Few words strike as much fear into people’s hearts as “IRS audit.” How can you nursemaid clients through the terror of an audit notice?
“Clients need hand-holding and a calm, soft voice,” said Kerry Freeman, an Enrolled Agent at Freeman Income Tax Service in Anthem, Ariz. “Often they’re scared and only see the IRS as a big stick ready to whack them for something they may or may have not done.”
“If they become afraid, it gets much harder to get the needed information to resolve the case,” said California-based EA Crystal Stranger, author of The Small Business Tax Guide. “Watching what you say and how you phrase it is key. It’s helpful to minimize the use of the word ‘audit.’ ‘Examination’ is much less frightening.”
“When the IRS comes after you, know that it’s not personal and historically there is an area you are involved with where overall returns [are at] a high risk for the IRS – and they want the money,” said Juan Macias, an EA at the prep service Fourlane in Austin, Texas. “As long as you have your documents and a good tax accountant, you have nothing to fear.”
Treasure hunts
The IRS audited 1.2 million taxpayers in Fiscal 2014, 150,000 fewer than in 2013, more than 300,000 fewer than in 2010 and the lowest level in a decade, according to a recent statement by IRS Commissioner John Koskinen. Audits fell in virtually every individual category and across income levels, a long-term trend.
“In a perfect world, there are tax laws and the IRS goes after anyone who breaks them, rich or poor, young or old,” said Macias, adding that audits can often turn into escalating IRS hunts for some past error – sometimes substantiated and sometimes not.
“I started working for a company that gave me a moving allowance to move from one state to another,” Macias recalled. “I used the money to move a long distance and when tax time came around, I excluded that money from my wages. It was on my W-2, so the IRS approached me and I told them the situation and submitted all my receipts. Weeks later they wrote back and said OK on the moving expenses – but that [my] return three years before was wrong regarding my Hope [education] credits.”
Explaining the types
Laura Strombom, an EA in Stockton, Calif., offers clients this advice regarding the various kinds of audits:
- Mail correspondence: Handled through fax and mail with some phone calls possible. These are the simplest audits, but often require multiple communications; misunderstandings abound due to lack of direct conversation.
- In-office: Face to face with the auditor at a local office. Clients are “strongly advised” against attending.
- In-field: The most thorough, usually handled at the preparers’ office, preferable to the alternative of being handled at the client’s location. The IRS often wants to do a site inspection; Strombom insists on being in attendance and requests clients not attend the audit appointments.
- Other mail-related: Examples include a CP2000. Not technically an audit, but can nevertheless change tax liability.
“I then explain that audits can take months or even years to complete,” Strombom added. “I also explain that the IRS may send notices or proposed assessments while we go through the audit. I instruct them to not panic about anything the IRS may provide as they are not final numbers, and explain that this is a hurry-up-and-wait process.”
EA Patrick O’Hara, in Poughkeepsie, N.Y., represents about 40 taxpayers each year in matters before the IRS. “Most are not audits,” he said, “but just notices from the IRS that the taxpayer’s return doesn’t match up with documents received by the IRS. I find that taxpayers are very anxious and tend to do nothing until the last minute … Many notices received by the taxpayer are incorrect, and just require an explanation.”
Documentation
Port St. Lucie, Fla.-based EA Jeffrey Schneider noted that audits usually come up in one of two sets of circumstances.
First, “when I will not place a questionable item on the return,” he said. “The media has noted that less than 1 percent of individuals are audited, so clients think, ‘What are the chances?’ Besides discussing the legality of the item … I mention that it would be their luck to get picked; I then mention how much it would cost them in fees (mine), and then they back off.”
The second circumstance? “When they get a notice,” Schneider said, “I explain what it means, what the auditor wants and the cost. My clients just want to know that I am there to protect their interests. We discuss that, what I do, what they do not do (talk to the auditor), and I handle it from there.”
When beginning work with a new client, “I usually have the audit discussion that states that they are required to have sufficient documentation to support all items on their tax return – income and expenses,” said Marilyn Heller Ayers, a CPA in Brick, N.J. “I don't need to see every piece of paper they have, but they need to keep it.”
“I emphasize that one way to avoid worrying about an audit is to know you [the business client] have good records that can back up your deductions,” said Laurie Ziegler, an EA at Sass Accounting in Saukville, Wis. “That way, if an audit does come, it will be less stressful. The same applies for individuals, especially for deductions such as charitable donations and non-reimbursed employee expenses.”
“Tell [clients] the truth: If they have good books and records and their data is reasonable, look over all the data and let them know if there are any glaring errors,” said Eva Rosenberg, an EA and founder of the TaxMama blog. (TaxMama.com)
She said that clients’ common honest errors include: expensing all the inventory at year-end instead of showing the December 31 value as an asset; expensing instead of depreciating leasehold improvements; picking up loans to the business as business income (an error in the client’s favor); and treating owner draws from a Schedule C business as expenses.
She added that common dishonest errors include writing off personal expenses in the business and home improvements in rental property (Schedule Es) and “making up numbers for meals, travel, entertainment.”
“If they haven't been selected for an audit and I want to bring the possibility to light, I discuss that I believe everything that they tell me. As devil's advocate, I ask probing questions, followed by the statement that in the unlikely event of an audit, if they can back up everything that they tell me with documentation, we can proceed,” said Debra James, an EA at Genesis Accounting & Management Services, in Lorain, Ohio. “If later they are selected for an audit, I gently remind them of the conversation and say, ‘Let’s just get those records together that you told me you had, and we have nothing to worry about.’”
Nothing personal
John R. Dundon, an EA at Taxpayer Advocacy Services in Englewood, Colo., offered several pointers to pass on to clients. “The best way to defend yourself is to file a tax return that is fully documented with all claims fully substantiated, ideally by external sources,” he said. “If you are audited and you know that you filed a return that has unsubstantiated claims, the first thing to do is to remain calm. Read the entire audit notice and make sure you understand. Respond to the notice with factual representations.”
Dundon’s three pieces of advice for clients: “Do not defend yourself, always feign a cordial nature no matter how much stress you feel and don’t allow the examiner to come to your house or place of business if at all possible.”
Second, “Most auditors simply want to get the file in their ‘inventory of files’ moved off their desk as efficiently as possible and usually do not have a personal vested interest in making the process any more cumbersome than it needs to be. Listen to the question asked and make sure you understand the question before responding.”
Finally, “The auditor’s real authority in the early stages of an audit is in making a determination as to whether opportunity exists to expand authority into other tax periods or tax matters,” Dundon pointed out. “Don’t give the auditor any reason to expand authority by simply reassuring the auditor that you share a mutual goal.”
“Give the client a realistic evaluation of the changes that IRS will insist upon,” Rosenberg said, “and tell the clients what they did wrong – and why they are wrong – as well as approximately what the additional taxes will be and how to prevent these issues in the future.”
