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

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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.