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This is part 6 of 6 of our in-depth guide to winning your audit.
Toward the end of every meeting with the auditor, ask her what adjustments she intends to make. While she may not be willing to commit without running it by her manager, she may have some idea. Try to pin her down. If you disagree, argue your case on the spot or ask her for time to get more documents together. Offer to pay any balance in full, if she will make a concession. It may not work, but it’s always worth a try.
Audit files sometimes get lost in the IRS bureaucratic maze for many months. When found, an unfinished audit file could be assigned to a new auditor who will not want to work on a half-done case and will look for a quick way to close out the file. Even better, the normal three-year deadline for auditing your return may expire before the file resurfaces. This means that the IRS forever loses its right to make adjustments, and you are in the clear.
When the auditor completes her work, you will be handed or mailed IRS Form 4549, an examination report. It shows changes proposed to your tax liability for the years under audit, and for any other open years if the auditor expanded the examination. The report also provides a brief explanation for each change, such as “You did not prove the amount shown was a rental expense.”
Internal Revenue Service Department of the TreasuryDate: 8/10/xx Tax Year Ended: 2007
Person to Contact:
Contact Telephone Number
Dear Ms. McMillian:
Enclosed are two copies of our report explaining why we believe adjustments should be made in the amount of your tax. Please look at this report over and let us know whether you agree with our findings.
If you accept our findings, please sign the consent to the assessment and collection portion at the bottom of the report and mail one copy to this office within 30 days from the date of this letter. If additional tax is due, you may want to pay it now and limit the interest charge; otherwise, we will bill you. (See enclosed Publication 5 for payment details.)
If you do not accept our findings, you have 30 days from the date of this letter to do one of the following:
1. Mail us any additional evidence or information you would like us to consider.
2. Request a discussion of our findings with the examiner who conducted the examination. At that time, you may submit any additional evidence or information you would like us to consider. If you plan to come in for a discussion, please phone or write to us in advance so that we can arrange a convenient time and place.
3. Discuss your position with the group manager or a senior examiner (designated by the group manager), if an examination has been held and you have been unable to reach an agreement with the examiner.
If you do not accept our findings and do not want to take any of the above actions, you may write us at the address shown above or call us at the telephone number shown above within 30 days from the date of this letter to request a conference with an Appeals Officer. You must provide all pertinent documentation and facts concerning disputed issues to the examiner before your case is forwarded to the Appeals Office. If your examination was conducted entirely by mail, we would appreciate your first discussing our findings with one of our examiners.
The Appeals Office is independent of the District Director. The Appeals Officer, who has not examined your return previously, will take a fresh look at your case. Most disputes considered by Appeals are resolved informally and promptly. By going to Appeals, you may avoid court costs (such as the United States Tax Court filing fee of $60), clear up this matter sooner, and prevent interest from mounting. An Appeals Officer will promptly telephone you and, if necessary, arrange an appointment. If you decide to bypass Appeals and petition the Tax Court, your case will normally be assigned for settlement to an Appeals Officer before the Tax Court hears the case.
Under Internal Revenue Code Section 6673, the Tax Court is authorized to award damages of up to $5,000 to the United States when a taxpayer unreasonably fails to pursue available administrative remedies. Damages could be awarded under this provision, for example, if the Court concludes that it was unreasonable for a taxpayer to bypass Appeals and then file a petition in the Tax Court. The Tax Court will make that determination based upon the facts and circumstances of each case. Generally, the Service will not ask the Court to award damages under this provision if you make a good faith effort to meet with Appeals and to settle your case before petitioning the Tax Court.
The enclosed Publication 5 explains your appeal rights.
If we do not hear from you within 30 days, we will have to process your case on the basis of the adjustments shown in the examination report. If you write us about your case, please write to the person whose name and address are shown in the heading of this letter and refer to the symbols in the upper right corner of the enclosed report. An envelope is enclosed for your convenience. Please include your telephone number, area code, and the most convenient time for us to call, in case we find it necessary to contact you for further information.
If you prefer, you may call the person at the telephone number shown in the heading of this letter. This person will be able to answer any questions you may have. Thank you for your cooperation.
From your point of view, the examination report falls into one of three categories:
Win. Instead of a report, you will receive a “no change” or even a refund letter. These require no explanation. You’ve won.
Lose. The report makes changes—you owe more taxes, plus interest and maybe penalties. This means you didn’t have good documentation or what you had was not accepted. Or, perhaps the auditor didn’t buy your legal entitlement to the tax benefits claimed.
Draw. A mixed bag. Some of your documents and explanations were accepted, but others weren’t. Or maybe your legal position was shaky on one or two items but strong on another.
Don’t worry if it seems to take forever for the IRS to send you the final report. Three to four weeks is standard, but I have waited for six months. Don’t take a long delay to mean that the IRS is giving your case special attention. More likely, your case has a low priority and is sitting on someone’s desk for routine processing.
The total amount of taxes, penalties, and interest added by the audit is shown on your report. Each change is listed, the tax code section cited, and a general explanation was given. As stated, most explanations are vague. You are usually not specifically told how you failed to prove your case. If you don’t know, call the auditor and ask. She must tell you where you failed. (See the sample examination report on the preceding pages.)
You have three choices after you receive the examination report.
Agree. The IRS hopes you will sign, date, and return a copy of the report along with IRS Form 870, Consent to Proposed Tax Adjustment. This is referred to by the IRS as an agreed case.
By signing Form 870, you agree to the immediate assessment of the tax deficiency found, plus any penalties and interest listed on the examination report. You give up your right to appeal or go to tax court. Theoretically, you could pay, change your mind, and sue the IRS for a refund in court, but this seldom makes sense. Although most tax lawsuits are filed in U.S. Tax Court, a refund case must be brought in a U.S. Federal District Court or the U.S. Court of Claims.
A report, even if signed by you, is not final until approved by the auditor’s manager. Occasionally, a report you signed will be kicked back to the auditor for correction of obvious errors or to further develop issues. If this happens, the auditor may contact you once more. It may seem unfair, but, you can’t complain about being audited twice. The first audit was not officially concluded.
Signing doesn’t mean you have to pay when you sign the report. Paying, however, may seal the deal. Auditors can offer a payment plan if you owe less than $10,000. You have up to three years to pay on a monthly basis. Interest and late payment penalties still accrue on the unpaid balance. Interest and penalties on late tax payments get added on. For bills over $10,000, you may have to reveal your finances and living expenses to get a payment plan. For such cases, consult a tax attorney to ensure adequate compliance.
It is okay to tell the auditor that you will just wait until a bill comes from the IRS campus center computer and then decide how to pay. Sometimes, the bill is less than the audit report figure because a penalty was dropped or a computation error was made or corrected. If the bill is more than the amount on the report, complain; if it is less, let your conscience be your guide. If you pay the lesser amount, no one may ever notice. Don’t be surprised, however, if you are later billed for the difference.
Argue. Examination reports are not cast in stone until you sign off. If you want to fight the report, call the auditor. Tell her what findings you disagree with. Ask what additional proof it would take to get her to change the report. Request 30 days to get a missing document or reconstruct a record. Most auditors will hold off until you mail the proof to them. Pushing for another appointment may be better. It forces them to face you again and shows that you are serious about contesting the report’s findings. If she is not cooperative, ask to speak to her manager. If you are ultimately successful, you’ll be sent an amended examination report to sign.
If your new documentation doesn’t help, ask the auditor for a copy of her work papers. These are the notes the IRS requires an auditor to put in a file. Workpapers should explain and justify any changes made to a tax return. If the auditor shows you her notes, ask her to fully explain them (and the conclusions she drew) if it isn’t obvious. Don’t be surprised if the auditor refuses to show you her work papers. If she refuses, tell her you to know you are entitled to see them under the Freedom of Information Act, and if she won’t show them to you, you will make a formal request for them. See Appealing a Tax Audit Within the IRS for more info.
If you don’t get anywhere with the auditor, ask to meet with her manager. Generally, the manager will speak to you. I call this an informal appeal. Managers don’t always back their auditors. They have a strong motive to close files handled by their group with an “agreed” notation, so they may appease you.
If you talk to or meet with the manager, don’t criticize the auditor. The manager may then concentrate on defending his employee instead of considering your position. Instead, talk about the adjustments you don’t agree with and suggest a compromise. Even if this doesn’t get you anywhere, the manager’s explanations may make the IRS’s position clearer to you or point out the weaknesses in your case. As a last resort, if the manager won’t budge, calmly say that you are disappointed and that you don’t want to appeal, but you don’t know what else to do. Again, keep in mind that the IRS doesn’t like appeals, and this subtle threat may get you what you want.
(For an example of compromising with an auditor’s manager, see the case history below.)
Managers may delegate audit disputes to acting managers. These are usually the more experienced auditors who know how to smooth things over. Remember, auditors are instructed to get you to agree to the audit report, if possible. It’s perfectly okay if you get an acting manager. This person may already be familiar with your case, especially if the auditor is a trainee or fairly new at the IRS. If your auditor ever excused herself for lengthy periods during your audit, ostensibly to make copies or check on something, she may have been asking a senior auditor what to do.
If you explain your position to the acting manager and he won’t help you, you can still insist on talking to the real manager. The IRS, like most others organizations, doesn’t like to be bothered by squeaking wheels—you may eventually get greased.
Do nothing. You don’t have to respond to a proposed examination report at all. If you ignore it, the auditor may call, or in a month or two you will receive something called a 30-Day Letter. This is your formal notice that your case is considered “unagreed” and that you have 30 days to start an appeal or the findings become final.
Appeal Rights and Preparation of Protests for Unagreed Cases. You should receive a copy of Publication 5 with your examination report. Read the article on the IRS audit appeals process for more clarification.
The IRS does not have to grant you an administrative appeal—it is discretionary. However, the IRS must eventually send you a 90-Day Letter, before the audit can become final. This letter may not arrive for months after the audit was completed. The IRS must send it by certified mail. To contest the audit results now, you must file a petition in the U.S. Tax Court within 90 days. If you don’t, the examination report becomes final—your right to contest the audit without first making the full payment has ended.
You can also contest by paying the tax bill and filing a claim with the IRS for a refund. Refund claims are always denied. You can then file a refund suit in U.S. District Court or the court of claims.
Eventually, you will get a Notice of Tax Due. This is the beginning of the IRS collection effort. See the article When You Owe the IRS for more on what to expect there.
There is a procedure for reopening a closed audit, called assessment reconsideration, initiated either by you or the IRS. Fortunately, the IRS rarely reopens closed audits. If it does, see a tax pro to find out if the IRS is acting properly, or do a little legal research yourself. (See Help Beyond the Book; the relevant laws are Internal Revenue Code § 7605(b); IRS Regulation 601.105; Revenue Procedure 85-13; and IRS Policy Statement P-4-3.)
Mr. Ky, a Vietnamese immigrant, and San Francisco restaurant owner, was audited. When he received the examination report, Ky was so distraught he considered jumping off the Golden Gate Bridge. Ky had fallen victim to a dishonest tax return preparer who guaranteed his clients they would never have IRS problems. His clients almost always got tax refunds, and he charged a percentage of the refund received.
One day, the office of the bogus tax adviser was raided and his records seized by the IRS. All of his clients got audit notices. Ky was understandably suspicious of anyone calling himself a tax expert, so he decided to handle the audit himself. He wanted to come clean knowing he would have to pay some additional taxes.
The auditor knew Ky was selected as part of a special IRS project involving the crooked tax preparer. At the meeting, things went from bad to worse. Ky spoke broken English and produced records written in his native language. The auditor became irritated and impatient. The examination report came quickly, disallowing most of Ky’s business deductions and finding a great deal of unreported income. The resulting taxes, with heavy fraud penalties and interest added, came to $79,500. To pay meant Ky would have had to sell his business and lose everything he had worked for in the ten years he had been in America.
Ky finally sought a tax professional. During their meeting, the tax professional became convinced that Ky should not owe anywhere near $79,500. The tax professional called the auditor’s manager and made an appointment to meet her in two weeks. He then found a Vietnamese-American accountant to convert Ky’s records and notes into a more conventional set of books. The accountant acted as an interpreter and helped the tax professional take sworn statements from Vietnamese people who had worked in the restaurant. These books and statements created a true financial picture of the business, in clear English.
When the tax professional met with the auditor’s manager, he presented the statements and records. In less than an hour they had agreed on a total tax of $13,000 and no harsh fraud penalty. After the tax bill came, Ky negotiated an installment payment agreement with the IRS Collection Division. Ky did not jump off the Golden Gate or any other bridge. His family now owns two restaurants in San Francisco.
While everyone considers being audited a problem, a few uncommon, yet serious, audit issues merit special discussion.
Many taxpayers receive bills from examinations they didn’t know about—phantom audits. Yes, the IRS is required to notify you in writing of an audit. Theoretically, if the IRS doesn’t let you know about an audit, your return can’t be audited. In reality, however, the IRS is only required to mail a letter to your last known address. It is not required to verify that you actually receive the notice.
The tax court says the IRS must update its files regularly and send notices to the address on your most recent tax return or newer address that you have provided. (Abeles v. Commissioner of Internal Revenue, 91 U.S.T.C. 1019 (1991).) The IRS is allowed three months to update its records on a change of address after it receives notification.
If you don’t answer an audit letter and it is not returned to the IRS by the post office, auditors can treat you as a “no show.” Exemptions and deductions are disallowed in whatever manner the auditor wishes and an audit bill is issued. It is not a pretty picture.
To make sure you get all IRS notices, file IRS Form 8822, Change of Address, whenever you move. (A copy is available at the IRS website www.irs.gov.) Do not just rely on a post office change of address form.
The unfairness of the IRS’s charging ahead when you don’t get the audit notice is underscored by what happens next. The IRS usually sends an audit report and a letter informing you of the appeal process to your old address. Or, the IRS may send a Notice of Deficiency giving you 90 days to object in tax court. This notice comes by certified mail. But, again, the law does not require that you actually receive the letter, only that the IRS sends it. The IRS doesn’t seem to care if you get any of these notices. Legally, as long as the notices are sent to your address in the IRS records, the audit was legitimate. Hardly fair, but you can fight back.
There are three ways to fight a phantom audit.
Assessment reconsideration. (Formerly called audit reconsideration.) If you receive a mysterious tax bill, immediately write or call the IRS office that sent it. Tell them you never received notice of the audit and you are requesting an assessment reconsideration. Or, call the Taxpayer Advocate Service. Make an appointment or send him the notices by fax or mail. Ask the advocate to help you get an assessment reconsideration meeting with an auditor. See IRS Publication 3598 for details on making a request.
You do not have a right to an assessment reconsideration—it is discretionary with the IRS. Usually, however, requests are granted. The IRS also has an audit reexamination procedure, which differs from an assessment reconsideration. A reexamination can open up your entire file for audit —and not just the items that were charged in the phantom audit.
Petition the tax court. If your assessment reconsideration is denied, file a petition in tax court, stating that a notice of deficiency was not sent to your last known address as required by law. See Going to Tax Court for more information.
Offer in Compromise. In addition to audit reconsideration and tax court, you can challenge a phantom audit by making an Offer in Compromise, based on doubt as to your liability for the tax bill. Unlike most Offers in Compromise, which are made to settle an undisputed tax bill, with an Offer in Compromise based on doubt as to liability, you do not offer any money to the IRS. The IRS may treat your Offer as it would treat an assessment reconsideration and reopen your case.
The IRS has a “shoot first, ask questions later” power to make quick tax assessments without an audit. This is called the jeopardy assessment. Normally there must be a formal assessment of taxes against you before the IRS can legally collect. The jeopardy assessment process allows the IRS to immediately grab your assets without prior notice. You have a right to a hearing, but not until after the seizure.
Thankfully, jeopardy assessments are authorized only if the IRS believes its right to collect taxes will be harmed, and:
Jeopardy assessments are most frequently made against foreign companies or foreigners operating a business in the United States, or persons arrested with large amounts of cash, especially suspected drug dealers. If you are ever faced with a jeopardy assessment, see a tax lawyer right away.
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