The ABCs of Handling an IRS Audit
By: SUE ANN NELSON
July 2004
You’ve just been notified of an IRS audit. Now what?
The first thing to do is review the years targeted and the scope of the information and document request accompanying the audit letter. For corporate taxpayers, this initial review is typically conducted by an internal tax department. For individual taxpayers, it can be done by the individual or the return preparer. The most important aspect of this initial review is to identify potential tax items for review and discussion before the revenue agent begins the audit.
If any such items are identified, the next step is to determine whether they raise any potential criminal ramifications (omitted or understated income, for instance). While many an audit letter has triggered a call to an accountant that starts, “I just received a letter from the IRS and there’s something we need to talk about,” you should not discuss any worrisome items with an accountant since there isn’t any accountant-client privilege in the criminal setting. You should instead contact a tax attorney with experience in criminal investigations (or have your accountant recommend one). The attorney will then review the issues with you to determine how to proceed. Each case must be approached differently to protect the taxpayer and to avoid a criminal investigation.
If, on the other hand, the initial review merely identifies items that are likely to be questioned or challenged by the IRS, then the focus should be directed to assembling the requested information and documents. (The IRS will undoubtedly supplement its information and document requests during the course of the audit.) Care should be taken to respond as accurately as possible to the IRS without going beyond what has been requested. Your accountant or attorney can assist you with this process as you proceed through this phase.
Another decision that will need to be made is where the tax records will be reviewed. In the case of an individual, the records can usually be provided by mail. In the case of a corporation, the IRS will invariably want to review the requested documents at the corporation’s offices. This may or not be convenient or in the corporation’s best interest. (For instance, if a discreet location within the corporate offices cannot be provided for the revenue agent’s use, you will want to avoid disruption or allowing the agent unfettered access to employees.) In most instances, your accountant or attorney can arrange to have the records reviewed in their offices or, if this option is impractical given the volume of records, make other mutually acceptable arrangements with the agent. In any instance, you should specify a contact person and request that the agent direct all communications only to that individual. In some instances, the contact person will need to provide a power of attorney (IRS Form 2848) to discuss any audit matters with the agent.
As the audit proceeds, you should not feel the need to discuss or respond to any impromptu questions or issues raised by the agent. There is nothing wrong with asking the agent to put any material questions or identified issues in writing for an orderly response. This process also provides a good foundation for any future administrative appeal or litigation of issues that cannot be resolved at the audit level.
At the conclusion of the audit, the agent will typically provide a preliminary audit report. Depending on the issues raised in that report, it may be worthwhile to request a meeting with the agent and the agent’s supervisor to attempt to resolve the proposed adjustments. If this is not possible or practical, the next step would be to administratively protest the agent’s proposed adjustments and have the case considered by the IRS Appeals Office. For the appropriate cases, fast track and mediation procedures are available to expedite the resolution of any unresolved issues. If the issues cannot be resolved, litigation in the United States Tax Court or one of the other federal forums may ultimately be necessary.
Sue Ann is a former IRS trial attorney and advises clients on all facets of federal and state tax audits, administrative appeals and criminal tax investigations.