Are you Interested in Generating Some Extra Cash?


Audits and IRS Strategies

  1. 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.
  2. 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.)
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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.

  9. 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.
  10. 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.
  11. 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.
  12. 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.
  13. 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.
  14. 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.
  15. 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.
  16. What can you do if your spouse gets caught red-handed by the IRSțand 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.
  17. 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.
  18. 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 returnsț0.93%. Taxpayers in the western region (composed of 17 western states) had the greatest percentage of audited returnsț1.73%. 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 just arranged to reprint a report which has been unavailable for many years. How The Internal Revenue Service Selects Individual Income Tax Returns For Audit shows the basis for IRS audit selection using excerpts from the U.S. General Accounting Office study. To order, send $25 to University Microfilms International, 300 North Zeeb Rd., Ann Arbor MI 48106. Be sure to specify catalog number AU00381 as they have over 100,000 titles in their catalog.
  19. 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.
  20. 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.
  21. 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.