As a result of the over $45 billion additional funding allocated to the U.S. Internal Revenue Service (the “IRS”) for tax enforcement under the Inflation Reduction Act of 2022, H.R. 5376, it is anticipated that the IRS tax audit activity will increase, so every taxpayer should prepare.

Why was I selected for audit?

Being selected by the IRS for audit does not necessarily mean the taxpayer has done something wrong, thus, the audit may or may not result in additional tax due. Tax authorities use various methods for selecting taxpayers to audit, such as;random audit selection, mismatching of information reported in the IRS system, or review of publicly available information for which the IRS wants more information.

What does the audit process entail?

The IRS may conduct the audit through correspondences (commonly referred to as a “desk” audit) or through an in-person audit at a specific location (commonly referred to as a “home”, “office” or “field” audit).

Depending on the size of the taxpayer and sophistication of the activities, the length of the audit may be a few weeks or last several years for larger taxpayers with substantial activities.

Tax auditors have broad authority to examine books, records, or other data relevant to the taxpayer’s tax return. The IRS interview may cover information about taxpayer’s financial history, business operations, and books and records that aren’t available from other sources. Additionally, the auditor may ask to tour the business to better understand the operation and review taxpayer’s documentation.

The IRS must follow the tax rules set forth by the U.S. Congress in the Internal Revenue Code of 1986, as amended (the “IRC”), and related treasury regulations, court decisions, and other rules and procedures. When interacting with the IRS, it’s important to understand that tax auditors have specific training on audit techniques, knowledge of the tax law, and audit expertise. Thus, the particular questions or document requests (“IDRs”) raised by the auditor are intended to detect audit issues or substantiate an audit risk that the tax authority identified.

Taxpayers should be mindful of their responses and documentation they provide to IDRs as such information lays the foundation that the auditor uses to support audit adjustments to the taxpayer’s tax return.

What are the taxpayers’ rights?

The Taxpayers Bill of Rights and Declaration of Taxpayer Rights provide certain basic rights that taxpayers should expect during the audit process.

Right to be informed: Taxpayers have the right to clear explanations of the laws, IRS procedures and decisions about their tax accounts.

Right to privacy and confidentiality: Any IRS inquiry should comply with the law and be no more intrusive than necessary respecting all due process rights. The taxpayer has the right to know why the IRS is asking for information, how the IRS will use it, and what happens if the taxpayer does not provide the requested information. Further, the IRS should not disclose to anyone else the information the taxpayer provides, except as authorized by the taxpayer or by law.

Right to representation: Taxpayers may represent themselves or elect to have representation by a person allowed to practice before the IRS (e.g., attorney, certified public accountant, or enrolled agent).

Right to payment of only the correct amount of tax: A taxpayer is responsible for paying only the amount of tax legally due.

Right to assistance: If a taxpayer cannot afford representation, they have the right to seek assistance from a Low-Income Taxpayer Clinic or through the Taxpayer Advocate Service, where a taxpayer has significant hardship and an unresolved tax problem.

Right to finality: The Taxpayer has the right to know the maximum amount of time the IRS has to complete the audit and when the audit has finished, as well as, the maximum amount of time the taxpayer has to challenge the IRS’s position(s).

Right to challenge the IRS’s position(s): The IRS should, promptly and fairly, consider and respond to taxpayer’s timely objections and additional documentation provided by the taxpayer in response to formal or proposed IRS actions.

Right to appeals and judicial review: The taxpayer has the right to a fair and impartial administrative appeal for unagreed IRS audit adjustments and to receive a written Appeals Office decision, as well as, the right to take their cases to court in many circumstances.

Relief from certain penalties and interest: The IRS may waive penalties, when allowed by law, if the taxpayer shows it acted reasonably and in good faith or relied on the incorrect advice of an IRS employee. Further, the IRS will waive interest that is the result of certain errors or delays caused by an IRS employee.

What are some best practices during a tax audit?

Preparation: Understanding the facts, tax positions and organizing supporting documentation early allows the taxpayer to timely respond to IDRs and minimize surprises.

Audit scope: The taxpayer should attempt to limit the scope of the audit and define the process by discussing with the auditor;the time and place for conducting the audit,

the specific areas of the tax return under review,

the expected timing for replies to any IDRs, and

the estimated completion date of the audit.

Contacts: The tax authority may assign various auditors to work different aspects of the tax audit from the case manager to certain subject matter specialists. The taxpayer should understand which auditor is the coordinator of the audit and those examiners that are solely in specific roles, as well as, the reporting line from case manager to their superiors. If a taxpayer believes that an IRS employee has not treated them in a professional, fair, and courteous manner, the taxpayer discuss the issue with the employee’s supervisor and further escalate the matter to the area IRS Director or the center where they file their return.

Anticipate: By understanding the scope of the audit, the taxpayer can anticipate and prepare responses to the auditor’s questions, rather than, simply react.

Establish the record: The taxpayer should treat every IDR response as building the file for possible appeal ensuring that every response;is well written with properly developed facts and legal analysis supporting taxpayer’s positions,

provides relevant documentation responsive to any IDR and positioned to support taxpayer’s position(s),

provide copies (not originals),

where appropriate, consider providing written statements that support the documents and taxpayer’s position(s),

in certain circumstances, it may be appropriate to offer alternative documents that support the tax item in question,

maintain complete records of documents received and submitted to the auditor.

Auditor file: The taxpayer may request the auditor’s administrative file containing any statute extensions, correspondences between the parties, taxpayer responses, a list of any third-parties contacted by the auditor, the auditors proposed audit adjustments and analysis in support of such adjustments.

Cooperation: Although a tax audit is an adversarial process, it is always best to cooperate with the auditors to build trust and bring the audit to a reasonable conclusion. Being rude or untruthful with the auditors may damage the relationship of the parties and cause an expansion of the audit scope, as well as, other possible repercussions.

At the end of the day, taxpayers should anticipate an increase in IRS audit activity and, therefore, prepare their records and audit strategy for possible defense accordingly.

Author:

John E. Hurley, Esq., Managing Member, Hurley Tax Law, PLLC

Phone: 561-704-3813

Website: www.hurleytaxlaw.com

Email: jhurley@hurleytaxlaw.com

The above article is intended for educational purposes only and should not be relied upon as legal advice nor creating any attorney-client relationship between Mr. Hurley and any person reading this article. Any person requiring tax representation or advice should retain the services of a tax professional.