In a previous blog, we answered the question What is an IRS audit appeal. I said:
It is your right to appeal the work of the auditor after he has examined your financial information and has issued his report. In his report, he details the additional amounts owed as well as the penalties and interest. The report also asks that you sign indicating your approval.
So what is the best way to challenge the auditor's conclusion? How do we prepare for the appeal? In this article, I will explain how we prepare for an IRS audit appeal.
We make a complete or partial audit of your books.
"Why do you do that?"
The short answer is that before we can convince the auditor, we have to convince ourselves. The long answer is that when we meet with the appeals officer we have to be sure that he will agree with our claim. We have to make it easy for him to do so and we make it easy by presenting the information in a clear organized manner.
"But my books weren’t in that good of shape to begin with. What can I do?"
Actually, we assume that your books are not that good. If they had been, you would have completed the audit successfully. We may have to take your checkbook and bank statement and reconstruct the books from scratch. We may be able to do something less arduous such as taking your receipts and preparing a spreadsheet for only the items contested on the audit report. In certain cases, we have to take data shown on receipts and use it to develop an expense claim in another manner. For example, a taxpayer may not have the mileage log needed to substantiate a mileage claim, but he has copies of his oil changes, service, emissions control reports and registration certificate. Those documents will have both a date and the mileage and from that, we can compute a good estimate of mileage.
Is that all you do?
First, we review your audit report. Why? Because errors can be mailed. As an example, in one of the cases we handled, we found a computational error. The client had claimed expenses that were patently excessive. That is why he was audited in the first place. He also had reported little income. When the auditor disallowed the expenses the software program he used reversed the expenses and created a substantial profit. We pointed that out to the auditor and that resolved the problem. We also looked for the auditor’s explanations of the disputed items. Did he apply the law properly? Was there evidence of bias? Did he take into proper consideration all of the evidence? Did he simply make a mistake? Was he correct?
Second, we ask if there were deductions that you did not take that you should have. If you operated your business out of your home; did you take a home office deduction? If you purchased equipment, did you take depreciation?
Third, we may have to counsel you. A frequent problem is that taxpayers have difficulty differentiating between an expense and expenditure. Certainly a taxpayer can see that the payment of an electric bill is an expense, but what about the purchase of equipment? That is not an expense. It is simply the exchange of the asset cash for the asset equipment. Both good accounting and tax administration prevent you from deducting the expenditure all at once. (There are some exceptions made because of public policy reasons) Instead, you have to depreciate the purchase over the course of several years in a manner approved by the tax code.
The foregoing makes a lot of sense to an accountant but is not easily understood by a taxpayer, yet accounting principles and tax law provisions must be followed. Another area is bank deposits. An auditor will analyze the deposit made to your banking accounts. Any item that you cannot identify is deemed taxable income. Thus the person who takes money from his ATM to go on a vacation or short trip and then upon his return deposits the change into the bank had better document the transaction, otherwise, it looks like income to the auditor.
Finally, you may for some reason believe that you can claim a personal expense as a business deduction. A good example is filling up your car in Vermont on a weekend and charging it to your company credit card. Another is taking the company pickup to Vermont to go skiing and then claim mileage. We need to make sure that you do not try to do that. At an audit we are talking about penalties and interest. We don’t want you getting into civil fraud and tax evasion. Incidentally, if you took out a liar’s loan make sure that your books are perfect. The IRS gets extremely upset when you claim one amount of income on a loan application and another on your income tax.
"Well, that’s good, but I have never been audited and don’t have to worry. See you on the slopes!"
The truth is that you have not been audited yet — the IRS never releases its methodology for who will be selected for an audit, as taxpayers would then game the system (although by every indication, the IRS will increase audits on the wealthy and those it suspects of owning undisclosed foreign bank accounts). The IRS may decide to audit you for a good reason or for no reason at all. Thus, never make a transaction that you cannot convincingly explain to an auditor. You never know when you will have to.
If you would like assistance auditing your books, or are already being audited by the IRS, contact us. We can help.