Surviving a tax audit

Surviving A Tax Audit

You thought tax season was over. But suddenly you get it: the letter you've always dreaded. The one that says the government is going to review your tax return.

Partnerships and sole proprietorships are audited at a far higher rate than corporations, so small businesses stand a strong chance of finding such a letter in the mailbox. One thing is certain: Whether your tax returns are on target or off by a mile, you'll be caught up in the red tape of the federal bureaucracy.

But don't panic. A series of savvy moves can help you cut through the red tape of an IRS examination while defusing the time bomb that a poorly handled audit can turn out to be.

* Assume the Internal Revenue Service notifies you that it wants to review a specific aspect of your tax return--say your 1986 interest income--and sets a date for an examination at an IRS office. Your objective here is to keep the audit from extending beyond the initial focus of review (in this case, your '86 interest income).

How can you accomplish that? The best bet is to stay away from the audit and have a CPA represent you before the examiners. Accountants are experienced in the review process, so they're in the best position to keep the investigation confined to a narrow scope.

In some cases, it's possible to avoid this type of audit entirely. You do it by requesting a change of venue. Here is how it works: Assume the audit is scheduled for an IRS office in the town in which you live. If you have a valid business reason for requesting a relocation of the audit to another city (perhaps where your company is based or your papers are kept), it's possible that the case will be dropped.

"A return that may be targeted for audit in a small IRS office may not be considered a priority matter in a larger one," says Sheldon Gannis, a partner specializing in IRS matters for the national accounting firm of Spicer & Oppenheim. "For this reason, it's possible that a case shifted to this larger jurisdiction may fall through the cracks."

* The IRS informs you that it plans to conduct a "field audit," dispatching an agent to your home or place of business. Generally, this is a wider-ranging examination conducted by a more sophisticated auditor. Again, the best bet is to shoot for a change of the audit location, in this case from your home or office to the accountant's office.

"Fail to make this change of locale, and you may find the agent conducting the audit at your kitchen table," Gannis says. "Once he's in your home, the agent may snoop around, taking note of your furnishings, art work, antiques, personal papers--all of which can get him thinking and wondering and expanding the scope of the audit. Although the IRS can insist on conducting the review at your home or office, a request to hold the audit at your accountant's office will usually be honored."

* On the surface, a "mail audit" seems to be the least intimidating type of examination. Typically, the IRS sends you a letter saying there's a discrepancy in your tax return--perhaps you reported $4,000 in interest income, and the IRS has documents submitted by the banks indicating you got $4,500. The letter asks you to pay additional tax or to forward evidence to support the $4,000 figure.

No matter who you think is right, the key is to respond promptly. Although the IRS may give you 30 days to reply, don't push the deadline. Make every effort to respond within 10 days to two weeks. You'll want to demonstrate that you are cooperating with the IRS and are not ignoring the letter.

Fail to respond promptly, and the bureaucracy really kicks into high gear, igniting a process that you may find yourself unable to halt.

* If you've heard the horror stories about how your first audit can open a Pandora's box, leading to an annual review by an IRS agent, you'll be pleased to know of an obscure rule that can save you from perpetual harassment by the IRS. Called the "repetitive-audit procedure," this enables you to win cancellation of an audit if a similar examination in any of the two previous years failed to produce additional taxes due and if the amount of the deduction claimed currently has not changed substantially since the last review.

Assume the IRS sends notice that it intends to audit your 1986 business-travel deductions. If this part of your return was previously audited for 1984 or 1985--and neither examination resulted in taxes due--in most cases the IRS will honor a request that the 1986 audit be canceled under the repetitive-audit appeal procedure.

* Sometimes it seems you just can't win. That's the case when you do everything right--you pay your taxes on time, you answer mail audits promptly--and still the IRS reaches out for you, making threats, putting liens on your assets, warning of dire consequences if you don't comply with the law. "The bureaucracy is so big that sometimes it doesn't know that you are in fact complying with the law," Gannis says. "For example, when one of my clients was accused of underpaying his quarterly estimated taxes, we knew that the IRS had simply failed to credit an overpayment that he had made in a previous quarter. While we were trying to straighten this out at an IRS office, the computer kept generating threat letters."

Fortunately, there's a way to end this bureaucratic nightmare. You do it by contacting the IRS's problem-resolution office, a little-known arm of the tax agency that is empowered to freeze actions against you while you present your case to the appropriate officials.

To avail yourself of this service, call the IRS taxpayer-information number listed in your telephone directory, and ask to be transferred to a problem-resolution officer.

Mark Stevens is a nationally syndicated writer specializing in small business.

COPYRIGHT 1989 U.S. Chamber of Commerce
COPYRIGHT 2004 Gale Group