quality and completeness of your response to interpret your tax position. If you want the best results, reply well before the deadline with an organized and thorough response that explains the items in question. Missed deadlines and incomplete responses lead to more notices and a higher likelihood that the IRS will close your audit and assess you additional taxes.

For office and field audits, prepare as if the IRS were auditing multiple years and your lifestyle. As the statistics show, office and field audits can result in a very high tax bill. That’s because the IRS looks to see whether there is any unreported income on the return. For example, the IRS can go through your bank statements and question deposits. Unexplained deposits can be considered taxable income if you can’t prove the nontaxable source, such as a gift or nontaxable sale of assets. Be prepared with an answer to these inevitable questions. A tax professional will be extremely valuable to help you prepare for office and field audits.

Know that the auditor’s decision is not final. The first appeal is made to the auditor’s manager. The second appeal is made to the IRS Office of Appeals. During the appeals process, it’s important to respond by all deadlines or you will lose important appeal rights.

So, how bad can it be? Potentially, a ’10’. But getting help from a tax professional, making timely responses and having thorough documentation will enable you to get through an audit with the best possible outcome.

Anthony Rivieccio is the founder & the CEO of The Financial Advisors Group, celebrating their 20th year as a fee only financial planning firm specializing in solving one’s financial problems. Anthony, a recognized financial expert since 1986, has been featured by many national and local media including: Klipingers Personal Finance, The New York Post, News12 The Bronx, Bloomberg News Radio, Bronxnet Channel 67 TV, The Norwood News, The West Side Manhattan Gazette, Labor Press Magazine, Financial Planning Magazine, WINS 1010 Radio, The Bronx News and The Bronx Chronicle.

For financial assistance or a FREE COPY of a 2015 Income Tax Guide, Anthony can be reached at (347) 575 5045 .

Print Friendly, PDF & Email
Share this Article: