How to Survive an Audit
Summer 2014
Developed by Alan Pinck, EA
Presented by XXXX
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Table of Contents
Introduction
The Process
Taxpayer Receives a Notice Letter:
2205-A: The Field Audit
3572: The Office Audit
CP 2000: The Correspondence Audit
Form 2848: Power of Attorney
Contacting the Auditor
Meeting with the Auditor
Form 4549: Issuing the Report
What to Have in your Representation Toolbox
First Things First: The Engagement Letter
Power of Attorney
Audit Interview Sheet
Personal Interview Sheet
Business Interview Sheet
Organized Records
How to Organize the Information
What Constitutes Acceptable Backup?
Mileage Log
Receipts Should be in Order
Electronic Software Training
Audit Techniques Guidelines (ATGs)
How to Deal with the Auditor
Let the Auditor Set the Pace
Do Not Let the Auditor Control the Audit
Never Take it Personally
Follow-up Information
How to Handle a Disagreement
Try to State Your Case with the Auditor
Talk to the Auditor’s Manager (Managers Conference)
Take Your Case to Appeals
Take it to Tax Court
Finishing the Case
When You and the Taxpayer Agree with the Findings
Take it to Appeals or Petition Tax Court
Finish Things with Your Client
Conclusion
#1: Understand the Process and Work Within it
#2: Be Well Prepared and Well Organized.
#3 Never, Ever, Take it Personally
1
Introduction
Over the course of this session, my goal is to help you understand the audit process, and to give you the comfort zone you need to be able to successfully represent taxpayers that are undergoing an audit. We will be looking at the types of audits, how and what you will need to prepare your defense, how to work with the auditor, and what to do if results are not favorable to your client.
One of the keys to success as an audit representative is the mantra: “Do not take it personally”. I understand this is easier when you have not prepared the return under question. But even if you were the preparer, remember that you did the return using the information provided by the taxpayer, and using your expertise about the positions taken. So breathe deeply and relax.
Most of the time you will run into reasonable auditors, unfortunately there are times you will deal with an auditor who is difficult. This is when your patience is necessary. A good auditor will begin by stating that his/her job is to ensure that the return was prepared correctly. If there is a mistake and the taxpayer ends up with a liability, then the taxpayer will have to pay. On the other hand, if there is a mistake in the taxpayer’s favor, then there will be a refund. And yes, believe it or not, there are occasions when the audit goes in the favor of the taxpayer. If you go into the audit with well organized documents and a good attitude toward your abilities, you will be successful and the results of the audit will be favorable. Even if there is a liability it can be kept to a minimum, if you as the representative are well organized and keep control over the audit.
The Process
Taxpayer Receives a Notice Letter:
2205-A: The Field Audit
This notice is issued by a “Revenue Agent” (RA), and informs the taxpayer that he is being audited. This type of audit is generally complex, and is usually, but not always, for a business. It is often referred to as a field audit, where the revenue agent will go to the taxpayer or the taxpayer’s representative. The letter will usually come with a prescheduled appointment to be held at the taxpayer’s business address, unless it is for a non-business issue, in which case it will be scheduled at the taxpayer’s residence. On some rare occasions it will be scheduled at the IRS office.
When you contact the auditor you first want to change the location to your office, and to also change the appointment time and date if there is a conflict with your schedule. Remember, you want to be sure to give yourself and your client enough time to gather the information requested.
3572: The Office Audit
This notice is generated by a “Tax Compliance Officer” (TCO) and informs the taxpayer that he is being audited. This type of audit is generally limited to just a few items. It will be an office audit where the taxpayer or representative goes to the IRS office with the documents being requested. The letter will inform the taxpayer of the items on the return that are being examined, and will request that they call the office within ten days from the date of the notice. If the taxpayer does not respond, the auditor will then issue a report disallowing everything in question, and issue a form 4549 Income Tax Examination Changes (discussed later). While it is never a good idea for a taxpayer to ignore deadlines,if your client receives this form, do not panic. Having access to the report has it merits, asit lets the taxpayer know the worst outcome that is possible (although it is never over until it’s over), and if there is any unreported income, it will show up here. It is no fun to be in the middle of an audit, and to be surprised with unreported income.
CP 2000: The Correspondence Audit
The CP 2000 is a letter generated by the Service Center, and is a correspondence audit, which is handled through the mail. This is by far the most common type of audit, generally due to an item of income that the taxpayer “forgot’ to include on the return. Sometimes there are CP2000 audits of deductions as well. For example, I have seen them issued questioning the mortgage interest claimed when two non-married taxpayers are partners in a home, and though the 1098 will show both names, only one of the social security numbers will show up. Currently the Service is also questioning line 21 other income and assessing SE tax on it.
Correspondence audits are relatively simple to defend, as you only need to verify the amounts the IRS is showing regarding the taxpayer. The first notice usually comes with a list of payers and amounts that were paid to the taxpayer. If you and the taxpayer agree with what is being shown, then have him promptly pay the balance due on the notice, and the case will close upon posting of the payment. The notice comes with all penalties (if they are being assessed) and interest calculated for thirty days from the date of the notice. In the event that you and your client disagree with the Service’s position, then you may want to obtain a POA (Power of Attorney) from the taxpayer and file it with the IRS CAF unit (Central Authorization File). Then write a letter detailing the points on which you disagree. I include a copy of the POA (if you are using one) with the letter so that the Service will respond to me as well as to the taxpayer. Unfortunately, it can take some time for the POA to show up in the system, and if the person resolving the case does not see the POA on file, then he or she will not respond to you, but only to the taxpayer. If you write a letter without having a POA on file, then you will not receive any reply from the IRS and will have to wait until they respond to the taxpayer. Be sure to attach all supporting documentation to the letter, so that the issue can be resolved with one correspondence.
Practice Note: We are inclined to prepare an amended return with our response but I have found that that can create bigger issues and do not advise you do so. You may want to do one for your file so that you can be sure that the final outcome is what you are expecting.
Example: Fred Mertz receives a CP2000 that shows a stock sale that was not reported on the return. Fred did not tell you about the sale because he knew there was no gain, as he had exercised some employee stock options and the income was part of his W-2. Your response should include a copy of the W-2, if the ESOP is included in the detail, as well as a copy of the employers’ reporting to the employee of the payout. Also include a clear explanation, and the stock basis calculations. You may surprise Fred and find that he actually had a small loss due to the expense from the broker. Also, remind Fred to be sure to tell you everything next time.
Form 2848: Power of Attorney
Next, a Power of Attorney must be completed and signed by the taxpayer or taxpayers if a joint return. IRS has revised the 2848 twice in the past year. Make certain that you are using the latest one (Rev March 2012)
An enrolled agent, CPA, attorney or other designated authority such as an officer of the taxpayer's organization may sign the POA. All representatives much have a CAF (Central Authorization File) number that must be put on Form 2848.
Un-enrolled preparers must have the taxpayer present or represent returns they prepared only.
What happens when IRS agent ignores the submitted POA (bypass) and goes directly to the taxpayer? Make sure that the agent has a legitimate reason for the bypass and has done it by the book. Inform your client what to do if contacted by the agent (do not speak with the agent). You should explain the meaning and purpose of the POA form to your client. They should be very clear on what they are authorizing you to do and not to do. While a POA grants powers to the representative to sign for the client, it is good practice to have the client to sign all documents after a thorough review. In the author's opinion, it is good practice not to sign for the client even in the event the audit results in a refund.
Prepare multiple originals for your client to sign. Copies will do, but the author has had the auditor ask for the original.
You can submit the POA by fax. Typically the POA will be in the system in 48-72 hours however it could take CAF a few weeks. I advise that you sign up for IRS “e-Services." With this service you can submit the POA online and have almost immediate access to the client's IRS records.
Contacting the Auditor
After reviewing the letter and the information in the request, you as the representative will contact the auditor and set up an appointment. If you received a generic request for items the auditor wants to review, be sure to ask for an IDR (Information Document Request) so that both you and the taxpayer fully understand what the auditor is looking for. After you are comfortable with the scope of the audit, be sure you ask for enough time for both you and the taxpayer to prepare the documents. Most auditors will send an appointment confirmation letter to you and the taxpayer.
Meeting with the Auditor
At your appointment you will first be asked if the taxpayer is aware of his rights, and if your client received publication 3498 “The Examination Process”. Next you will answer a series of questions about your client. As the representative you are acting on the behalf of the taxpayer, so you need to be able to answer these questions. The Service will be asking about your client’s personal affairs, and about the business, if in question. The auditors have specific preformatted questions they ask as well as questions they make up along the way. The auditor may tell you that the taxpayer needs to be present at the initial appointment for the interview process. As the representative, you can respectfully decline that request, which the auditor is required to accept. If during the interview you do not know an answer to a question, do not make anything up; simply say that you will get back to the auditor with that answer. Unfortunately, it is common for a taxpayer or representative to have other audit issues raised due to trying to improvise. When answering questions keep them short and to the point, and never volunteer any information. When you do not want to commit, the best answer is “to the best of my knowledge….” This will keep you out of trouble, especially if your client did not tell the whole truth. When you know the truth is not going to be in your client’s best interest, simply decline to answer that question at that time, and often the auditor will just move on. During the interview you may be asked about your review of the case, and whether you found anything that you are aware is incorrect.This is a little tricky. If it is an item that is already in question for which there is no support, then you may want to disclose it so that the auditor sees that you and the taxpayer are not trying to hide anything. Of course if it is something that may result in a refund for your client, then you definitely want to disclose it. The main thing to remember here is: if an issue is going be discovered, and you knowingly did not disclose it, the auditor may not want to trust you. You could easily end up hurting the taxpayer, and the auditor may want to expand the scope of the audit.
You will then present the information as it is asked for. Do not assume that you know what the auditor will ask for next, just wait and see. If the auditor asks: “where you would like to start?”, always start with the items that are fully documented, and will not create any changes. However, if there are multiple items on different forms in question, be prepared to stay on each form until all items in question are addressed.
Form 4549: Issuing the Report
At the conclusion of the audit, the auditor will issue Form 4549 (Income Tax Examination Changes). The first two pages show the adjustments, and the tax, penalty and interest charges. The second page is what the taxpayer or you as the representative will sign when you are in agreement. The pages following are going to be the interest and penalty calculations, and any statutory adjustments such as AMT, Earned Income Credit, or SE tax calculations. This is followed by form 886-A: “Explanation of Items”. Be sure to review all the pages so that you understand the changes that occurred and why. Where there is a difference between what has been claimed and what is found to be correct per the audit, the items are individually listed and given a generic explanation.
Example:
Schedule C – Legal and Professional Services
Tax PeriodPer ReturnPer ExamAdjustment
2007$15,500.00 $0.00$5,500.00
Since you did not establish that the business expense shown on your return was paid or incurred during the taxable year and that the expense was ordinary and necessary to your business, we have disallowed the amount shown per Internal Revenue Code 162
What to Have in your Representation Toolbox
First Things First: The Engagement Letter
Unless you work for free, an engagement letter and retainer are crucial. The engagement letter should be specific and spell out everything expected from both parties prior to beginning work. At the conclusion of the audit the client may not want to pay you. The engagement letter protects you in the event that you have a problem. It also protects you if the client does not perform his agreed part. If the audit does not turn out positively, the taxpayer will want to blame you, especially if you were the one who prepared the original return.
This is an example of an engagement letter:
This letter of engagement lists the duties and obligations of both you and this firm in the income tax matters now pending before the Internal Revenue Service (IRS) for the year 20XX.
What you need to do:
You need to sign Form 2848, Power of Attorney.
2. Pay a nonrefundable retainer of $XXXX.XX. Time billed at $XXX.XX per hour & will be deducted from the amount of the retainer. Any additional time required will be billed to you at the same rate per hour. Payment is expected in advance of services provided.
3. You must provide copies of all relevant forms, correspondence, and any other requested information and documentation to support what was reported on your 20XX tax return on or before xx/xx/xxxx.
4. Immediately inform my office of any contact from the IRS.
What this firm will provide to you:
I will assemble, analyze, and prepare any necessary exhibits from the information you provide to me to best resolve any pending issues with the IRS.
2. I will keep you informed about the progress of the audit.
3. I will attempt to obtain the best possible resolution in this matter.
I will begin work when I receive the required retainer, a signed copy of this engagement letter, and the signed Power of Attorney. Should you have any questions, please don’t hesitate to call my office.