Tag: IRS Audit

  • How an IRS Audit Starts

    An IRS Audit is a review of an individual’s or business’ accounts and financial information to ensure they are complying with tax laws and paying the correct amount of taxes. The IRS is focused on collection issues and selects tax returns for audit where they think they will be able to find additional taxes due. With preparation and advice, you can fight an IRS audit.

    IRS Letter 566
    Most taxpayers who are being audited by the IRS receive a letter. IRS Letter 566 is a notification of a correspondence audit. The letter will indicate what items on your tax return are being audited. Some common tax return items that might be included:

    • Adjustments to Income
    • Schedule A – Itemized Deductions
    • Unreimbursed Employee Expenses
    • Schedule C – Gross Receipts
    • Schedule C – Expenses
    • Tax Credits

    The IRS will also include Form 886-A which lists the documentation they are requesting. Since you have 30 days to respond to this IRS request, you should start gathering the paperwork listed on this form. Often, the IRS will ask you to fill out additional forms detailing your expenses or other accounting info.

    In a correspondence audit, the response to Form 886-A is your defense of your tax return. An experienced tax resolution specialist can help you present the best and most complete response to the IRS. The IRS will examine these documents carefully to find ways to disallow expenses and credits, while looking for extra income in order to assess additional taxes. Filing your response in the best possible way is a crucial first step in emerging from an audit with the least damage possible.

    Many taxpayers are not sure how to substantiate their tax return items or may be missing certain documents. It is prudent to speak to someone who can help you find the best strategy for presenting your case to the IRS based on what they have seen IRS auditors ask for in the past.

    IRS Letter 3572 and IRS Letter 2205
    Some taxpayers receive IRS Letter 3572 or IRS Letter 2205. The IRS is asking for a field audit. They are asking the taxpayer to bring documents and records to the IRS office for an examination there. Or they may ask to conduct the audit at your business. Be wary of this tactic. Consult with a professional before scheduling an IRS auditor appointment at your own premises. A tax problem specialist is familiar with the IRS audit techniques for your business and can advise you on strategy.

    While you may feel that your income tax return is accurate and that you are able to prove this to a trained IRS auditor, i do not recommend attending this meeting yourself. The auditor will ask you many questions and will try to expand the scope of the audit, given the chance. It is difficult to be objective when the IRS is examining your own taxes.

    IRS Letter 3572 and IRS Letter 2205 will ask you to call the IRS to schedule an appointment. Once you do, and every time you call the IRS, they will ask you additional questions to gather as much information as they can. Instead, you should call a tax problem specialist. Once you’ve signed a Power of Attorney, they can speak to the IRS on your behalf and meet with them to defend your tax return.

    A field audit is more serious than a correspondence audit. Both of these IRS audit letters indicate that an IRS employee has already researched your return. Generally, they provide just 10 days to respond so do not delay.

    IRS Audit Telephone Call
    The IRS may call you instead of sending a letter for an office audit. Be careful. Instead of scheduling an appointment, you should tell them that you will be contacting a representative to meet with the IRS. Write down the IRS auditor’s contact information and call a tax problem specialist for help. Once you have signed a Power of Attorney, they can call the IRS auditor and begin working on the best defense of your tax return.

    All taxpayers are entitled to representation and it can make a big difference in the outcome of an audit.

  • Why Am I Being Audited?

    Wondering how you got chosen to be audited by the IRS? There are several avenues that may lead to the dreaded IRS examination. If you omit income that was reported to the IRS, their computers will pop-up and send you a notice to correct the error. This may get your return pulled for a closer look. Be sure to include all 1099s, w-2s, etc. If the income listed on the form does not belong to you, contact a tax professional for help.

    Another way that computers help the IRS find potential audit targets is your DIF score. What’s that? It is a Discriminant
    Inventory Function System score. We don’t know how it is calculated but the IRS does! Tax returns are scored automatically and those that have a high score might be audited.

    The formula for a DIF score is a closely-guarded IRS secret but we can speculate that very high deductions for your income or similar anomalies could trigger an audit. However, if you have good records for unusual deductions — by all means, take the deductions. Most likely, the DIF score formula is a combination of several factors; we just don’t know.

    In order to calculate DIF scores, the IRS seems to do research. You may be selected for a personal or business income tax audit to help the IRS fine-tune its audit-selecting prowess.  Many audits under the National Research Program are very, very thorough. I sincerely hope this does not happen to you.

    Instead, may you be fortunate enough to win a big prize, like the first season of Survivor. The IRS might check on newsworthy winners to be sure they’ve paid taxes on their bounty.

    Finally, I truly hope that no one dislikes you enough to tattle to the IRS on you. If they report your alleged tax indiscretion on Form 211, the source can get a piece of any money recovered by the IRS from you. Depending on your tax bracket, this could be a powerful incentive, so choose your friends and associates wisely!

    Well, forewarned is forearmed. I hope these insights into the IRS audit factory are helpful or scary, or both! With good representation, many audits can be resolved with the least possible hassle. An excellent place to start if you are being audited is Pub 556 and the phone number of a good tax professional. As I always say – whatever you do, do not ignore an IRS notice!

  • Audit Risk Highest on $10Million+ Income

    Recently released data from the IRS shows that 19% of  income tax returns showing an Adjusted Gross Income (AGI) of $10,000,000 or more were examined in 2010 even though they were just .01% of all returns submitted that year. That’s a pretty good odds for being audited, unfortunately. Though you might consider yourself fortunate enough to be in that tax bracket!

    If your AGI was just a step below, from $5,000,000 to $10,000,000 — you’re a bit better off, audit-wise.  Just 12% of those returns were examined by the IRS while they were the same percentage (.01) of the total tax returns. Great reason to shift some income into next year to stay below the dreaded $10 million level. Ah, to have such problems…

    Examination rates continue to plummet as for mere millionaire earners, it is a comparatively meager 3% – 6%, depending on how far over the fence your pot o’ gold extends this particular year.

    While middle class and upper middle-class are very fuzzy terms, I can tell you that taxpayers with an AGI from $50,000  – $200,000 face very similar examination rates,  around 3/4 of a percentage point on average. This group includes about 55% of  all tax returns submitted.

    Audit rates actually go up on tax returns showing an AGI from $1 to $25,000. That is 40% of tax returns and just about 1% of them got looked at by the IRS. The last category as reported by the IRS is “No Adjusted Gross Income,” which includes a negative AGI, presumably from a net loss. These suspicious returns,  just 2% of those submitted, had an audit rate of more than 3%.

    What have we learned?

    • The IRS trusts the middle class most
    • It’s better to make $8,000,000 than $11,000,000, and
    • Try not to show a negative income on your return