IRS Audit! The Big White Envelope in the Mail
For years, you've done the same things on your taxes and no one's questioned it. You've taken the same deductions as your co-workers without incident. Or something unusual came up but you were certain you handled it correctly.
Then the large white envelope arrives. Perhaps even two of them, if you're married and file jointly. The Department of the Treasury. Internal Revenue Service. Asking you to prove, demonstrate, explain.
Remind yourself: Except for a tiny number of people who actively commit fraud, the IRS isn't out to get anyone, and doesn't want to put anyone in jail. It's expensive to put you in jail. The IRS prefers to receive money, not spend it. They want you to pay what they think you owe.
Do not ignore this letter. If it tells you to call the auditor, do so. You can always ask for a postponement but if you ignore them, they can arbitrarily find you at fault and impose hefty penalties. If the letter asks you to fax your response, it will provide a list of the paperwork desired and the date by which the reply is expected.
Let's take a moment to look at how your return was chosen for this honor.
The first possibility is the easiest to deal with: the IRS has been notified of income through a third party, and they can't find it on your tax return. The W-2 or 1099 might have been left off in error, you might not have received it, or you might have reported it on a different line than the IRS was expecting.
The next possibility arises because every tax return runs through an IRS computer that assigns a statistical score. Scoring is based partly on complexity – more forms allow more opportunity for errors and omissions. Large amounts on certain forms are a concern – Schedule A (itemized deductions) high in relation to income, Schedule C (small business) with large losses or no income, Schedule E (passive and rental income) with high losses or property that appears to be personal-use. Large changes in the return from one year to the next may be a consideration. Opening a new business may trigger an audit because the IRS knows taxpayers don't always handle their start-up expenses correctly.
A third possibility is that your return is somehow connected to another audit. This situation typically arises when you're a member of a partnership or corporation, and the business books are being audited. Similarly, if your tax professional is caught getting fraudulently creative, it's likely that all the returns she did will be audited.
You might be part of a random "compliance audit," in which the IRS asks you prove everything on your return. These are strange when you don't have anything but wages, but that just proves they can truly be randomly chosen.
The IRS doesn't announce exactly how it determines which returns will be audited, but generally it's triggered by something big, unusual or erroneous.
Next, figure out what is being questioned. The year of the return is in the upper right of the letter. It typically takes the IRS 12 to 18 months to identify returns for audit, so right now they are probably looking at your 2014 return, filed in 2015. Once the 2014 catches the interest of the IRS, they can also decide to include the year before and year after. For most tax return errors, the IRS has a three year window in which an audit can be initiated.
The text of the letter will tell you if the audit is correspondence (by fax or letter) or in person (at either your location or the nearest IRS office). It will also tell you which forms or items are under review, and an outline of what the auditor wants to see.
Dig out your copy of your tax paperwork. If you can't find the return itself (and the auditor will ask you for a copy), you can request a transcript (for free) by calling 1-800-908-9946 or a full copy ($50 fee per copy) by mailing in Form 4506. Requests for a transcript can also be made through the internet, www.irs.gov , though recent hacker activity on the site has forced the IRS to limit this service. Transcripts don't look like a tax return, and may not have what you need to help you reconstruct your documentation. Try to keep your important tax papers in a secure place for at least three years -- it's easier to read!
Supporting documents are up to you. If you can't find them, you'll have to begin reconstructing them. The IRS considers "contemporaneous" (timely) records the best, but will strongly consider reconstructions, reprinted receipts, and Google-aided mileage calculations. Make copies of everything and don't leave originals with the IRS.
Should I hire a CPA?
Taking a neutral party, who understands the IRS-speak, has some advantages. A Certified Public Accountant or an Enrolled Agent (an IRS designation for a tax preparer who has demonstrated a certain depth of knowledge) isn't as likely to get upset when the IRS questions the veracity of your documentation. The CPA / EA may be able to suggest things you didn't think of, which may help offset any damage the auditor does. At the least, the CPA / EA should remind you not to offer information, but to answer only the questions that are asked. A CPA / EA may even suggest that you not go to the audit at all, if you are too emotional about it. Taxpayers don't lose money by taking a CPA / EA to an audit (except perhaps the professional's fees), but many have paid the IRS too much for not having an adviser along.
The IRS keeps a list of Enrolled Agents on their website, and CPAs can be found in your phonebook or by recommendations by friends.
Have you ever been audited by the IRS?
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