How to prepare for an office audit.
by Wendy Kravit, CPA
In the case of an office audit, a taxpayer is typically sent a letter that his return has been selected for audit. The letter details the items on the return that are being examined and requests that the taxpayer produce specific records pertaining to those items in person at an Internal Revenue Service (IRS) office at a specified time on a particular date.
The date and time of the audit is easily changed. The IRS does not expect most people to be available at the random date and time that it chose to put on the letter. Therefore, there is no negative connotation placed upon a taxpayer or representative who calls to change the appointment.
An Overview of the Typical IRS Office Audit
Prior to meeting with the taxpayer or his representative, the IRS Tax Auditor should have inspected the return and the classification check sheet created during the classification process when the return was selected for audit. While the audits are often confined to the items on the classification checklist (which are the same items that are detailed in the letter to the taxpayer), IRM 22.214.171.124.1 instructs the auditor that the scope of the examination should not be limited to the classified items if other significant issues are revealed during the examination. Therefore, an audit may be expanded depending on what the auditor discovers. The IRM urges the auditor to get managerial permission before expanding the scope of the audit. If the scope of the audit is expanded to another tax period, the taxpayer is to be notified in writing.
Office audits are not as complex as field examinations. Most office audits are allotted initial time slots of a few hours. The examiner has a worksheet that he will fill out upon examining the evidence that the taxpayer or representative presents for the items listed on the audit letter.
Preparing for an Office Audit
Generally, the meeting at the IRS office is fairly informal and relaxed. Most office audits do not involve complex issues and the auditor is verifying gross income and documentation to verify deductions. The auditor has to complete a form to create his report. He uses Form 4700 to record what he has seen and verified. The key to a successful office audit outcome is organization. A representative should have thoroughly reviewed all documentation that will be presented to the auditor. If there are multiple receipts to verify a particular expense, they should be organized together preferably with an adding machine tape to show the totals. The auditor may test some of the tapes to verify the accuracy.
Common areas for an office audit include itemized deductions, employee business deductions, and less complex Schedule C and Schedule E issues.
The representative should have a copy of the Power of Attorney (POA) with him even if it has already been submitted. The POA should include all open tax years for the taxpayer. If the auditor finds a significant issue in one year, he is very likely to look at the same issue in any other years that are currently open by statute.
The auditor will generally go through his check sheet. If there is disagreement between the representative and the auditor regarding the final audit findings, the representative may request a meeting with the auditor’s manager. If no adjustments are made, the case will be closed and a “no change” letter will be issued to the taxpayer. If there are adjustments to be made to the return, obtain a copy of the report and review it with the taxpayer. Do not sign reports on behalf of your client, always discuss the report with the client and, if agreed, have the client sign the report.
If the taxpayer agrees with the adjustment, he may sign and pay the tax immediately or sign the form, consenting to the assessment and wait for a bill. If the total amount due is less than $100,000, the taxpayer will have 21 calendar days to pay the bill without incurring additional interest. If the amount is at least $100,000 or more, he may pay the bill within 10 business days without incurring additional interest charges.
Handling Audit Disagreements
IRS Publication 556 outlines taxpayer appeal options.
As mentioned earlier, the first step to be taken to resolve a disagreement with the auditor is to meet with the auditor’s manager. However, if that resolution is not satisfactory, there are different options available depending upon the amount of money in dispute. The examiner will write up the case explaining your objection and close it out. A case is closed subject to managerial approval.
The taxpayer will receive a “30-day letter.” The letter proposes the adjustments that the auditor found and requests that the taxpayer either sign his agreement to the assessment of the additional tax or request an appeal.
If the taxpayer does not respond to the 30-day letter, he will receive a “90-day letter.” The 90- day letter is a “statutory notice of deficiency.” It contains information and instructions for filing a Tax Court petition. If the taxpayer does not respond to the 90-day letter and does not file a tax court petition, the tax will be assessed.
Field examinations are handled by revenue agents and are generally more complex audits involving a business. Usually these are done at either the taxpayer’s place of business or the representative’s office. The taxpayer may be initially contacted by the agent by telephone or letter, depending on the practices of that area. Once a Power of Attorney has been submitted to the IRS all communications should be done through the representative.
The agent will submit a rather exhaustive request of books and records that he wants to examine to the taxpayer on an IDR, Information Document Request Form. Obviously, he will not be able to examine all of those records on the first day, so it is not unreasonable to ask him which records he really expects to be examining for that first day. Assuming the audit will take more than one day, he will typically issue a new IDR at the end of that first day detailing more specific records requests.
Often an issue arises because the revenue agent wants to speak to the taxpayer even though the representative has a valid Power of Attorney on file.
IRM 126.96.36.199.1 states that “Honoring a valid power-of-attorney submitted by a taxpayer is always required unless the criteria for bypassing the power-of-attorney has been met.”
Furthermore, IRM 188.8.131.52.3.2 provides the following information to IRS auditors:
Internal Revenue Code section 7521(c) states that an examiner cannot require a taxpayer to accompany an authorized representative to an examination interview in the absence of an administrative summons. However, the taxpayer’s voluntary presence can be requested through the representative as a means to expedite the examination process.
Should an examiner find that a representative has unreasonably delayed or hindered an examination, an examiner can bypass the representative and deal directly with the taxpayer.
Revenue agents are trained to request an interview with the taxpayer. However, if the representative is well prepared and knowledgeable about the taxpayer’s business and sources of income such a meeting should not be necessary.
The initial interview will include questions concerning possible nontaxable sources of funds as well as unreported sources of income. Therefore, the representative should be familiar enough with his client’s financial picture to be able to answer questions regarding loans, family gifts, inheritances and so on.
IRM 184.108.40.206.3.3 instructs the auditor to conduct a tour of the business site. The agent is instructed to visit the principal location and any other locations acquired during the period under examination. This is not required for office audits, although a visit may be conducted if appropriate. The purpose of the tour is for the revenue agent to gain familiarity with the taxpayer’s business operations and internal controls, identify potential sources of unreported income and to confirm the existence of assets.
Field audits of small businesses usually last several days or longer, depending upon the complexity of the business. The agent will have conducted a survey of the return before the visit; however, he will determine the scope of the audit based upon the initial interview and subsequent findings.
This article has been excerpted from The Adviser’s Guide to Doing Business With the IRS. You can purchase the publication at cpa2biz.com.