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IRS Audit - A True Story

By: Arik Rozen CPA

Who does not fear an IRS audit? We all do. We all fear the face to face, exhausting, unpredictable and time consuming interaction with the Internal Revenue Service's agent.


We all have that scary feeling when submitting our tax return... Would I be audited? Was I too aggressive? Will the IRS "red flag" my tax return? Maybe I should ask for a lower refund so I will not be audited...


And then the refund check comes along, we deposit the check in our bank account and after a while we tend to forget about the IRS, the audit and our fears remain nothing but an old memory.


For most of us, the story stops here (at least until next year). For some it just starts. The real story begins when you open your mail and see an envelope from the Internal Revenue Service and in it a letter notifying you that your tax return is being audited. Wow!!! an audit. What should I do now, you are asking yourself? imagining the end of the world.


Best thing to do at this point is to "face your fears". Read the notice carefully, see what the IRS wants, what year is being audited, the extent of the audit (partial, full, examination) and what is the required documentation, and then, call a CPA.


A CPA that specializes in audits, has the experience, knowledge and skills to better confront the IRS, and maneuver through the tricky road of an audit.


Face Your Fears


Our real life story begins at the point, in which I have received such a letter from a client, notifying him that his 2002 tax return is being audited by the IRS and asking him to pay extra taxes of $20,000. Needless to say that the client (a small business owner from the "Big Apple") was extremely confused, concerned and nervous.


Since I have not prepared the 2002 tax return and was only retained by the client to represent him at the audit, the first thing I did was to explain the client what are we facing.


An audit , I have explained, is not the end of the world. The goal in an audit, is to provide the IRS as much information as possible without disclosing unnecessary details. In the next few weeks we will go through the audit letter and your tax return and see which documents we should forward to the IRS to support the return, I have added and asked the client to send me the tax return, the IRS notice and all supporting documents for the tax return.


After I have reviewed all of the information, it was clear to me why the IRS has decided to audit this specific tax return - the ratio between income and expenses (deductions) on the return did not match the IRS averages and the fairly large variation from the average triggered the full IRS audit.


When I called the client and asked him why was the return filed overlooking the IRS statistics, he responded that it was a case of bad advice he had received when preparing the tax return.


Too bad, I said, but again, not the end of the world.


We had 30 days to respond to the IRS, so we had to move fairly quickly nut not under pressure. Always request more time, if you feel necessary.


Information, Information, Information


The next step was to gather all the relevant information, documents and statements that would help us support the tax return. Normally, (and so in this case) the necessary information includes:


Bank statements


Copies of cancelled checks


Receipts of deductions claimed on the return


Income statement report - also known as profit and loss report (if you have business income and expenses)


Payment verifications - for mortgage, property tax, donations and other deductions


So, we have started collecting the information; calling the banks, mortgage companies, county administration and suppliers billing departments, asking for copies of documents, receipts, checks and statements. Within 3 intensive weeks we had all the required information.


To assure I am not missing anything, I went through the tax return thoroughly, and checked each and every item on it, marking all the documents that support and correspond to each item.


The clock was ticking quickly, we had one more week to go until the IRS deadline expires.


One on One with the IRS


At this point I have reviewed the client's tax return and all supporting documents, I knew what are the problems with the return and what will the IRS agent look for.


I was ready to go one on one with the IRS.


I have called the IRS agent, nice but very strict lady (who was not too happy with my request to meet her after the deadline expires) and set up a meeting at her office to conduct the audit.


On the audit date, I showed up right on time, 9:30am, ready with all the necessary information. The IRS agent showed me to her office, located behind locked door ("Only Employee Beyond This Point"). She did not hide the fact that she was very skeptic about this taxpayer and tax return and indicated that the numbers look very odd.


The first part of the audit included a long series of questions about my client. In this section the IRS tries to collect information about the taxpayer, his income, expenses and assets. The IRS goal is to cause you to disclose data which will assist the agents in determining that your tax return is incorrect (or even worse, fabricated):


Where does he live?


What is his profession?


Where is his business?


Who are his clients?


Who are his suppliers?


What are his source of income?


Where does he bank? What kind of assets he owns?


and many other questions about the taxpayer, his business and operation.


I have answered the agent, providing her only with the information I wanted to disclose about the taxpayer and not a drop more. It is very important you answer the questions openly without volunteering information that has not been asked for.


Once this part was over, the moment of truth has arrived: the numbers. At this point I pulled out a huge package I have prepared in advance which included hundreds of documents, statements and most importantly a summary of all the data in one simple report with suggestion to reduce the additional tax from $20,000 to $3,000!!!


I have explained The IRS agent about the package I brought with me and suggested going through all of the documents (knowing that it could take long long time) or use my summary report and sample few of the items to verify its accuracy. The agent who was motivated by her will to finalize this audit, embraced my second suggestion and asked to see my summary report.


She took my report and ask me for supporting documents of several deductions included in the summary. I was ready with all the supporting documents and therefore was able to verify each of the inquiries. After she received proof for the accuracy of about 10 items the agent felt comfortable enough to accept my report as true and correct.


End result of the audit was an additional tax $3,000, a long way from the original $20,000 asked by the IRS.


Conclusion


When you receive an audit letter from the IRS - do not panic.


Review the letter, see what exactly is being audited and what is needed to proceed.


Call your CPA for advice and representation (your CPA is better equip to handle the IRS's tricky questions).


Prepare for the audit thoroughly and collect all the necessary information to support your tax return.


Do not rush to reply, get an extension for responding to the IRS notice.


Identify the problematic areas in your tax return and try to draw attention away from them.


Be honest (but not to open, do not volunteer information) with the IRS agent.


Try to lead the audit not to follow it.


Tax USA Inc.
------------


Tax USA, Inc. is a complete tax, accounting and financial management firm specializes in small businesses, corporations and high income individuals. Tax USA Inc.'s mission is to exceed clients' expectation by providing superb tax, accounting & financial Management services. We offer our clients tax, accounting and bookkeeping services, CFO Outsourcing, Budget Review and Business Plans, Cash Flow Management, Payroll Services and Entities' Incorporation.


Our Clients
-----------


We focus on small and mid size businesses, non-profit organization and high income individuals. Client list comprised of corporations, non-profit organizations and high-tech employees. Our corporate clients operate in various industries:


- Security
- Information Technology
- Internet
- Retail
- Manufacturing
- Transportation
- Real Estate
- Project Management
- Business Development

ARIK ROZEN, CPA
---------------
Mr. Rozen is a certified Public Accountant; holds a BA in accounting and M.B.A. (majored in Finance). Mr. Rozen has 15 years of experience in tax, public accounting and financial management, serving in a range of executive financial positions and as an independent CPA for various companies and organizations. Mr. Rozen has specialized in accounting and taxation of micro and small businesses.


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