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What you should do when facing a tax audit
Tax audits aren't necessarily as awful as many might assume. Not only are there ways to make them less of a headache, the chances of being audited have gone down in recent years. - photo by Jeff Wuorio
April 15 is understandably unnerving for many taxpayers.

For others, its the rest of the year that really makes them jittery.

A tax audit when the Internal Revenue Service notifies you of its intent to examine your tax returns in detail to make sure that your reporting of income, deductions and other details is accurate has taken on the mistaken spectre of torture by relentless government agents.

Less than 1 percent of taxpayers are audited. But if youve received an audit notice from the IRS or are just jumpy about the possibility, there are ways to make the process a good deal less harrowing.

Most auditing pros won't let their clients even see an IRS auditor; and in rare cases, the taxpayer can come out ahead. Once, I was able to get a client a $40,000 refund," said Cari Weston, a senior technical manager with the American Institute of Certified Public Accountants. "But, for the most part, audits are very run-of-the-mill and straightforward.

Dont ignore the notice

Popular media are as responsible as anything for the overblown vision of a tax audit phalanxes of suit-clad IRS agents badgering taxpayers to account for every deduction and every penny of income since time began.

The process actually begins with a simple letter via the U.S. mail.

As innocuous as a letter may be, dont toss it aside hoping the problem will simply vanish.

Always be responsive to the letter, said Weston. If you dont respond, theyre going to keep escalating things until they take some action against you.

But be cautious in your response. Although its within any taxpayers prerogative to answer, it's better to hand off the task to someone experienced in government tax audits.

Never handle an audit yourself, said Jeffrey Schneider, a Port St. Lucie, Florida, enrolled agent who can represent taxpayers before the IRS. If you write or say anything to the IRS, it can cause major problems you might have no idea about.

That advice may sound self-serving coming from some who makes a living handling tax audits. But Weston said a CPA or enrolled agent can usually determine how serious the IRS issues are by just looking at the letter. For instance, the specific department cited in the letter can offer valuable clues as to just how grave the IRS considers the matter.

Ive seen so many of these letters, I can usually tell very quickly whether its a big deal or not, said Weston.

Handing the letter to a CPA, enrolled agent or attorney isn't the end of the process, however. The taxpayer still needs to provide whatever information and details the IRS requests.

That means maintaining accurate and comprehensive records. For a small business even a modest, part-time one be sure to keep detailed records separate from your personal finances: Its all about records, records, records, said Schneider. You need to document everything that goes into the return.

In general, the statute of limitations for an audit is three years; six years if the IRS suspects a substantial misstatement of income; and in the case of suspected fraud, indefinitely. The IRS says it generally tries to conduct audits within two years of a returns filing.

So, how long should you hang onto documentation the IRS may wish to see? Weston recommends at least seven years for all supporting material receipts, pay stubs and anything else that supports your tax filings. As for tax returns themselves, keep them indefinitely (a task made easier by electronic storage in lieu of paper copies.)

The audit

After providing the requested documents delivered via Form 4564 now its time for the audit itself. That can occur either in person or via letter correspondence, which is most common. A taxpayer can request a face-to-face meeting if he or she is slated for a mail only audit, something that Weston often recommends: Mail audits can be far too time consuming.

Just as taxpayers should let a hired pro respond to the initial notice, they shouldn't directly deal with the IRS during the audit, either. Never, ever speak to the IRS yourself. Always have your tax professional do that for you, cautioned Tom Wheelwright, a Tempe, Arizona, CPA.

Many professionals worry their client may say something even with the best of intentions that may jeopardize their case: I go so far as to tell my clients that they are not welcome at the tax audit, said Weston.

If I have my way, my client will never even see what the auditor looks like, added Schneider.

How long an audit takes depends on a number of factors, including the complexity of the situation and the case load of IRS agents. Taxpayers who owe anything generally have 30 days to pay after receiving notice in the mail. Setting up a payment plan is also an option.

If you disagree with an audit decision, you can request an internal review of the case. Your representative can also propose an offer in compromise a settlement between what the IRS wants and what you and your representative offer.

Audits are rare

Audits are becoming increasingly rare. The IRS audited on average only 0.86 percent of individual taxpayers in 2014, the lowest rate in a decade due in large part to budget cuts that have strained the services resources. As Commissioner John Koskinen noted in remarks in late March, the IRS has lost more than 30,000 full-time employees since 1992.

The chances of being audited are even lower if annual income falls in the range of $25,000 to $100,000.

There are also proactive strategies that can reduce those odds even further.

Wheelwright said that having your return prepared by a tax pro can remove potential red flags, such as unexplained disparity in income from one year to the next and suspect deductions.

A good tax preparer knows how to prepare a tax return in such a way as to reduce the risk of audit," he said. "Hell also make sure that your tax return is well documented so you are prepared in case of an audit.
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