Six Tips for Surviving a Tax Field Audit

April 13, 2011
Henry Stimpson

If you're about to be subject to a field audit, where the IRS or your state agency goes through your records with a fine-tooth comb, you should prepare yourself before contacting tax authorities. Here's some advice to help you cope with the process.

Panic typically sets in moments after taxpayers receiving the envelopes in the mail informing them they're about to be audited. Generally, however, audit requests can be resolved quickly and painlessly over the phone, or by mail by providing additional documentation, such as charitable receipts or expense reports.

But if you're about to be subject to a field audit -- where the IRS or your state agency goes through your records with a fine-tooth comb -- you should prepare yourself before contacting tax authorities. Larry M. Elkin, CPA, CFP, president of Palisades Hudson Financial Group LLC, a financial-planning firm and investment advisor headquartered Scarsdale, N.Y., that prepares tax returns for clients, offers these tips.

Don’t Assume That the Tax Authorities Are Correct. Federal and state tax offices send out huge numbers of notices advising taxpayers that they owe money. Most result from simple data or reporting errors the tax authorities believe you made. But if you carefully gathered your tax information and had someone competent prepare your return, there is a good chance the notice is incorrect.

Do Not Just Pay the Bill. Check the facts first, or ask your tax preparer to investigate. If the tax authorities’ figure is wrong and yours is correct, you should be able to clear up the matter routinely.

With field audits, the situation is far more complex. Unfortunately, the tax agent may not fully understand the law, or even the facts. Field agents often lack a detailed knowledge of applicable tax law, or may seem to make up rules that are not in the tax code or regulations. That’s because they are typically some of the least-experienced and least-trained personnel in the enforcement staff -- those with greater knowledge tend to be promoted to review-level positions.

Educating the agent is part of a tax professional’s job in representing a taxpayer, but what about those who represent themselves and who know even less about the tax laws than the auditor? They are vulnerable to "pulled-out-of-thin-air" declarations.

Do Not Represent Yourself. The audit process works best when it is limited to the issues the auditor raises. Your presence invites incomplete or incorrect off-the-cuff answers to the auditor’s questions. An effective taxpayer representative -- usually a certified public accountant, attorney or IRS-authorized enrolled agent (http://www.naea.org/memberportal/Resources/ForTaxpayers/whatis_EA.htm ), a tax expert who is empowered by the U.S. Department of the Treasury to represent taxpayers for IRS audits, collections, and appeals, will find out what the auditor wants to know, gather the information and present it clearly and concisely without triggering collateral issues.

Remember, skilled professional representation is expensive, and your representative does not control how many hours the audit will consume -- the auditor does. Auditors do not care how much they cost you in professional fees. Sometimes tax authorities seem to have a pretty good idea how much it will cost a taxpayer to appeal or litigate a dispute and offer to settle for about the same amount. It may be worth accepting such an offer if the auditor raises a valid point.

Once you hire a representative, get out of the way. You have nothing to gain by participating in the process.

Do Not Extend the Statute of Limitations. You have a few months after the end of the year to file your tax return. The authorities generally have three years thereafter to examine it and ask anything they want. Auditors have heavy caseloads, however, and they like to manage them by asking taxpayers and their representatives to waive the three-year limit. Taxpayers usually grant such requests. Just say no.

Waiving the statute allows the agent to drag out the process, inflating the taxpayer’s cost for representation and increasing potential interest and penalty charges. It gives the agent more time to raise more issues. It lets the agent raise additional issues if new legislation, regulations or court decisions provide support. You get no benefit. Taxpayers who represent themselves may not want to upset an agent, but the auditor is not there to be your friend.

Do Not Be Bullied or Intimidated. Most agents will not threaten, yell at or mistreat you, but an occasional miscreant will. If that happens, documenting the misconduct so that the agent’s supervisor or an appeals officer might learn about it is one way to handle the situation. Another is to simply ask to speak with the agent’s supervisor.

If an agent becomes belligerent with you, calmly tell the individual that you or your representative must speak with a supervisor before having any further dealings.

Keep Excellent Records. If you can demonstrate that your tax return is correct and complete, and that you have taken positions that comply with the law, you should have no problems if you are audited.

Keep in mind that even the best tax professional representing you must work with the information you provide. If you don’t have a system to efficiently maintain the records you need, your tax adviser can help you set one up, or maybe even maintain the records for you. You will get the best results through helping the auditor do his or her job well, by offering information that is credible, responsive and well organized.

Pay What You Owe, Promptly. Interest and penalties, including penalties for late payment, add up quickly. If you have the money to pay what you owe, pay it. It is possible to get installment plans and even compromises on tax debts, but the tax authorities do not cut great deals for solvent taxpayers.

If an auditor raises an issue in which you clearly are wrong, concede the point. Owning up builds credibility and shows the agent -- and any appeals officer who reviews the case -- that you are making a good-faith effort to comply with the law. That credibility might earn you the benefit of the doubt on other issues, such as minor gaps in your records.

Though tax enforcement theoretically is about collecting the correct tax owed, revenue agents do care about revenue. If they are not going to find a lot of money by auditing you, they will want to move on to a more productive assignment.

Your goal in an audit should be to show the auditor that it is time to move on. That’s the quickest, safest route through the field audit minefield.

Larry M. Elkin, CPA, CFP, president of Palisades Hudson Financial Group LLC, a fee-only financial-planning firm and investment advisor headquartered in Scarsdale, N.Y., with $1 billion under management. It offers estate planning, insurance consulting, trust planning, cross-border planning, business valuation and appraisal, family office and business management, tax preparation, and executive financial planning. Branch offices are in Atlanta and Fort Lauderdale, Fla.