Your Rehearsal of Tax Audit!

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How to handle tax audit

Let us discuss the process of tax audit preparations and how to handle the outcome of tax audit.

If you authorise a representative to appear before IRS agent, then he/she will do most of the work. However, if IRS is particular about asking you, it will issue a summons. Just because you are present with your representative at hearing, IRS agent cannot start questioning you. You can stop that under the pretext of consulting with your counsel.

As for every other exam, the key for this audit is to prepare in advance. You should organize your records sequentially, so don’t mess up at audit leafing pages one after another.

If the tax auditor goes on asking you questions on items which are not mentioned in his notice, then you can refuse to answer. You can tell the agent that you need to refer your records. May be you can ask for another meeting. If the agent decides it not worth the effort, he may drop the issue.

You should always be polite, avoiding clashes. These will not end the issues smoothly. However, if the agent is acting unreasonable, then you can tell clearly that you may go to the court to win your point. A hesitant approach may weaken your position to reach out a settlement.

If IRS informs you of a field audit, its advisable to hold the examination at your representative’s office. If you do not have a representative and the examination is conducted on your business place, then try to isolate the area where the examination is going to take place. Ensure that there are no distractions for the agent due to office operations. Warn your employees not to respond to questions on your business.

Audio Recording

You can make an audio recording of the interview. Video recording is not permitted. You need to give at least 10 days clear notice for audio recording before the interview. Requests made thereafter are at the discretion of IRS. You are responsible to bear for the expenses of recording.

Mistakes in Returns

IRS can impose 20% penalty for the underpayment of tax. Generally the reasons for such a penalty are – negligence, disregard of IRS regulations, understatement of tax liability, over-valuation of property. If you are able to show some reasonable cause for this underpayment, these penalties may be waived.

Changes proposed after Audit

Generally the IRS agent will propose changes. If you agree, then the agent will ask you to sign form 870. This form once signed, will allow immediate assessment of tax deficiency and penalty as well as interest. By signing on that form, you are actually limiting the interest added to your deficiency. Of course, the signed form 870 does not prevent an IRS agent to assess further deficiency. If such further deficiency is assessed, then you are forwarded a revised form 870. Generally, the case is closed on first signing the form.

You may disagree

If you feel the decision of the agent is inappropriate, you can ask for an immediate meeting with a supervisor to tell your side. If no agreement is reached in this meeting, the agent will prepare a report on the proposed adjustments. You are given 30 days to decide whether to request for a conference. You may decide not to ask for conference.

The Conference

If the disputed amount is under $25,000, you are not required to prepare a written protest for a conference. In the written protest you are supposed to present the reasons for not agreeing with the report of the agent. However, even if a written protest is not required, you have to provide a statement mentioning the reasons for not agreeing with the agent. You may appear in person or through your representative at the conference. You can also bring witnesses. Actually the conference is conducted informally and you are given an opportunity to present your case. If settlement is not reached, then you will get a notice of deficiency, which will inform you that at the end of the 90 day period from the date of the notice IRS will assess the additional tax.

If there is an unreasonable delay by IRS agent in completing the audit, you can file form 843 for abating interest which is due to unreasonable delays or errors of IRS agents.

Courts – your final resort

On receiving 90 day letter, if you are still confident about your position, you can take the case to Court. For deficiencies of $50,000 or less you can file your petition with a Tax court. Such cases are handled quickly. But the decision of the Court is final. You or IRS cannot appeal the decision.

There is another way. You can pay the tax, file a refund claim and once the refund claim is denied, you can file the petition in a federal district court. The decision to go to such a court should be taken in consultation with an experienced tax practitioner.


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