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Preparing for an IRS audit

uninstalled materials, revenue recognition, construction, accountingIt’s not news the IRS is auditing fewer returns; staff levels are down. Still that is no excuse to “play the audit lottery” and cheat on your taxes. Despite low audit risk, the IRS is still conducting audits, whether or not you are preparing. What to do when that dreaded fat envelope shows up from the IRS? This post will outline what to expect as well as a few “dos” and “don’ts” in navigating through the audit process.

Don’t miss: Today’s IRS audit trends

First off, do not panic. Contact your tax preparer and let them know. Hopefully, your CPA has been through this process before. Send him/her the correspondence you received and likely you will fill out a Power of Attorney form so that all further correspondence related to the audit will run through your CPA. You will receive an Information Document Request (IDR) from the IRS. This might give an indication as to whether the IRS is looking at one or two specific issues or is conducting a full blown “fishing expedition” (sorry to throw technical terminology in here). It makes sense to meet with your CPA before responding the IRS to deal with preparing for the audit. You will want to look at the year(s) in question but also the preceding and succeeding years to see if there are any aggressive positions that were taken and start working on how to present the facts in the best possible light as well as lining up legal support for your position. You need to pull the information requested in the IDR together. If at all possible pull the information together in a comprehensive manner. I would suggest PDFs rather than live files in a bookmarked document arranged in order of the items in the IDR.

A few things to expect and “dos” and “don’ts”:

The IRS will want to conduct an initial interview with the principal. You should have your CPA present. Be forthcoming and honest but answer just the question asked and don’t “elaborate” if silence follows your original answer. Hopefully, your CPA will have prepped you.

The examiner very well may ask for copies of the tax returns for the years in question. This surprised me the first few times it happened because you might expect the examiner would have copies already but the information the examiner pulls from the IRS system looks different and is more difficult to follow than an actual tax return on forms. Just provide the copies.

You/the CPA should ask the IRS if they are looking at any issue in particular (if not apparent from the initial IRS correspondence or IDR).

The IRS will almost certainly want to tour the physical business location. This is commonplace and no need to worry. Just make sure the IRS examiner is accompanied, preferably by your CPA.

Don’t: Allow the examiner’s ability to engage in “casual” conversation with employees who might not understand the nuances of answering a question they might not understand what the examiner is really asking.

Do: Try to conduct this tour during off hours; this would minimize the preceding “Don’t”.

Do: Have the auditor conduct his/her fieldwork off site, preferably at your CPAs office which makes it easy to avoid the above.

Do: Your CPA should have the IRS in its own space, preferably away from the hustle and bustle of the firm.

If they are related entities, whether they be companies organized in separate entities or individual owners, the examiner may ask to see copies of the related party returns particularly if there are transactions between the related entities (e.g., S corporation renting business location from LLC owning the real estate where both companies have common ownership).

Do: If in prepping for the examination you discover an obvious error, ethically you need to disclose that to the IRS. This could build some goodwill. However,…

Don’t: You need not give up an aggressive position if there is support for taking it. This could be useful down the road if you end up “horse-trading” issues.

Finally, beware of the examination/relationship goes sideways. We (both CPAs and clients) always try to act professionally but sometimes it just does not play out that way. If that happens, there are some options you have: asking to speak to examiner’s manager or heading straight to the Taxpayer’s Advocates Office.

Don’t: Finally, don’t panic, lose sleep, lose weight, gain weight, well, you get the idea. This is a normal fact of life, like getting a colonoscopy or root canal. This too shall pass.

Contact us with any of your tax questions and concerns. For more on how Henry+Horne can use our decades of audit experience to help you in preparing for an IRS audit, check out our Audit Services page.

Bradley Dimond, CPA