The Tax Audit. It’s a phrase that has long struck fear into the hearts of many a person. Yet despite its menacing reputation, the IRS system for identifying problematic returns is not necessarily about targeting specific individuals. In reality, most returns are accepted as submitted. However, with random sampling and computerized screening, more and more tax returns may be chosen for additional review. The complexities of an audit can be overwhelming. And since you might become one of those “random” persons (or businesses) who will face this at some point, understanding how professional tax audit representation can help is important. Authorized representatives, such as a CPA or tax attorney, can assist with the audit process, protect your rights, and provide the needed ongoing advice to deal with the issue. Expertise can help ensure you are in compliance with the respective tax authorities and reduce the negative outcomes that may come from tax audits.
While the Internal Revenue Service may often seem like some faceless, silent entity behind the scenes, the IRS has actually been quite active and more aggressive over the past few years in cracking down on tax avoiders, with a particular focus on the wealthy and higher-earning individuals. Even the IRS itself declared in a recent news release that it was focused on increasing audits. For instance, the agency says it now plans to almost triple the number of audits on corporations with assets over $250 million to over 22% by the year 2026, up from only 9% being audited in 2019. Amazingly, the Service also noted it will soon increase audit rates on complex partnerships with assets over $10 million by a factor of ten.
Not just on the federal level, but states as well are becoming increasingly aggressive with audit actions and targeting taxpayers who may not be paying their correct tax liabilities. Take New York State for example. In 2022 (the latest data available), the state tax department indicated it had conducted 771,000 audits, up an astounding 56% from the previous year. Interestingly, Empire State tax regulators are also turning to the newest technology to identify and target audit candidates, namely artificial intelligence.
With the technology identifying patterns, auditors are sending out letters focusing on two key areas that are triggering potential audits: 1) filers with changes in tax residency and 2) remote workers. Why? During the Covid pandemic, many higher earners moved from higher-tax states such as New York, New Jersey, Connecticut, and California to lower-tax ones such as Texas and Florida. When these higher earners relocate, they move their tax dollars with them. This is now being challenged by tax officials from states who say these resident moves were not permanent or not considered adequately legitimate.
What is an IRS Tax Audit?
Simply put, an audit by the Internal Revenue Service is an examination of an individual’s or business’s financial accounts and recordkeeping that are included when reporting tax obligations. The IRS audit process includes the examination of tax returns to verify that income, expenses, and credits are accurately reported. The main purposes of an IRS audit are to ensure that taxpayers are compliant with federal tax laws and to accurately identify the amounts due to federal tax collectors. For the individual or business, how to respond to an audit letter (or notice) is not something to be taken lightly.
The IRS Tax Audit Process
Receiving a Tax Audit Notice
The Internal Revenue Service will perform a tax audit either in person or through the mail. In some cases, an IRS agent may visit the taxpayer’s home or place of business to conduct a thorough examination of their financial records. The formal notification letter (or notice) a taxpayer receives indicates that the person or business entity is being audited with information as to why a return is being examined. Additionally, what documents (if any) the IRS says they need and how the taxpayer should respond are included. The IRS also will provide the recipient with all necessary contact information for the process.
Gathering Necessary Documents for the Tax Audit
Preparing for an audit takes work. In-person audits may occur at an IRS office, where taxpayers meet with an IRS agent to provide documentation and answer questions. To begin with, keeping important financial tax documents organized helps. Depending on what type of tax audit is being conducted (personal versus business audit), will drive the kind of paperwork necessary to include. That said, what is typical will be relevant tax returns, any employment documents such as W-2 forms and 1099s (for freelancers), financial records such as credit card and bank statements, as well as receipts for charitable contribution deductions, and if appropriate, relevant business expense deductions. Also, it may be beneficial to have both physical as well as digital copies of the above-mentioned documents.
The overall audit may take time and include back-and-forth exchanges before the IRS can finalize its examination of the return (or returns) if more years are under suspicion for inaccuracies and insufficiencies. This audit duration will also vary on factors such as the complexity of the returns and how cooperative the taxpayer is when responding to the IRS’s requests. By the end of the process, the agency may accept a return as filed, propose specific changes, request additional monies to be paid, or in an optimal situation, offer a refund to the audited person or entity.
Risks of Going Solo when Managing an IRS Audit
While it is possible to respond to an IRS audit request and undergo the process without tax guidance or representation, this can be a risky strategy. Tax professionals such as attorneys, CPAs, and enrolled agents are authorized to represent taxpayers during IRS audits. Of course, some people (and organizations) may not go that route and try to handle it alone. It is, however, not typically the best option. Why? The reasons are multiple:
Consequences of Inadequate Representation
Without proper guidance, taxpayers can face severe consequences. It is crucial to have qualified tax professionals, such as tax attorneys, to represent them during an IRS audit. These include hefty fines, increased future tax scrutiny, criminal prosecution, and even jail time. Additionally, without the benefit of expert tax representation, the audit process will usually result in a more time-consuming and stressful experience.
Consider the case of Sara Ann, the owner of a mid-sized chiropractic clinic who faced an IRS audit that was launched after she inadvertently failed to timely file her firm’s taxes post-Covid. Initially, Sarah thought that she could handle the audit on her own. Part of this stemmed from the fact that she had typically filed her own personal return, filed her clinic’s taxes, and had enough financial and business savvy that she was often the go-to person for friends and family on such matters. She presumed she could handle the audit alone.
Unfortunately, as the process progressed, Sara Ann found herself overwhelmed by repeated requests for complex documentation and additional explanations for her business’s deductions. This was compounded by the fact that as the audit moved forward, her inability to respond adequately and on time caused the auditors to look back at even earlier tax-year filings and subsequently expand the audit. With a lack of experience in the process and additional miscommunications in reporting to the IRS, the audit ultimately resulted in fines as well as a tedious, drawn-out ordeal.
Benefits of Hiring a Tax Audit Representative
Finding and Employing Expert IRS Audit Representation
A professional tax audit representative can provide an audit recipient with specialized expertise and specific audit guidance so that clients know that their rights and interests are best protected throughout the process. Tax professionals, including IRS-enrolled agents, tax attorneys, and CPAs, are qualified to assist taxpayers when facing audits. With their help, the risks of potential fines and criminal conviction can be minimized.
Consider the case of Carlos, the owner of a mid-size electronics retailer. Since 2021, Carlos has expanded his business significantly by adding additional physical stores across the state of Georgia and into northern Florida. He even began to tip his toe into e-commerce. As exciting as these developments were, the business structure and operations of the firm grew in complexity and brought various challenges. For one, the business now included transactions that involved multiple tax jurisdictions. While Carlos focused on operations and growing the business, he and his in-house bookkeeper still relied on outdated knowledge. They failed to take into consideration updated laws related to sales tax responsibilities when it came to e-commerce, as well as changing laws regarding interstate taxes.
Ultimately, the IRS audited Carlos’ business after discrepancies were found in his reported sales taxes, particularly from online transactions. While Carlos was busy running the firm, he ended up having to confront a time-consuming, stressful, and costly audit process. The benefits of having professional IRS tax audit representation became painfully evident.
Choosing the Right IRS Tax Representative
Qualities to Look for in Tax Experts
Choosing the right IRS tax representative is crucial when facing an audit. Clearly one needs to select a professional that is not only qualified such as a tax attorney or a certified public accountant (CPA) with the appropriate licensing but also selecting a representative who specifically has IRS audit experience is a huge plus. For low-income taxpayers, Low-Income Taxpayer Clinics (LITCs) can be a valuable resource and assist with audits, appeals, and collection disputes.
Other factors to consider for tax representation include:
· A track record of success
· A high-quality, professional reputation, and
· Effective communication skills
Particularly valuable are communication skills (noted above), in which a tax audit professional provides understandable explanations, updates regarding a case, and knows how to retrieve the right information from the client.
Taxpayer Rights During an IRS Audit
Your Rights and Privileges
Throughout the audit, taxpayers should know that it is not a one-way street in that the IRS holds all the cards, and the person or entity being audited is solely at their whim and discretion. On the contrary, those being audited have responsibilities and specific rights throughout the process. First off, recipients of audit notices must be informed of the audit’s purpose; they must be given access to the various data on which the IRS bases its decision, and they must have the option to appeal any IRS decision that comes their way.
Last but not least, any tax-paying individual or business entity must know that they have the right to be represented by tax experts. Having IRS tax audit representation plays a crucial role in managing and, frankly, surviving an audit. Taxpayers deserve qualified and experienced expertise to ensure their legal and financial interests are thoroughly protected.
In Conclusion
Navigating an IRS tax audit can be a daunting and complex process, but you don’t have to face it alone. Professional tax audit representation provides invaluable support, protecting your rights and ensuring compliance with tax regulations. At Walters & Associates, CPAs, our experienced team is dedicated to helping you manage the audit process effectively and minimize potential negative outcomes.
Don’t let the fear of a tax audit disrupt your peace of mind. Contact us today to schedule a consultation and learn how our expert audit representation services can safeguard your financial interests and provide you with the confidence you need.
