Audits and IRS Strategies

         
         
         
                         Audits and IRS Strategies
         
         
          80) You don't have to meet an IRS agent most of the
          time.  In the past, many taxpayers -- particularly
          business taxpayers -- would send their advisors to
          audits.  The IRS tried to change this in 1987.  The IRS
          Manual advises auditors that much information can be
          gained by meeting with the taxpayer (preferably alone)
          at the beginning of an audit.  In these situations
          taxpayers usually go out of their way to be cooperative
          and unwittingly give away important information.  The
          Taxpayers Bill of Rights, enacted in 1988, changed the
          IRS's strategy.  Now you do not have to appear at an
          audit unless the IRS issues an administrative subpoena.
          You can send any representative who is qualified to
          practice before the IRS.  If you have been issued a
          subpoena or choose to go to the audit, it is a good
          idea not to go alone.  Bring along your tax advisor.
          Any questions about the law or your reasons for taking
          a certain position should be referred to your advisor.
         
          81) You don't always want to continue negotiating with
          the IRS and challenging audit results.  Usually this is
          a good idea, because the Appeals Office is more
          reasonable than the auditors.  They settle about 85% of
          their cases, and most of those cases result in some
          reduction of the amount owed by the taxpayer.  But you
          don't want to do this if the auditor missed something
          questionable on your return, because the Appeals Office
          looks at the entire return.  When you have something to
          hide but also believe that the audit results should be
          appealed, simply ask the IRS to issue a notice of
          deficiency after the audit.  That allows you to appeal
          to the Tax Court within 90 days.  (You also can do
          nothing for 30 days after the audit results are
          received; then you'll receive a notice of deficiency
          automatically.)
         
          82) Persistence pays when discussing your tax return
          with the IRS.  An auditor is to meet with a taxpayer
          before issuing a report.  The idea is to reach an audit
          result that you will consent to, since this holds down
          costs by keeping the case out of the Appeals Office.
          But the auditor also has a time deadline.  Cases have
          to be processed at a certain rate, and the agent cannot
          spend too much time on your case.  This can operate in
          your favor if you refuse to leave the conference until
          the auditor gives in on one or more of your points.
          Simply make your arguments, let the auditor respond,
          shift the conversation to another topic, then come back
          to your points again.  Persist in this manner until the
          auditor finally gives in or announces that the
          conference is over.  Most of the time the auditor will
          give in.
         
          83) When you can't pay your taxes, get a 60-day loan.
          If you don't have the money to pay, file a return
          anyway.  After a while the IRS will contact you about
          the unpaid taxes.  Respond immediately.  You can simply
          call the employee designated in the letter sent to you.
          The employee will tell you how important it is to pay
          the bill, but he or she will not tell you that a 60-day
          installment loan is yours for the asking.  IRS policy
          is not to publicize this program, but any taxpayer
          qualifies for it.  All you do is tell the IRS employee
          that you can have the money within 60 days and want an
          installment agreement.  The employee will try to get
          you to agree to a shorter payment period but will
          accept 60 days if you insist that's the best you can
          do.  There is no credit check or other investigation.
          You get the 60 days if you ask for them.  Of course
          interest is charged during this period, so it is to
          your benefit to pay the bill as soon as possible.  In
          addition, be sure that you make the payment within the
          agreed time period.  If you do not meet the payment
          schedule, the collection division will accelerate its
          collection efforts.
         
          84) What's the best time to schedule an audit?  Near
          the end of the month is good.  Auditors have rather
          strict quotas to meet.  If your auditor has not closed
          enough cases for the month, there is an incentive to do
          your audit quickly to get it closed by the end of the
          month.  If there is a three-day weekend coming up, the
          Friday before it starts could be even better.  The
          auditor is likely to be distracted by plans for the
          weekend and may not examine your return as closely.
          There also could be a rush to get the audit done and
          get an early start on the long weekend.  The best time
          of day to schedule the audit is around ten in the
          morning.  Then you're reasonably sure that lunch plans
          will keep the meeting from dragging on.  The threat of
          missing or being late for a lunch date also could cause
          the agent to hurriedly make some concessions that he
          wouldn't ordinarily make.
         
          85) When you're in a dispute with the IRS and plan to
          go to court, you don't have to let interest expenses
          mount.  If you lose the case, interest is charged on
          your overdue taxes.  One way to avoid this is to write
          a check to the IRS and label it as a deposit or cash
          bond.  This stops the interest from accumulating.  If
          the IRS decides you are wrong and issues you a notice
          of deficiency, you can still take the case to Tax
          Court.  Should you lose the case, the IRS keeps the
          money; if you win, the money is returned without
          interest.  But if you fail to label the payment
          properly, as a deposit or bond, it will be considered a
          payment of the taxes in dispute and no notice of
          deficiency will be issued.  You will not be able to go
          to Tax Court.
         
          86) You haven't reached an agreement with the IRS until
          the proper officials sign it.  IRS employees often
          negotiate settlements and compromise with taxpayers,
          but they do not have authority to bind the IRS.  The
          agreement has to be signed by officials higher up after
          you sign it.  So don't rest easy until you are notified
          that the settlement has been signed.  Sometimes a
          higher-level official rules that the lower-level
          employee gave away too much.  In those instances,
          taxpayers who thought they had settlements are
          surprised to find notices of deficiency in their
          mailboxes.  Ask the employee when the agreement should
          be approved and when you should receive word of it.
          Follow up with a telephone call if too much time passes
          without your hearing anything.
         
          87) When it seems the IRS isn't listening to your
          problems, there are several steps that can be taken.
          First you should realize that the IRS is still having
          problems with its new computer system, and you should
          expect delays and foul-ups.  Also, lower morale
          apparently has increased turnover at the IRS, so there
          are fewer experienced people to handle your problem.
          The 1986 tax reform bill included substantial increased
          funding for the IRS over five years, but as of 1990 the
          IRS had not yet hired and trained enough employees to
          ease the backlog.  Whether or not you think the
          government ought to be run this way, you'll have to
          accept the fact that it is being run this way.  Second,
          you should consider whether you really want the problem
          handled quickly.  It is always uncomfortable to have an
          unresolved tax issue hanging over you, particularly if
          a lot of money is at stake.  But many advisors believe
          that by waiting you can work the IRS's high turnover to
          your advantage.  There is a feeling that an agent who
          gets assigned your file after it has sat on the corner
          of someone else's desk for months will try to close the
          case quickly and finish his or her own cases.  You are
          more likely to get a favorable decision when a new
          agent takes this attitude.
               If you want a resolution quickly and the current
          employee has been given a reasonable amount of time
          (which should be several months and varies with the
          complexity of the problem), it is time to contact the
          problem resolution office.  Your local PRO should be
          listed in the telephone directory.  The IRS says that
          the backlog in PROs is now quite substantial.  You will
          get better results if you write a letter to the PRO
          that clearly states your problem and gives your name
          and taxpayer ID number.  The IRS says that you now
          should wait 45 days for a response.  If you haven't
          heard anything, you can call the PRO and ask who has
          been assigned your letter and what the status is.  When
          discussing your case be cooperative instead of
          demanding.  Offer to do anything necessary to get the
          matter resolved.
               If the PRO takes too long or you don't want to
          bother with it, simply tell the agent handling your
          file to issue a decision.  Tell him or her that you
          prefer a negative decision to continued negotiation and
          discussion.  Once a decision has been rendered, you can
          take it to the appeals level.  Turnover is lower at
          appeals and employees are better informed about the tax
          law.  In addition, appeals officers have strict quotas
          and time limits on handling cases.  They have to close
          cases quickly and keep them out of court.  When your
          position is truly reasonable and the audit agent just
          won't accept it, you are better off taking the case to
          appeals.  If your problem is with the collection
          division instead of an auditor, you should stick with
          the PRO.
         
          88) Never give originals of any documents to the IRS.
          Auditors frequently will resolve an issue in your favor
          when they see documentary evidence that supports your
          writeoffs.  But always send photocopies to the IRS, not
          originals.  It is not unusual for documents to be lost
          in the post office or the IRS mail room.  When an agent
          claims not to have received documents or to have lost
          them, there's nothing you can do about it.  There are
          numerous court cases holding that you cannot sue the
          IRS for damages, and the burden of proving the
          writeoffs remains with you.  Always send copies of
          documents.
         
          89) The word to taxpayers who've been audited is to
          appeal all negligence penalties.  IRS auditors are
          routinely imposing negligence penalties any time they
          find a deficiency in someone's taxes.  But that's
          wrong, because the penalties are to be imposed only
          when the deduction was clearly inappropriate and the
          taxpayer should have known that.  Because auditors are
          misconstruing the law, the Appeals Office is just as
          routinely reversing the negligence penalties.  Filing
          an appeal is an easy way to save money.
         
          90) You lost your right to use the Tax Court if you
          don't tell the IRS you moved.  You have only 90 days
          after the IRS issues you a notice of deficiency to file
          a petition in the Tax Court.  If you miss the deadline,
          you can't use the Tax Court.  But the 90 days starts
          running when the IRS mails a notice to your last known
          address.  It doesn't matter if you no longer live at
          that address and do not receive the notice if that
          address is your last known address.  The IRS generally
          is justified in mailing the notice to the address on
          the tax return in question.  It usually doesn't matter
          that you've moved and filed subsequent tax returns with
          the new address.  If you gave a full power of attorney
          to a tax advisor, the IRS can send the notice to that
          person unless you have informed the IRS that the power
          is revoked.  The only official way to notify the IRS of
          a change of address is to report the change of address
          to the IRS on their official change of address form,
          Form 8810, which you mail to the service center where
          you have been filing the returns.  Keep a copy for your
          files.
         
          91) Don't let the IRS bluff you into losing legitimate
          deductions.  Auditors are trained to say that if you
          don't have exact records, you can't take the
          deductions.  But this isn't always true.  It is true
          where travel and entertainment expenses are concerned.
          But in other cases, the Cohan rule applies.  This rule
          allows you to estimate the amount of your expenses when
          the records are incomplete.  All you have to do is give
          reasons why the estimates are reasonable.  The Cohan
          rule even applies to auto expenses under the law passed
          by Congress in 1986.
         
          92) Mailing your tax return late is not always going to
          get you into trouble.  First, if you realize before
          April 15 that the return is going to be late, you can
          file Form 4868.  This gives you an automatic four month
          extension, and your return is not due until August 15.
          You still have to pay the tax by April 15, but there is
          no penalty when the final return is filed late.  There
          are other reasons the IRS will accept as reasonable
          excuses for filing late.  If you mailed the return on
          time but didn't put sufficient postage on it, the IRS
          will let you go.  But save the original envelope as
          evidence.  Other valid excuses are a death or serious
          illness in your family, a fire or other disaster that
          destroyed your records, sending your return to the
          wrong service center, being unavoidably absent from
          your home or business, asking for the proper forms from
          the IRS and not getting them on time, and visiting an
          IRS office for help but being unable to get it on time.
          If you qualify for one of these excuses, file a
          complete explanation of the reason for the delay along
          with your tax return.  That way you should avoid any
          penalties for filing late.
         
          93) Late-filing penalties are based on a percentage of
          the tax due.  If you had net losses for the year, and
          filed late, there is no penalty.  Your accountant may
          be able to clear up the backlog more efficiently and
          accurately if he does your return a week or two after
          the deadline, when he isn't overloaded with returns
          that must be filed on time.
         
          94) When the IRS Special Agent comes knocking, don't
          let him in.  A Special Agent is the IRS employee who
          investigates taxpayers for criminal fraud.  If he is on
          your case, he's trying to put you in jail.  You don't
          have to talk to him, and you don't even have to let him
          into your home or office.  The problem is that most
          people think they can stop the investigation in its
          tracks by appearing open when the agent first shows up.
          Little do these people know that the agents readily
          acknowledge their most important evidence is often
          gathered in that first meeting with the taxpayer when a
          lawyer is not present.  Taxpayers give away all kinds
          of damaging evidence without even realizing it.  The
          most important question to many agents is how much
          money you had in the bank at the start of the year.
          They then add up all the money you've spent and
          deposited in it during the year, subtract the beginning
          balance, and say the remainder is your income.  You
          have to prove that there were gifts, loan repayments
          and other sources of money that are not taxable.
          Remember that if the special agent is talking to you,
          he already has thoroughly examined all the paperwork
          the IRS has on you and probably has talked to friends,
          neighbors and people you do business with.  Tell him
          that there probably isn't any problem, but you're going
          to play it safe and not talk to him unless your lawyer
          is around.
         
          95) What can you do if your spouse gets caught
          red-handed by the IRSþand you signed the joint return?
          Since you both signed the return, each of you is
          potentially liable for the entire tax deficiency.  The
          IRS generally will go after whichever spouse has more
          money and seems easier to collect from, even if the
          couple is no longer married.  It is very common for one
          spouse to entrust the couple's financial affairs to the
          other and merely sign the joint return without
          questioning.  The IRS realizes this and does provide an
          escape hatch for an "innocent spouse." It is very
          difficult to qualify as an innocent spouse because the
          IRS doesn't want spouses who knew what was going on to
          get out of their tax liabilities.  When your spouse or
          ex-spouse failed to report a large portion of income or
          deducted an expense that never was incurred, you can
          avoid personal liability by showing that you didn't
          know about it, had no way of knowing about it, and that
          it is not fair to hold you responsible for it.  It is a
          tough test to meet.  A much better idea is to take
          preventive measures so that you won't fall into this
          situation.  Be sure you are fully informed of your
          spouse's financial affairs.  If you can't do that and
          think there might be a problem, you should file
          separate tax returns even if it means paying higher
          taxes.
         
          96) Getting attorney's fees from the IRS gets easier.
          The 1986 and 1988 laws made changes that make it more
          likely the IRS will have to pay some taxpayers'
          attorney's fees.  To win, you must establish that the
          IRS's position was not substantially justified.  That
          means you usually must show that the IRS knew or should
          have known that it was wrong on either the facts or the
          law.  This applies to any position the IRS takes after
          you receive a notice of deficiency or a notice of the
          decision of the IRS's office of appeals.  This is an
          improvement over the prior law, under which the IRS
          could successfully argue that it could take any
          position it wanted prior to a court case without
          incurring attorney's fees.  There is no ceiling on the
          amount of attorney's fees that may be collected.  But
          you are limited to a maximum rate of $75 per hour
          unless you can show the court that a higher rate is
          justified under the circumstances.  Usually a high rate
          can be justified by showing that the case was
          especially difficult or the attorney usually gets a
          much higher rate.
         
          97) Where you file your return affects your chance of
          being audited.  As strange as it might seem, you can
          reduce the chances of being audited by moving.  IRS
          statistics show that taxpayers in the national's
          central region (Ohio, West Virginia, Michigan, Indiana,
          and Kentucky) had the lowest percentage of audited
          returnsþ0.93%.  Taxpayers in the western region
          (composed of 17 western states) had the greatest
          percentage of audited returnsþ1.73%.  Among individual
          cities, taxpayers in Manhattan had by far the greatest
          likelihood of being audited.  Of all Manhattan
          taxpayers, 1.98% were audited.  The odds climb
          dramatically for business taxpayers.  The IRS says
          2.83% of corporations and 3.42% of partnerships in
          Manhattan were audited.  You're least likely to be
          audited if you live in Boston, where only 0.69% of
          returns were audited.  The IRS offers no explanation
          for the difference in audit rates.  Wondering if the
          IRS will pick you to audit?  UMI Books On Demand has
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          98) Be sure you avoid the IRS's "badges of fraud."
          These are acts that the IRS uses to identify tax
          returns that could yield significant back taxes after a
          detailed audit.  The IRS will give a return an initial
          review.  Usually if one of these badges is not found,
          the auditor will conclude that time is better spent on
          other returns.  The first thing the IRS looks for is
          understatement of income.  If you fail to report a
          substantial amount of income or an entire category of
          income (such as tips), the IRS will look further into
          your return.  Fictitious or improper deductions also
          are a sign the IRS is alert for.  If you claim a
          nonexistent dependent or inflate a category of
          deductions, you can expect a long and detailed audit.
          The same holds true if you engage in accounting
          irregularities such as keeping two sets of books,
          having inadequate records, or routinely postdating
          documents.  The IRS is particularly interested in
          taxpayers who have no books or records.  Allocating
          income to related taxpayers is another act the IRS
          looks for.  Often these allocations are made to
          fictitious taxpayers, or the device used to allocate
          the income to someone else is a sham.  The IRS will
          closely examine such transactions.  A taxpayer's
          conduct when meeting with an auditor is another sign
          the IRS considers.  If you evade questions, refuse to
          provide documents, claim that records were lost or
          destroyed, or appear hostile to the agent, it will be
          taken as a sign that you have something to hide.  You
          can avoid attracting the IRS's attention by keeping
          accurate records, correctly stating deductions, and
          complying with an auditor's requests for documentation.
         
         
          99) Taxpayers in some occupations are more likely to be
          audited than others.  The IRS recently announced a
          campaign to examine more returns of self-employed
          individuals.  These are returns that include Schedule
          Cs listing different business expenses.  The IRS says
          these individuals are in the best position to
          underreport income and overstate deductions and will
          get closer scrutiny in the next few years.  Airline
          pilots are frequent audit targets because they have
          high incomes (at least until recently), tend to invest
          in tax shelters, and often claim questionable travel
          expenses.  Professionals, artists, entertainers, real
          estate agents and independent contractors are big audit
          targets for similar reasons.  Flight attendants,
          curiously, have a high audit risk because travel
          expenses tend to be an unusually high proportion of
          their income and many attendants try to deduct clearly
          personal expenses such as hairstyling, pantyhose, and
          cosmetics.  It is believed that executives have the
          lowest audit risk because they are salaried employees
          and this limits their tax avoidance possibilities.
          Consultants have a high audit risk because they can
          easily underreport income and overstate deductions.
          But if you write "executive" as your occupation and an
          auditor discovers you are a consultant with your own
          corporation, this will be considered an act of
          deception and the auditor will take a close look at
          your return.
         
          100) If you've found a loophole here that you forgot to
          take in the past, you can file an amended return.  Form
          1040X can be filed anytime within three years after the
          original return is filed.  You file an amended return
          to change how you reported an item in the past or to
          add items that were forgotten.  The problem, however,
          is that the IRS will not only scrutinize the change you
          are making but often will decide to look over the
          entire return.  Most tax advisors agree that filing an
          amended return substantially increases your chances of
          hearing from an audit agent.  The solution could be to
          hold the amended return until about a week before the
          filing deadline.  The IRS has only three years from the
          date a return was filed to make any changes in it.  So
          if you file the amended return at the last minute the
          IRS doesn't have much time to examine the original
          return.  The only objections it can make are to your
          changes.