For most people, the scariest words in the English language are “IRS audit.” Not “grim reaper,” not “root canal,” but “IRS audit.” You can just imagine this menacing IRS agent knocking on your door and handing you a tax bill for thousands of dollars.
You feel so helpless. You tell yourself, “Who am I to take on the big, mean IRS?” Well, you’re not helpless, because the Bradford Tax Institute is in your corner. Not only can you take on the IRS, but you can also beat them—
provided you know how to handle the audit.
The first step is to not panic. Just calm yourself and read this article.
We give you five tried-and-true strategies for dealing with an IRS audit. These are strategies that tax professionals successfully use in their tax practice.
What Are the Odds You Will Be Audited?
Before we discuss how you handle an IRS audit, you should know how likely an IRS audit really is. Two big factors determine your odds—how you operate your business and how much you earn.
Let’s take a look at the audit statistics from the IRS Annual Report for fiscal year 2015.
If you reported $200,000 or more in income on your individual tax return, the chances of an IRS audit were one in 38, according to the latest data. If you reported over $1,000,000, then you increased your chances to one in 10. If you reported over $10,000,000, then your chances were greater than one in three! More income increases your chances of an IRS audit.
Schedule C filers are on the IRS’s radar. If you reported over $25,000 in income on a Schedule C, then your chances of an audit were one in 43.
S corporation return audits are on the rise as well. While the chance of an audit was still relatively low, at one in 250, this was an 11 percent increase from the year before. Similarly, the chance of an audit of your partnership tax return was one in 196, an increase of 18 percent from the year before.
So, while the odds are in your favor to avoid an IRS audit, you need to prepare yourself just in case. This is especially true if you are in one of the agency’s targeted groups—Schedule C filers, pass-through entities (S corporations and partnerships), and millionaires.
Strategy 1. Know When to Hire a Tax Professional
Let’s assume you were not in the “lucky” category and the IRS chose to audit you. What do you do now? It depends on whom you will face in the audit: a tax auditor or a revenue agent.
Tax auditors usually have basic accounting knowledge and are not tax experts. The auditor simply follows a set of questions given to them by someone else in the agency.
· receive training in tax law from the IRS,
· have substantial freedom in how they conduct the audit, and
· are more versed in the rules and regulations.
If the IRS calls you into their office, you likely will meet with a tax auditor. If you are not the nervous type and have the right personality for this, you may want to go to the audit yourself after consulting your tax advisor. You and the auditor will generally speak in nontechnical terms. You don’t have to agree to anything during the audit, and that gives you a second chance if you need it.
On the other hand, if the IRS comes to see you, expect a revenue agent. In this type of examination, you want your tax professional with you. In most cases, your tax professional speaks the same technical language as the revenue agent, and this helps ensure that you don’t lose your rightful deductions.
Strategy 2. Create an Audit File
Create a separate IRS audit workpaper file and include only the items listed in the audit notification letter. This ensures that you don’t hand over other files from your records that will either confuse the agent or open a can of worms on a different matter.
Additionally, if any calculations are unclear (e.g., you grouped numerous items together on a line in the tax return), prepare a supplemental schedule to help the agent understand your numbers. This will cut down on the questions that the agent will have for you.
If you took a certain tax position based on tax research and that’s under IRS scrutiny, include a copy of the research in the file with the relevant information highlighted.
Remember, the fewer questions the IRS has for you, the shorter the audit, and the better your life will be.
Strategy 3. Follow the Double Copy Rule
When the revenue agent comes to your business, never give him or her free access to your copy machine. In fact, don’t allow the agent to bring his or her own copy machine. This kind of open access only works to your disadvantage.
Instead, you should follow the double copy rule. Offer to make copies of the requested documents for the agent. Give the agent one copy and keep one copy for yourself. Having a copy of each requested item allows you to monitor the issues the agent is focusing on.
Strategy 4. Know Which Laws Beat the IRS
When you square off against the IRS, it’s important to know which tax laws trump the IRS arguments.
The tax code will always be the last word in any tax argument. It’s the bible of tax and beats any argument to the contrary. If the code is on your side, then you are golden. If it’s against you, then don’t even waste your time arguing.
Next in the hierarchy come regulations, followed by prior case law, and finally IRS documents.
Always look for the highest authority when making your case. If nothing speaks to your case, then go to the next level down and search again.
Read Find the Winning Tax Law for Your IRS Audit for more details on understanding the tax authority to which the
IRS gives credence.
Strategy 5. When All Else Fails, Pay Installments
If you fought the good fight but still lost, consider paying in installments. The less you owe, the easier it is to get an installment plan approved.
If you owe less than $50,000, the IRS will let you apply for an installment agreement online by submitting Form 9465, Installment Agreement Request. If you owe more than $50,000, you need to contact the IRS and submit the required financial information.
There’s a fee ranging from $31 to $225 for setting up the plan. Interest and penalties still accrue during the payoff period, so use the installment plans when it’s too difficult to pay your bill at once.
See Owe Back Taxes? Try Deals that the IRS Accepts for more payment options.