IRS Audits

Question: I just completed an IRS audit by mail for 2013.  I had done several office audits over many years and this was my first by mail.  It lasted about 8 months, but they did totally clear us.  It was a heck of a lot of copying. With a local office audit you just take paperwork in to show them, talk to them, bring in more if they ask for it, and answer their questions and you're done.  Here I wasn't sure what to say and explain, so I mostly just documented.  Anyhow, I have this vague recollection that if they clear you one year, you probably are not going to be audited for three more years.  I googled that, and don't find any such policy.  Is this urban legend, or maybe just wishful thinking?  (It is my experience that several years go by between audits, but I am wondering if there is any such policy.)  Second, local is a heck of a lot faster, and past local audits have also cleared us.  It looks to me as if correspondence audits are more common now.  I am wondering, if we are audited again, are there any considerations/drawbacks to asking for a local audit instead?

Answer:  In today’s age of big-data processing computers the IRS is conducting more audits by correspondence.  The IRS reports that more than 90% of tax returns are being filed electronically, meaning most tax returns arrive at an IRS processing facility electronically and are electronically processedwith no human intervention.  IRS computers verify the information you report against information they receive from other sources like your bank, your employer, and your investment brokerage firm.  When the information doesn’t match, the computer sends you a letter.  Computers also check your expenses and deductions against IRS norms. If you are reporting a deduction that seems high relative to your income, the IRS may ask you for backup documentation.

There are three basic types of audits; Correspondence, Office Examination, and Field Examination.   In a correspondence audit, usually the easiest, you receive a letter from the IRS asking you for more information or asking you to pay additional tax. In the latter case, you have the option of either paying the additional tax or explaining why you don’t owe it.

In an office examination, you receive a letter asking you to bring documentation to an IRS Examiner’s office.  Because the examiner is your adversary, not your friend, always hire a competent tax-wise CPA, Enrolled Agent, or attorney to represent you at an office audit meeting and stay home. Otherwise you might put your foot in your mouth, expand the scope of the audit, and cost yourself more money.

 In a field audit, the IRS comes to your home or place of business.  Field audits occur when the IRS suspects serious violations.  (Do you really have a home office and are the expenses justified?)

According to Margy Dunn, an Enrolled Agent in Monterey CA, the IRS does have limits on repetitive audits. The Internal Revenue Manual states that if you are contacted by the IRS for an issue they examined you for in either of the two prior years, and there was little or no change in taxes due, then the new examination will be discontinued.

 

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment advisor and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to ken@montereypw.com.