Death and taxes share more than just a cliche'd phrase about inevitability. They share a common process when it comes to an IRS audit, the five stages of grief. Few events cause as much grief as an IRS audit. How you handle the five stages determines your eventual audit outcome as surely as the quality of your documentation.
The first stage is denial. "This isn't happening to me." "There must be some mistake." Denial often manifests itself through procrastination. Some people don't open the IRS envelope with the audit notice. Some open the notice, but never respond to the scheduling information. They lose precious weeks of preparation. If you need to produce bank statements, you can't make the bank respond overnight. You can't find a competent professional to represent you overnight.
Denial, in the form of procrastination, is the first step to a bad audit outcome. When you get the dreaded IRS notice announcing your audit, gather all of your tax records for the year being audited, and immediately contact a CPA or attorney to represent you. Your professional representative will schedule the audit. Audits are about credibility, and nothing establishes credibility with the IRS like a professional representative.
The second stage is anger. This is the "How dare they? I'm a God fearing, honest American. They have no right to audit me." stage. An audit is a legal proceeding. You are legally obligated to participate. There is an alternative minimum tax but no alternative minimum audit.
Anger, during an audit, never works in your favor. IRS examiners face angry people every day. You and I might have trouble handling personal rejection, but IRS employees face it every day. They develop immunity, or they don't last long. Remember, audits are all about credibility. Anger costs you credibility. An auditor, who likes you, might give you the benefit of the doubt in a gray area of tax law or documentation.
The third stage is bargaining. "If I just tell the auditor..... he has no choice but to take my word." Yes, he has a choice. As much as audits are about credibility, they are about documentation. The auditor has a checklist for every issue selected for audit. If he's auditing real estate taxes, you need mortgage interest statements and mortgage documents from your bank. Nothing else will work. Your aim in the audit is to help the auditor complete his checklist. If he feels you aren't cooperating, he can increase the scope of the examination. If you're caught in a lie, he can place additional years under audit. Again, your credibility determines your outcome.
In one audit, one of my clients was caught in a lie in the first half hour. What looked to be a half day audit covering one year turned into a three month nightmare covering three years of not just his personal tax returns but also his corporate tax returns.
The fourth stage is depression. "This audit will never end." "I never have enough documentation for the auditor." "He's not being fair." "I can't possibly pay the taxes he is going to assess." You will get through the audit. I have never seen one last forever. The IRS takes a cost benefit approach to audits. An audit is done when the auditor believes that any additional efforts will yield little in additional taxes.
Combat your depression by helping he auditor complete his checklist. You don't have to agree with his conclusions. That's not your aim here. Your aim is to get him through his procedures and to an assessment. There are lots of inexperienced auditors at the IRS. they make a lot of factual mistakes. Arguing with the field auditor wastes your time and doesn't get you any closer to the end of the audit.
Once you have the tax assessment, you get to argue your case before a more experienced supervisor. Many times, I have been able to knock out almost all of the field auditor's conclusions in a telephone call with the supervisor. They have the experience to know what they'll lose in a formal appeal or in tax court.
The final stage is acceptance. If you made mistakes in your tax returns, or can't support the deductions you claimed, you will have to pay additional taxes. If the assessment is large, the IRS will work with you to arrange a payment plan. Of course, I don't recommend handling the payment negotiation or any part of the audit yourself. An audit is an adversarial procedure. The auditor represents the interests of the IRS, not you. You need someone knowledgeable representing your interests or you may face payments you can't afford. That's bad not only for you but the IRS. If you're broke, they can't collect their taxes.
If you legitimately owe more taxes, sometimes the best thing your representative can do for you is negotiate down any penalties. If you're assessed an accuracy related penalty, a good representative can make a case that you acted in good faith and shouldn't face penalties. If you and your representative have established credibility with the auditor, you'll get the benefit of the doubt here. The auditor has a lot of discretion with this penalty. Removing or reducing it is your reward for being a decent human being during the process.
Thanks for reading! For real tax and accounting advice, visit the main S&K web site at www.skcpas.com. Also please like the "How to Screw up Your Small Business" Facebook page. I post there several times a day.
Until next time, let's do it to them before they do it to us.
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