IRS Audits aren’t ever fun but they are survivable. There should be two goals in surviving an audit and they should be kept in mind during any audit. These goals can help minimize the financial fallout and limit the scope of the IRS audit. Here’s what to do:
1. To minimize financial damage
Accept the over 80% chance that your audit will end with a tax bill. Aim for damage control—keeping your tab as low as possible. I’m not saying to go in with a defeatist attitude, but at the same time don’t have unrealistic expectations. In a recent year, audits resulted in additional taxes and penalties of $19 billion owed to the IRS, and only about $600 million in refunds—a ratio of 32 to 1 against taxpayers.
2. To prevent expansion
One way to minimize the financial damage (your first goal) is to prevent an expansion of the audit. An auditor can examine any open tax year if such an examination is likely to be fruitful—that is, result in more money owed. Open tax years are those for tax returns filed within the past three years. The limit is extended to six years if the IRS believes you are guilty of underreporting your income by 25% or more, or forever if you are suspected of outright fraud.
Expansion most frequently occurs when during the audit, the auditor sees something such as an improper deduction that might be present on tax returns other than the one under audit. You might hang yourself by showing the auditor something related to an open tax year.
EXAMPLE:
In November 2012, Noreen is audited for 2010. The auditor asks to see Noreen’s business check register for 2010. Noreen cooperatively hands it over, failing to edit out the portions that relate to other years. The auditor nonchalantly rummages through the information for 2009 and 2011, the other open tax years. The auditor finds a few things she believes are questionable, and expands the audit into those years.
CAUTION:
Never show the auditor anything related to a year other than the tax year being audited. This is the one rule to follow in order to minimize the expansion of the audit.
In the example above, Noreen could have photocopied the check register for 2010 before the audit, or offered to send it to the auditor after the audit meeting. The best way to avoid showing unrelated documents to the auditor is simply not to bring the unrelated documents with you to an office audit or not to have them on your premises during a field audit.