Receiving an IRS audit letter is a frightening proposition for many taxpayers. Often individuals experience feelings of fear, helplessness, frustration, or shame. Furthermore, IRS audit letters are often accompanied by a multiple page request for documents, which often ask for records that are several years old.
Taxpayers equate the experience of being examined by the IRS with being questioned by the police about the commission of a crime. However, an audit from the IRS does not necessarily mean you’ve done anything wrong. Depending on the circumstances surrounding the audit and the type of audit, there may be no cause for concern at all.
Why Am I Being Audited?
There are many reasons why a taxpayer may be subjected to an audit. However, a majority of audits are triggered by evaluations of automated DIF scores. As outlined in Publication 556, the IRS uses a computer program called the Discriminant Inventory Function (DIF) system to assign a score to individual (and some corporate) tax returns after they have been processed. DIF scoring formulas vary based on the type of taxpayer and tax return. The exact DIF formula is kept a secret to keep taxpayers from gaming the system. In 1996, former Bentley University Professor, Dr. Amir Aczel, reverse engineered the DIF scoring method. He found that the system is designed to weed out:
- Taxpayers with Schedule A deductions that are more than 44% of total income
- Taxpayers with Schedule C deductions that are more than 63% of total income
- Taxpayers with Schedule F deductions that are more than 67% of total income
The IRS will take DIF scores and proceed to audit accounts with scores that fall outside of the acceptable range. The IRS will start conducting audits of accounts with the worst DIF scores and work their way towards the acceptable range until the audit budget is exhausted. Nevertheless, a poor DIF score isn’t the only way to be selected for an audit. You may also be selected for an audit if your ex (ex-employee, ex-coworker, ex-spouse, etc.) turns you into the IRS, a transaction you engaged in is being investigated by the IRS, your tax preparer is being audited, or the IRS has grown suspicious over a 1099-K audit. Taxpayers who are self-employed, own a foreign bank account, claim home office deductions, or report disproportionately high charitable contributions are more likely to face the risk of an audit.
Types of IRS Audits
Ultimately, there are four types of IRS audits. Each audit varies in complexity and severity. The type of audit and circumstances surrounding an audit will help determine whether or not you need the assistance of a qualified tax attorney.
IRS Correspondence Audits
The first type of audit is a correspondence audit. Correspondence audits are the most common and least complex types of audit. If the IRS has questions they feel can be answered through mail that don’t require significant investigation, they will initiate a correspondence audit. Correspondence audits are typically requests for missing documentation.
As long as you’ve prepared your tax return correctly and have the source documentation to back it up, you likely won’t need the assistance of a tax attorney. If documentation is missing or you have reason to believe your return was not filed correctly, then you should consider consulting a tax attorney.
IRS Office Audits
An IRS office audit will be scheduled when the IRS has questions about a return that are too complex for a correspondence audit, but still too small for a field audit. The IRS will invite you to come into an IRS office for the audit. An auditor will ask you questions about the issue under examination. It’s important to be careful when answering questions. Auditors are trained to ask questions that can get taxpayers to unintentionally provide damaging information. If the IRS has reason to believe there are errors beyond the current scope of the audit, they can expand the scope.
IRS Field Audits
A field audit is the most detailed and involved form of IRS audit. It is reserved for larger issues related to a return. An auditor will visit your home or place or business to review documentation and conduct interviews. If you are faced with a field audit, you should retain the services of a qualified tax attorney. A tax attorney can be present for the audit to communicate directly with the auditor and ensure the scope of the audit isn’t accidentally expanded.
IRS Taxpayer Compliance Measurement Program Audit
The main purpose of an IRS taxpayer compliance measurement program audit is to update data for IRS DIF scores. The scoring system is updated by analyzing up to 50,000 randomly selected accounts via an audit. Every line of a tax return is audited in a TCMP audit, which means documentation must be provided for every item. These audits can be excruciatingly painful and time consuming to deal with, but as long as you have all of the necessary documentation, the process should be smooth.
What Should I Expect From An IRS Audit?
As previously mentioned, the steps in an IRS audit will vary depending on the type of audit. Each audit will begin with notification from receipt of a notice or letter. You may also receive a call from the auditor who will be conducting your audit. Most audits start with a single tax year that can later expand in scope to multiple years.
If you’re involved in an office or field audit, you will have a meeting with the auditor. The audit can last anywhere from a few hours to a few weeks with longer durations typically stemming from field audits. The IRS will collect and request documentation, as well as, conduct interviews to retrieve information pertaining to the tax issue at hand. The revenue agent may also request documents from third parties.
At the end of an audit, you will receive a Notice of Proposed Adjustment along with the revenue agent’s report. If an adjustment is proposed, you will either need to agree or disagree. If you agree to the adjustment, you will have to pay the balance in full or your case will be sent to collections. If you disagree, you will have the opportunity to file a petition to dispute the adjustment.
From Tax Audit To Criminal Investigation
A civil audit can very quickly become a criminal investigation if the IRS believes firm indications of fraud exist. The most terrifying aspect of involvement from the Criminal Investigation Division (CID) of the IRS is that many taxpayers don’t know they’re under criminal investigation until the IRS comes knocking on the door. An auditor can alert the CID of suspicions after an audit is conducted. The IRS has no obligation to inform you that a criminal investigation has begun. Often, an existing audit will likely be suspended once a criminal investigation is under way and the taxpayer is left to believe the audit is simply over. With a taxpayer’s guard down, the IRS can begin building a criminal case.
Despite failing to receive notification that you’re under criminal investigation, there are usually warning signs or red flags you can pick up on that indicate a criminal investigation has begun. Red flags include:
- The IRS starting to conduct net worth analysis and subpoenaing bank records
- The IRS not disclosing contacts with third parties (in a civil audit they’ll normally let you know if they reach out to parties like your bank or your venders)
- Receiving a summons for records or an appearance
- More than one revenue agent showing up to interview you
- The auditor canceling your next appointment or suddenly failing to return your calls
- An officer of the IRS wearing a gun and a CID badge approaching you
Of course, some of these signs may not always indicate the initiation of a criminal investigation, especially a loss of contact with the auditor. Due to budget cuts, the IRS has lost over 15,000 personnel in the past 5 years. Their resources are stretched thin, so an agent may not always have time to return your calls. Nevertheless, if more than one of these red flags are raised, you have reason to be concerned.
If you have been selected for an audit and have reason to believe any of the following, please visit our Criminal Tax page:
- you may be subject to criminal prosecution;
- the information contained on your return for the year selected is false or has become false;
- the income on your return is understated;
- the deductions taken on your return are overstated; and/or
- you are a business and pay a large amount of workers in cash without making proper payroll tax withholdings.
Why Hire A Tax Attorney Over Any Other Tax Professional For Representation In An Audit?
CPAs are licensed to give qualified opinions about the accuracy of financial statements. An enrolled agent is someone, other than an attorney or CPA, who may practice before the IRS, but is not an actual member of the IRS. Please note that these designations do not always confirm any formal knowledge of tax law or of IRS internal audit procedure.
Having a tax attorney represent you has many advantages. Tax attorneys have the formal legal training to interpret the ramifications of tax court cases and advice on other related legal issues. Additionally, tax attorneys are well versed in the IRS audit procedure in conducting the audit along with fighting the audit determinations should the taxpayer disagree.
A tax attorney will act as the mediator between you and the IRS. RJS Law handles IRS audits on a daily basis. Our firm has forged a great working relationship with a majority of the local San Diego, San Marcos, Beverly Hills, and Orange County auditors. Due to our frequent dealings with IRS auditors and their managers, we are very experienced in presenting an audit to make the process easy for both the taxpayer and the auditor. A combination of diligence, professional relationships, and document presentation has enabled RJS Law to achieve exceptional results for clients facing audits.
Non-attorneys can be admited to practice before the tax court, but they do not have the legal education or experience. It is highly recommended that a qualified tax attorney assist in case your audit has a taint of criminality or large adjustments. Furthermore, conversations between an attorney and you are protected by the attorney-client privilege and cannot be used against you later in the audit or in court.
In many scenarios, it is not advisable for you to have the same CPA/enrolled agent/tax attorney who prepared the tax return also represent you in the audit. An preparer’s natural inclination is to defend their work and not appear incompetent in front of his/her client. This creates a natural conflict of interest and may be very damaging during the audit. In cases of negligence or perceived fraud, the preparer will be very hesitant to accept responsibility for their own mistakes. Furthermore, some audits are conducted because the IRS has found a large amount of mistakes or suspects fraud based on its review of other returns the person or firm set up. Your preparer may suspect this based on interactions with their other clients, but may not disclose this to you until after the damage has been done.
Avoid a potentially serious and costly mistake. Rather than take your chances with unqualified or unfit representation, get an independent analysis by a professional knowledgeable in tax law who can properly defend your rights in an audit.
RJS Law Is Here To Help
Experienced attorneys can often limit the scope of an IRS audit to one year, rather than a general fishing expedition through multiple years. Experienced counsel is often also able to identify problem areas with the return through their own internal investigation. This internal review allows counsel to tailor responses to the Revenue Agent’s questions, and ultimately may avoid or minimize exposure to tax deficiencies and the opening of other years.
RJS Law has helped clients across California navigate IRS audits to receive the best possible outcome. If you have any questions or you need further IRS audit assistance, please contact our IRS audit attorneys in San Diego, Orange County or Los Angeles today.
For more information, please see: