Don't fret: IRS letter isn't always an audit
© St. Petersburg Times, published April 8, 2001
IRS audits come in three basic varieties: an audit by mail, an audit at the IRS office and an audit at your place of business or your accountant's.
The correspondence audit is the most common. The IRS sends you a letter asking for documentation of an item on your return. You copy the appropriate paperwork and send it back.
Not every letter from the IRS is an audit. IRS computers generate letters when they catch discrepancies between what you reported on your return and the W-2 and 1099 forms filed by people who paid you money during the year. Last year this document-matching program led to assessments of an extra $2.1-billion in taxes on 1.4-million returns.
Technically, those are not audits, in part because audits require taxpayers to produce documents. They look behind the numbers on a tax return, attempting to verify whether the deductions and credits claimed are legitimate or whether there is unreported income.
Correspondence audits are more convenient and considerably less frightening for most people than a face-to-face encounter. But they can be a hassle for self-employed people who have more complex tax issues that sometimes are easier to resolve in person.
Office and field audits involve meetings between an IRS worker and the taxpayer or the taxpayer's representative, usually a certified public accountant or enrolled agent.
The good news is that if you have a professional to represent you, you don't have to go -- and it's probably better that you don't. Most accountants say they prefer to handle audits without their clients around.
"It's more effective if they're not there," said Gregory A. Rosica, tax partner with Arthur Andersen in Tampa. "When people are questioned on things they tend to be defensive."
He said if the taxpayer is in the room, the auditor can ask questions directly, making it easy to expand the scope of the audit. Nervous taxpayers also have been known to blurt out information the IRS never requested.
An office audit starts with a mailed notice directing you or your representative to appear at a particular time and place with your records. The document request may be as broad as all the books and records for your business, which back up the income and deductions claimed on a Schedule C.
"The severity of the letter is not the reality," Rosica said. "You can reschedule it and you can show up without all that information."
He said an auditor will be assigned your file and go over it with you or your accountant.
"They'll usually have one or two issues that need to be addressed, Rosica said. "You may be able to satisfy it with explanations. You may need to meet with them again or you may just mail something in to them and that may be the end of it."
But he said the follow-up sometimes drags on for months or years.
"The biggest frustration people have with audits is the amount of time it takes to resolve what seems to be a simple issue," he said.
Self-employed professionals and business owners may get the third type of audit, a field audit in which the IRS comes to visit.
Clearwater accountant W.H. Simon said he always invites the agent to meet at his office rather than the client's.
"We go through the records before the agent comes," he said. "We then try to walk the agent through it to get them in and out."
He said some accountants stack the records in a conference room, hand the key to the agent and say, "Help yourself."
"The problem with that is that the agent can fumble around for days," Simon said. He said an agent who has spent a lot of time on an audit may be inclined to come up with additional taxes to justify the time spent.
IRS agents can and sometimes do dig deeper, getting records from banks and other sources, interviewing business associates and inspecting the taxpayer's business operations.
"They're trying to understand the way the business operates," said Simon, who worked for the IRS as an assistant regional commissioner for examinations. "They are looking for areas that they think could indicate underreporting of income or overstatement of expenses."
For example, a lot of new equipment on site is a signal to check whether it was written off in one year as an immediate expense when it should have been depreciated over many years.
"The civil audit is not a very exciting thing unless they find interesting transactions such as money being wired to foreign bank accounts, a condo in Aspen being expensed or people on the payroll who are not employees," Simon said.
Findings such as those might lead to a criminal investigation.
Any of the three types of audits may result in the assessment of additional taxes, no change or occasionally a refund.
"Sometimes we stumble upon credits or deductions folks didn't know they were entitled to," IRS spokeswoman Gloria Sutton said.
The average in-person audit results in an assessment of $9,540 in taxes, which last year added up to $2.4-billion.
If taxpayers disagree with the audit's outcome, they can go through the appeals process and ultimately to court. The complexity of the tax code leaves plenty of room for differences of opinion, but the high cost of paying lawyers and accountants to pursue a case means most people settle with the IRS at some point.
"It's not an all-or-nothing thing," Rosica said. "You can negotiate if you have a strong leg of law to stand on, but you have to have strong factual arguments. If you don't have a letter from the charity to support your deduction and you can't get it, there's no arguing."
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