YOUR TAXES : PART FIVE: PAYING YOUR TAXES : How best to escape an audit unscathed : Stay calm, be courteous and bring plenty of records, experts advise
Quaking, quavering and absolutely convinced he was going straight to jail, the man arrived at Lowell Langers’ office for his Internal Revenue Service audit.
“He really thought he might go to jail from our office,” recalled Langers, a former auditor who now serves as a press officer for the IRS in Los Angeles. “But after I recomputed his taxes, he ended up with a refund.”
Each year, about 2 million U.S. taxpayers receive word that their tax returns are being audited. Yet the chances of being audited are surprisingly slim. More than 178 million federal tax returns are filed each year. Ninety-nine million are from individuals, and of those, only 1.3% are audited, according to Sandor Frankel, a tax lawyer and co-author of “You Can Protect Yourself From the IRS.”
If your total income exceeds $50,000, an audit is more likely because 3.5% of the returns in that range are audited, according to Frankel.
Although most taxpayers will never be subjected to an IRS audit, if you are, it pays to be well informed and prepared.
Auditors, certified public accountants and others who deal with the IRS say most people can survive--and even win--their battles with the IRS if they follow some basic advice: Stay calm, be polite, be prepared to answer questions, be armed with documentation to back up your deductions and do not assume that the government is always right.
“You ought to treat the IRS agent with a tremendous amount of respect and act as if he or she is the highest court in the land,” said Bob Brown, a Pasadena CPA. “If you try to trick him or overpower him, you’ll just cost yourself time and money. It’s not a game, it’s serious stuff.”
What most taxpayers don’t know is that IRS auditors are under tremendous pressure to complete and close cases. Each case is supposed to take 1 1/2 hours from start to finish, including the final report, according to the IRS’ Langers. On an average day, an auditor sees five taxpayers and has little patience with people who waste his or her time, Langers said.
The IRS computer is programmed to red-flag anything unusual, primarily focusing on large deductions taken for medical, travel or entertainment expenses, substantial business or casualty losses and questionable charitable deductions, according to CPAs and tax experts. Any type of tax shelter--especially a money-losing one--is sure to attract attention.
As a general rule, the larger the loss or deduction, the more likely the return will be audited. Although the initial work is done by computers, an actual person, called an examiner, has the final say on which returns are audited.
In addition to returns kicked out by the computer’s Discriminant Function System (which selects about 80% of the returns that are audited) the IRS relies on several other methods of selection. Some returns are chosen at random through the Taxpayer Compliance Measurement Program, which collects data every two or three years. The information gathered helps the IRS measure the average amount of deductions and exemptions claimed by taxpayers at all income levels.
Still other audits focus on certain types of occupations, such as private-duty nurses who may not report all their income or casino dealers in South Lake Tahoe who are suspected of not reporting all of their cash tips.
Other taxpayers are audited because their tax preparer is under investigation for fraud or negligence. In those instances, all of the returns prepared by a specific person are audited, according to Mary L. Sprouse, former IRS audit group manager in Los Angeles and author of “Sprouse’s Income Tax Handbook 1987.”
So, what if you are among the unlucky 2 million people subjected to an IRS audit?
Tax professionals say it is important to understand how the system works before you appear for your audit appointment. The primary question to be answered is how did you arrive at a specific figure and what do you have to back it up? If you are prepared to answer calmly this type of question, the rest is easy. Remember, too, that audits can result in a tax refund, not just penalties.
The experts provide these basic tips:
Stay calm.
Give yourself plenty of time to get to your appointment. Many IRS offices do not have parking lots or convenient places to park.
Wear comfortable clothes; there is no need to dress up.
Organize your documents before the audit. A shopping bag filled with receipts will not win any friends among auditors.
Bring every type of record or document you think you might need, including divorce and escrow papers, personal calendars, log books, canceled checks, etc.
Be polite. Don’t be antagonistic. The auditor is there to do a job, not give you high blood pressure or an ulcer.
Brown, the Pasadena CPA, said the type of records that you bring to an audit can make or break it. The best proof is “contemporaneously prepared records,” such as third-party invoices, receipts and other types of official papers.
The second-best evidence is internally prepared records, such as checkbook registers, journals and ledgers.
The least acceptable records are personal calendars and notes prepared by the taxpayer himself, but Brown said even these are helpful in certain instances.
Many taxpayers wonder if they should hire someone to represent them or face the auditor themselves. A general rule of thumb, experts say, is that if you prepared the return by yourself and the amount of tax in question is nominal, meet with the auditor yourself.
If a CPA, attorney or other tax preparer completed the return, he or she usually will continue to represent you after you sign a form giving power of attorney.
Jerry Brockett, a senior tax manager in New York with the accounting firm Seidman & Seidman/BDO, suggests hiring professional help if thousands of dollars are at stake. He also emphasizes the importance of attaching as much information as possible to the return when it is filed to avoid questions being asked later. Receipts, invoices and other records immediately show the IRS examiner that you stand firmly behind whatever you are claiming.
Because auditors are under so much pressure to close a case, they are more likely to disallow a deduction if you cannot quickly provide something to back it up, Brockett said.
He also suggests being very careful when you prepare your return. Read the instructions twice and be sure you understand all the questions asked.
“Complete information increases your chances of a favorable outcome,” Brockett said.
He said it is important to attach all the proper forms, such as W-2s (which record wage and salary figures) and 1099s (which banks and financial institutions provide to document dividends and interest payments). Copies of these forms are sent directly to the IRS, and the figures must match the ones you have on your return, Brockett said.
In most cases, Brockett said, he has had good experiences dealing with IRS auditors.
“They don’t use Gestapo tactics,” he said. “They don’t assume you are a crook and they are there to put you in jail.”
Most IRS auditors are polite and professional people who come from varied backgrounds. (Langers, for example, worked as an English teacher, librarian and welfare eligibility worker before joining the IRS.)
Sprouse, the former Los Angeles audit group manager, offers these additional inside tips on dealing with an auditor.
“First, don’t volunteer information. What you don’t know about the tax law can hurt you,” she writes. “Answer the auditor’s questions but don’t feel you have to elaborate.”
As the session progresses, she said, it is important to find out which areas most concern the auditor. Ask the auditor if you are providing the information he or she needs so you can get a feel for where things are headed.
“Knowing where you stand gives you time to prepare a convincing argument that each deduction is reasonable,” according to Sprouse.
If you are unhappy with the results after meeting with an auditor, you have 30 days to appeal. The administrative appeals process has two levels: informal, where you meet with a senior auditor or group manager to review the audit report, and formal, where your case is heard by an appellate conferee. A written protest calling for a formal appeal must be filed if the amount in dispute is more than $2,500. Normally, 80% of all appeals are settled before they go to court, Sprouse said.
If a taxpayer cannot resolve his problem at the IRS appeals level, he can take his case to Tax Court or the nearest U.S. District Court.
Despite all this good advice, most people still dread dealing with the IRS and love to share their horror stories. One young professional woman recalled the pain of having her 1983 return audited.
“It was horrible. I almost gave up and paid the $2,000,” she said. But she didn’t give up. After several extensions and a few transfers to various offices because she moved, she hired a new accountant to fight for her. She finally won and was allowed to deduct certain travel and entertainment expenses related to her work as a journalist.
But her boyfriend wasn’t so lucky. He fought but ended up paying $4,000 in back taxes. And they soon realized that several friends and acquaintances who shared the same accountant were all being audited.
Before you breathe a sigh of relief because you haven’t heard from the IRS in a while, remember that the service has three years from the time the return was filed to complete an audit. So it’s a good idea to keep your tax records for at least three years--and preferably five or six--in case you do face an audit.
AVERAGE TAX DEDUCTIONS IN 1984
Adjusted Medical/ Contri- gross income dental Taxes butions Interest $20,000 - 25,000 $1,469 $1,820 $767 $3,076 25,000 - 30,000 1,339 2,184 803 3,477 30,000 - 40,000 1,749 2,698 1,156 4,032 40,000 - 50,000 1,876 3,488 1,105 4,796 50,000 - 75,000 3,127 4,755 1,546 6,492 75,000 - 100,000 6,316 7,002 2,421 9,589 100,000 - 200,000 9,494 10,641 4,234 13,704 200,000 - 500,000 25,417 22,684 14,312 22,522 500,000 - 1 million 34,771 50,032 30,823 44,611 Over 1 million 51,701 150,784 139,291 105,474
Source: Internal Revenue Service
