40a. How To Handle A Tax Audit

Taxpayers typically face a dilemma when preparing tax returns. How aggressively can you interpret certain gray areas of the tax code and/or take regular deductions? If the IRS finds some questionable areas and audits your return, chances are it may disallow some deductions. What's more, the audit may open up other areas to closer scrutiny. But you should have little to fear if you can support your deductions o even just most of them.

The IRS conducts several kinds of audits:

·    Correspondence audits are the least threatening. You are asked to send receipts or other backup information about one or two specific items. Send copies only.

·   Office audits. You're required to visit the IRS district office.
On the back of the notification letter are noted specific matters
the auditor wants to review. Although your entire return may be subject
to examination, it's necessary to bring only documentation for the
specified items. You may be able to simply send it.

·    Field audits. An IRS agent comes to your home or business to
examine a wider range of your records. In this case, you should have
a tax accountant or lawyer representing you, and should insist that
the audit be conducted at his office or at the IRS office.

·   TCMP audits. This refers to the Taxpayer Compliance Measurement
Program. The IRS chooses approximately 50,000 returns at random for
a line-by-line audit. Individual, corporate and partnership returns
are each examined every three years.

· What To Do At The Audit
In a tax dispute, you have the burden of proving that the numbers
you provided are accurate. So good preparation is essential. Be ready
to cooperate up to a point:

· Provide as much documentation as possible covering the specified
areas of your return. Papers should be arranged so you can quickly
present them to the auditor and he or she can examine them easily.
But don't bring in more than you have been asked for. If the auditor
decides to probe into other areas, this reduces the opportunity to
make additional judgments.

Don't volunteer information. If you must answer a question, be brief
and direct. Stay on your guard at all times the auditor is trained to
regard even idle conversation as a means of eliciting additional
information.

· Maintain a businesslike attitude. If you show you're serious and
honest, you may receive the benefit of any doubts. But if you play
games with the auditor, his or her anger may turn against you in the
form of a more detailed examination or an unwillingness to compromise.
Pleas that "everyone else does it," condemning inequities in the tax
code and presenting yourself as a victimized taxpayer won't work.

· Don't automatically cave in to the agent's questions or challenge.
Office auditors make many mistakes, so don't give in unless you're
convinced the auditor is right. If you disagree. say so and why. Quick
agreement may even raise suspicions that your return deserves a closer
examination.

· Don't concede immediate defeat even if you don't have full documentation for your deductions. The auditor may accept a reasonable explanation of how you came up with a figure even if you can't support it fully. You might get a partial deduction.

· Don't "give away the store." Although it's frowned upon, agents often make trades by giving in on some items while you give in on others.
But beware of making too many concessions along the way or you could end
up with a large deficiency. Also be aware of compromises on recurring
deductions those you deduct every year. If necessary, say you'll talk to
your accountant or obtain additional documentation. Don't allow yourself
to he rushed, confused, intimidated or insulted. If you're having numerous
problems with an auditor, you have the right to demand another one.

Hire Piofessiona1 Help?
If someone else prepared your return, you can ask for advice on whether
his or her presence at the audit would be helpful and how much it would
cost. Whether you should have an advisor with you depends on two main
factors:

· The nature of the information required. Most audits cover only facts
and documentation, so it may simply be a matter of sup-plying back-up
material. If you don't agree with the auditor's findings, you can always
consult later with your advisor or, if the dollar amounts justify it,
bring the advisor along to another session. But if gray areas- those
based on tax law interpretations are involved, you may want
representation.

RIA Observation: Any appeal within the IRS involves the risk that your
entire return will be reexamined and your potential tax deficiency
increased. If your return contains vulnerable areas involving larger sums,
weigh the odds before appealing.

Court In Session?

If you decide to carry your dispute further, Tax Court is the most
common choice. You don't pay the disputed tax first, but once you have
filed a petition, you may want to pay the tax deficiency to stop the
accumulation of interest. The court will order a refund if you win.

Sessions are held in 100 cities.

In Tax Court, you must show that the IRS is wr9ng, but you needn't specify exact figures or prove you owe no money at all. Just show that what the IRS wants is excessive, and the judge will determine any deficiency. If you lose, you can go to the Court of Appeals.

RIA Observation: Tax specialists say Tax Court is your best alternative
if you have a strong but technically complex case, since no jury is
involved..

· Small case division: If the amount at stake is under $5,000, you
can cut down on time, effort and legal expense by going to the Tax
Court's small case division. This is an informal court that doesn't
confine itself to strict rules of evidence, and you may present your
own case.

One possible draw-back: the court's decision is final; neither side
may appeal.

In District Court, cases are tried by jury if you wish. The judge also handles non tax cases. Experts suggest this alternative for cases that may be technically less strong but emotionally more so. You also must specify the amount of refund you want.

Court of Appeals is the next step.

Court of Claims sits only in Washington, D.C. and may be suitable for an especially complicated case. This court sometimes follows different legal precedents than do other courts, so you may find it more favorable for your kind of case. Appeal is to the Supreme Court only.

When appealing to either of. the above two courts, you must pay the
disputed tax amount in advance. You then sue for a refund, if you win,
the government pays you interest at the going rate. In either situation,
suits can take years to come to trial.

While you're waiting for your case to come to trial in any court,
you may go back to the IRS in search of a settlement. Filing in court
provides additional evidence of your seriousness, and avoiding a
trial cuts both your costs and those of the IRS.

The longer you dispute an IRS decision, the higher your legal fees probably several thousand dollars if the case goes to court. The exact amount depends largely on the type of issues involved. Factual ones take less time, and you can do much of the work yourself. But a technical or legal issue involves research into tax law, court rulings and interpretations.

Most lawyers work on a straight per-hour basis, although some take on
contingency fee cases, depending on the issues, dollar amount and your
chances of winning.

Penalties:

If you're found to have underpaid tax, you'll have to pay the additional
sum plus interest, pegged to the prime rate. You could be hit with a
penalty payment of 0.5% of the unpaid tax per month. The IRS could also
impose a nondeductible 5% penalty if the examiner thinks you've been
negligent, have deliberately overstated a deduction or failed to report
income; and an additional interest penalty at half the regular rate.

Reprinted for the FEA-GEA Newspaper.