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The IRS normally has only 36 months to begin and end an audit of your return—beginning on the day you file it. (If the IRS suspects underreporting of income by at least 25%, the IRS has six years to complete the audit.
And if the IRS suspects fraud, the IRS has forever to audit you.) The Internal Revenue Manual, however, directs auditors to complete audits within 28 months after you filed your tax return. This allows the IRS an additional eight months to process any appeal you might file.
Delays can work in your favor. The IRS is under deadline, and not the model of efficiency. Audits get delayed for various reasons—backlogs, agent transfers, postponements, and lost files. When an old file surfaces, the file may be assigned to a new auditor, who is reluctant to work on a half-done case.
The three-year deadline for auditing your return may expire before the file resurfaces. If the file does reemerge, the auditor will be anxious to close it. An auditor can be fired for failing to close an audit within the three-year deadline.
Generally, there is no stopping an audit once it begins. Once the IRS sends an examination notice to your last known address, the audit has begun. Even if you die, your spouse or the executor of your estate is obligated to carry on the audit. You may be able to slow down—or even end—an audit, however, if you ask for a transfer of your file to another IRS District. Audit transfers are discretionary with the IRS, and you need a good reason to get one—such as a more convenient location of your tax documents or nearer to your accountant’s office.
Daniel, who lived in one IRS District but had a jewelry business in another, received an audit notice for her residence district. She requested a transfer to the district where her business was located. Daniel told the IRS that her records were at the business location, which was true. The transfer was granted, but the new district’s audit plate was already full. They never got around to Janiel’s audit. The three-year deadline expired and Janiel’s worries came to an end.
If an auditor hasn’t completed work on your case within 28 months of when you filed your return, he or she will ask you to sign IRS Form 872, Consent to Extend the Time to Assess Tax, giving the IRS extra time to finish the audit. When you are asked to sign the consent form, you have three options:
The auditor will let you know that your options are the first two—to sign or not to sign. If you agree to sign, the auditor will probably ask you to sign an open-ended extension agreement. This will mean that an audit adjustment can be made on any item, at any time in the future. It’s never in your interest to sign an open-ended extension. Instead, refuse to sign or negotiate the terms of the extension. Ask that the form be limited to specific items—those on which the auditor wants to do more work—such as rental property or the gain on the sale of securities.
Also, agree to a period of extension for no longer than six months. These perfectly reasonable limitations on the auditor narrow your risk and assure finality in the audit. If your negotiations are unsuccessful or you refuse to sign the extension form, the IRS will take one of two courses of action:
• The auditor will issue simultaneously the examination (audit) report and a notice of deficiency explaining your right to contest the audit in tax court. This means that you cannot appeal the examination report within the IRS but can only contest it without first paying the tax by going to tax court. This is the most likely outcome.
• The IRS may slip up and accidentally let the three-year audit deadline pass—without issuing an audit report—meaning that no audit assessment on this return can ever be made against you. This does not happen very often. The IRS disciplines auditors who blow the deadline. But when it does happen, it’s like winning the lottery. Even rarer, the IRS can conclude that you understated your income by more than 25% and determine that the statute of limitations is six years, not three. This determination does not have to be made before the audit begins.
Although you usually want to slow down any audit, occasionally it makes sense to rush along a field audit. Having the IRS in your life is just plain stressful—and field audits are the worst. Furthermore, the longer the auditor looks, the greater the odds he or she will find any problem that lies lurking.
One of the best ways to hurry things along is to point out any obvious problems early on—ones the auditor would surely find later.
Example: The auditor hasn’t yet seen Philo’s bank statement with a mysterious $10,000 deposit. Philo, for reasons of his own that have nothing to do with his taxes, prefers not to talk about it. Philo says, “I’ve heard that auditors usually find some problems. I hope you try to find them quickly so I can get back to my business.”
Philo, hoping the auditor will stop looking after finding a few small adjustments if it’s obvious that he won’t fight, points out glaring math mistakes in his records. In addition, each individual auditor seems to have a psychological tax adjustment level—and once having reached that amount, feel okay about closing your file. Although you won’t know the amount, this may tell you why the audit mysteriously ended when you thought the auditor would continue to dig. This mentality is probably leftover from the days when auditors’ work was evaluated by the number of dollars per hour they produced in audit adjustments.
Allison claimed a very questionable $2,000 business deduction. The auditor hadn’t yet reached that part of the tax return. Nearing the end of the first day of the audit, Allison volunteered that she mistakenly took a $350 deduction that year— she should have taken it the following year when the bill was paid.
Because the auditor had already found $3,200 in disallowances, Allison thought she might be satisfied with one more. She was. The auditor closed the audit.
But don’t appear too anxious if you know there are big problems that the auditor may find by taking a good long time. Auditors are sensitive to overly nervous taxpayers who want to rush things.
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