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This is a continuation of “The Importance of Maintaining Proper Records for the IRS.” The most current data available from the Internal Revenue Service shows that the IRS audits currently are handled by correspondence audits (74.8% in Calendar year 2017). The remaining 25.2% are handled in the field by Revenue Agents or Tax Compliance Officers. Revenue agents are generally trained for and involved in more complicated individual partnership and corporate returns. Tax Compliance Officers are trained and deal with individual return matters. There were 150,043,277 Individual Income Tax returns filed in 2017, and 6% were audited resulting in 19% handled by the field agent and the Tax Compliance Officers. The Correspondence Audits handled 81% of the audits and recommended additional taxes 49% of the time and the Compliance Officer 51% of the time.
As you can see, the IRS is heavy into Correspondence Audits as a result of information they accumulate in the form of 1099s, W-2, K-1 and other information documents.
Non-filer cases are referred for examination by the Collections Program and the Automated Substitute for Return (ASFR) Program. Under the ASFR Program, the IRS uses information returns from third parties (such as Forms W–2 and 1099) to identify tax return delinquencies, and constructs tax returns for certain non-filers based on that third-party information, and assesses tax, interest, and penalties based on the substitute returns.
Case Study
The Tax Compliance Officer (agent auditor) conducts an audit of a tax return containing a Schedule C with income and expenses. After a review of the taxpayer’s records the agent auditor issues a report, commonly referred to as a “30-day letter” with a response “due date.” The report will show adjustments to the return and a tax liability with penalties and interest. It is very important to pay attention to the “due date” and the instructions in Publication 3498 and those below.
30-Day Letter – Choices available
- If you agree with the proposed changes in the report, sign, date and return a copy of the report by the due date. If a joint return, both spouses must sign the report. If you owe additional tax include payment in full to further limit penalties and interest charges.
- If you agree, but cannot pay the full amount you owe, sign, date and return a copy of the report by the due date and contact the IRS to discuss payment arrangements.
- If you do not agree with the proposed changes in the report, contact the agent and request a meeting or a telephone conference with the supervisor. If you still don’t agree after the meeting or telephone conference you can request a conference with the Office of Appeals, but you must still submit a small case request or formal protest by the response due date.
- If you do not reply by the response due date the case based on the proposed changes will be processed and a notice of deficiency will be sent to you. You will have 90 days to agree or to file a petition with the US Tax Court. The case will go back to the IRS attorneys for an attempt at a pretrial settlement. If no settlement is made, the case will be heard in court. If you do not file a petition during the 90-day period after receiving the notice of deficiency, the amount of the notice will be assessed and the full amount will be required to be paid or arrangements for payments will have to be made.
Caution: Do not allow the agent auditor and their manager to make adjustments, issue a new draft of the 30-day letter without changing the “due date” of the 30-day letter. If they will not extend the “due date” in the newly adjusted report you must prepare an appeal to the Office of Appeals within the 30-day period. If you do not, you will be required to file a formal protest for US Tax Court.
Most small business men and women are busy doing business, selling their products or services, and generating income. They incur ordinary and necessary business expenses to acquire the business income, but they do not want to be bothered by an IRS audit. By the same token, most do not maintain good records, but dealing with the Tax Compliance Officer or the Revenue Agent can be a scary activity. The best offense against an IRS audit is to start to keep your business and personal records separate and organized with your return. Always maintain your receipts and copies of your bank statements with the checks attached and organized on a monthly basis.
Based on experience with clients, the agent auditors will consider “all deposits” to your bank account as income and you will need to prove otherwise, including transfers from other accounts and gifts from you deceased uncle. Do not rely on the records of your bank because the big banks are no longer copying your deposit slips, upon which you would normally explain the deposit, now for their convenience they just make a copy of the check deposited. Also, mobile banking where you send a picture of a check to your bank is convenient, but not best for recordkeeping. Having to go back 4 or 5 years to get bank records is very costly. I recommend saving your banks statements with the related checks in a folder on your computer when you reconcile your monthly statements.
Also, it is important to keep the receipts that relate to deductible business and deductible personal expenditures. If the agent auditor questions an expenditure, your oral explanation and notation on a transactions journal from Quicken or QuickBooks will not be acceptable without “substantiation” of the receipt and or a check. When writing a check include a notation on the Memo line as to what the expenditure relates. (You can find information on this on the Beacon February 2017, burden of proof newsletter)
Having good records of income and expense for the audit year, and being responsive to the agent auditor should build your credibility with the agent in your recordkeeping ability and the items included on your return.
Be careful with employment of your children (See Beacon Article June 2019) and the use of your home for business purposes.
With good records to start, combined with the expertise of a reputable return preparer, CPA, Enrolled Agent, or Attorney, a taxpayer’s life as an individual or business person will be easier.
If you or your client wants to avoid the potential perils of the IRS Auditor or Field Auditor, be proactive and consider hiring a licensed private investigator / forensic accountant, by contacting Chief Investigator Edmond Martin of Sage Investigations, LLC at 512-659-3189, or email edmartin@sageinvestigations.com. Let our 26 years as an IRS Special Agent and 17 years as a private investigator and forensic accountant benefit you and your clients. Click to read about our team and their CVs
