Here's Exactly What Happens If The IRS Audits You
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It's a scenario many taxpayers entertain: What would happen if I was audited?
With April 15 in the rear view mirror, some taxpayers are finding out. Still, the odds of being audited are slim: According to the Internal Revenue Service, less than 1 percent of individuals' returns were audited in 2013, and fewer audits are expected this year due to budget cuts.
High-income taxpayers and self-employed individuals have the highest chances of being audited, according to Robert McKenzie, a partner at the law firm Arnstein and Lehr LLP in Chicago who previously worked in the collection division of the IRS.
Bob Fodera, a partner with ParenteBeard. an accounting firm headquartered in Philadelphia, agrees, adding that taxpayers who have claimed inconsistent deductions over the years are more likely to be audited. And if your spouse has a small business, especially one the IRS considers more of a hobby, that, too, is often a trigger, Fodera says. "I've seen this come up with amateur photographers quite often," Fodera says.
So if you've recently received a letter or notice from the IRS informing you that you're being audited, what can you expect – and what should you do?
What to expect.
If you're like Elizabeth Safran, 45, who owns a public relations company in New York City and files as a sole proprietor, you will probably feel "fear, later followed by shock," she says, when you receive the letter.
When Safran received hers in 2011, she reread it a couple of times. "It was a whole lot of text. I saw the years 2008 and 2009 and Schedule C," Safran recalls.
She struck out on her own as a public relations consultant in 2007 and the new, single mom was understandably petrified. But it was the spring of 2011, and she had until July to gather her paperwork and visit the IRS office in midtown Manhattan.
While some fear is understandable, don't let it consume you. "The first thing to do is not to be overwhelmed and shut down," says Mike Campbell, a tax partner at BDO USA LLP, a professional services organization headquartered in Chicago.
According to McKenzie, there are three types of audits: correspondence, office exam and field exam.
The correspondence audit is conducted through the mail, and it’s common – McKenzie says 80 percent of individual audits are done this way.
The office exam requires face time at an IRS office, which is what Safran experienced. "It normally lasts four hours or less, and by necessity, the IRS only reviews limited issues on the return," McKenzie says.
The field exam is a comprehensive, thorough audit that strikes fear in the hearts of taxpayers. It's usually held at the taxpayer's place of business, and McKenzie says it involves "hours of intense review and verification by a revenue agent."
It’s important to be honest and respond as thoroughly as you can, Campbell says. But he adds: "It's not necessary to volunteer additional information outside of the scope of the audit, as that will only lead to new potential questions and possible expansion of the scope of the audit."
You could also end up slowing the process if you throw every bit of information and data you have at your IRS agent, he says.
When Safran went to the IRS office, she says she was pleasant and professional and had a feeling the agent appreciated it. After she met her contact, they walked back to an office and passed another office where a taxpayer was shouting, "I paid cash! I didn't pay with receipts!"
Read: 8 Errors You're Most Likely to Make on Your Tax Return
Don't be that person, Safran suggests.
But you shouldn’t be a doormat, either. Richard Houston, a Los Angeles businessman who specializes in website development, says he was audited in 1975 for tuition and related education expenses. "Even though I didn't complete the rest of the courses required for a degree, I was in total compliance with the IRS code and the appropriate regulations," he says.
Houston went to his local IRS office armed with a reference book ("U.S. Master Tax Guide," published by CCH) and showed the agent why he believed the deduction was allowable.
The agent disagreed. Houston then asked to talk to the supervisor, and after a discussion, the deductions were allowed. "Be prepared and be armed with the truth, because they aren't pushovers," Houston says.
What’s the worst that could happen?
That's what everyone wants to know. If you can't show the records requested, will you go to jail?
You're probably not going to the clink. "Generally, only in extreme cases of willful negligence and tax evasion does someone end up in jail," Campbell says.
But an audit experience could be expensive. "In most audits, the worst that can happen is that the IRS would adjust your return to remove deductions you claimed and can’t substantiate or include income you may have omitted," Campbell says. "Then you would pay the tax due, plus interest from the time that tax should have been paid."
That's assuming the IRS feels you’ve been cooperative, because as Campbell says, "The IRS can also choose to assert a 20 percent accuracy-related penalty under Section 6662 if it deems even your mistakes on the return to be egregious or to represent a substantial understatement of your tax liability."
And, of course, if you have to hire an attorney or accountant to help you organize paperwork or make your case, that will also require an outlay of funds.
Above all, if the IRS comes up with a figure that you owe, don’t neglect to pay. The agency can “garnish wages and put liens against your assets and other avenues to collect the tax, interest and penalty," Campbell says.
Advice for the hopelessly disorganized.
Tax experts advise keeping good records in case of an audit, but what if you haven't done that?
Michael Raanan, a former IRS revenue officer and president of Landmark Tax Group in Santa Ana, California, says you might have luck gathering records from your employer or previous employers, your bank or financial institution, the IRS (if you've lost your old tax returns), your tax preparer or bookkeeper and your mortgage lender.
Types of paperwork to gather include "sales slips, credit card receipts and other proofs of payment, invoices, canceled checks, bank statements and, of course, mileage logs," Raanan says.
The logs are very important if you've deducted a lot of miles. "Without a mileage log or a GPS record of mileage incurred, it would be difficult for the IRS to accept all of the miles claimed," Raanan says.
See: Avoid These 10 Common Tax Mistakes
And, sure, spending all this time on your taxes is, well, taxing, but it’s worth it to be as prepared as possible for your audit.
That’s what Safran found. Before her audit, she faced the possibility of owing the IRS $40,000. In the midst of running her business and adjusting to motherhood, she traveled the paper trail, gathered every document she could and asked for an extra month when she realized she needed more time (the IRS obliged).
After the three-hour meeting, Safran's tax bill was whittled down to $5,000 since her paperwork supported the numbers on her return.
"I think if I had had better documentation, I could have gotten it down to $3,000," Safran adds.Source: www.businessinsider.com