Tax Audit Tips
Litigation to Appeal Income Tax Audit Results

It's usually a dark day when you as a taxpayer receive a letter from the Internal Revenue Service requesting a tax audit.  It may not be as bad as it seems, and you have the option of hiring a tax professional like Kass and Kass to help you prepare and represent you when you need representation.

Types of Tax Audits

• Desk Audit: The least serious is the desk audit where you mail all documentation requested by the auditor to him or her. Usually, the IRS assigns its most junior and least experienced agents to a desk audit because the tax issues involved are usually more cut and dried than other types of audits.
• Field Audit: Field audits are usually for business entities. With a field audit, the IRS sends an auditor to your place of business. Usually with a field audit, the agent in a letter defines the scope of the examination before and so you know how to prepare for the visit.
• Estate Audit:  The examination of an estate tax return Form (706) where someone has died. In these audits, rather than income, the agent is looking for assets. The auditors in these cases are frequently tax attorneys and are very experienced.
• TCMP Audit:  The IRS examines every line of the tax return and all documentation. These are called TCMP audits, chosen at random and used by the IRS to update the statistics they use in selecting tax returns for audit. Thankfully, only about 70,000 of these are done annually. The taxpayers for these are selected at random.
• Special Audit: The fifth and last type of audit is a special audit done by IRS’s criminal division. You should never represent yourself in this situation.

We advise taxpayers to hire a tax professional to represent them in all but a desk audit.

Representing Yourself

If you decide to represent yourself, here are some rules to be followed:

• Always be courteous to the agent. Remember he or she is merely doing his or her job in auditing your tax return.
• Get yourself organized. You need to be very organized. If the agent wants to examine your proof for the charitable deduction you deducted on your tax return, pull out all of the checks you wrote to charitable organizations that year. Take an adding machine tape of them. Attach the adding machine tape to the envelope holding the checks. If some of your proof, for your deductions, are charges on a credit card statement circle or highlight the charges you deducted for charitable contributions for the year being audited. You should put these in an envelope with an adding machine tape attached. The more organized you are in documenting the deductions under examination the more quickly the auditor will conclude the examination and the less items he or she will find to disallow.
• Don't get emotional or defensive. Although you can represent yourself in a tax audit, in our experience it is not prudent to do so as many people get emotional about their own taxes.  The best result is always obtained if the audit is approached in a calm businesslike manner.
• Don't volunteer information.   Your best results are usually obtained by giving the auditor exactly the information requested and nothing more.  Don’t volunteer information and be careful what you say! Volunteering extra information or carelessly telling the auditor information which he did not ask for is how many people who handle the audit themselves wind up with large assessments.
• What if a large deficiency shows up?  If the auditor finds a large deficiency for the year examined, he or she may seek to examine the same item in a subsequent year. Generally, it is wise to cooperate if this is the case. If you refuse the auditor can suggest to his superiors that another of your returns for a different year be examined. In all likelihood, the scope of his examination for the subsequent year will not be limited as it would have been if you had merely agreed to opening up another year for him to look at the same item.

Representation by A Professional

If your tax preparer is not an attorney, a C.P.A. or an Enrolled Agent, he or she cannot represent you in a tax audit.

Modern day tax regulations and tax law are as complicated as most anything you can imagine.  The advantages of using a professional such as Kass and Kass is that we are both CPAs and David is a tax attorney.  We understand the rules and regulations.  We have been through hundreds of audits before and generally know what to anticipate for any particular type of audit and how to respond in ways that will minimize your exposure and risk.

One of the reasons this is important is something you may not know about?  The federal and state governments generally cooperate in the sense that if one audits your tax return and finds a deficiency, they will notify the other of that deficiency and you will then have to pay the other entity, too. For example, if the IRS finds a deficiency of $1,000.00 on your 2007 tax return (assume they disallowed some of your charitable contributions); they will notify New York State and if your New York State tax rate is 6%, New York will assess an additional $60.00 plus interest 6% X $1,000.00.

Litigating and Appealing Unfavorable Tax Audit Results

If your tax audit results in a large deficiency, there are several options available to you.

If you choose to appeal, the first step is a Conciliation Conference with the auditor and his or her supervisor. Before you request such a conference, you should be sure you have a cogent and logical argument. Simply complaining about the size of the tax deficiency will not help. Arguing that the taxes are more than you can afford may be a cogent argument, but not at a Conciliation Conference. If for example, the auditor disallowed a large portion of your entertainment expenses (restaurant charges) deducted by you because he deemed them to be personal in nature; if you kept a daily diary detailing the dates, whom you took out, and the business discussed; you have a cogent argument. If you present your argument at the Conciliation Conference and are still not happy with the result of the audit, you can appeal to the next level of the IRS.

See our discussion about offers in compromise and negotiating settlement of tax deficiencies.

There are actually three levels of IRS appeals and the Service is very cognizant of “the hazards of litigation” and, at each level, has more ability to compromise on the amount of the deficiency. The Internal Revenue Service is also very aware of the fact that the number of tax attorneys on its staff is limited and that if those attorneys can settle with you they may have more time to pursue more lucrative cases.

The IRS appeals process starts with having your tax attorney write a formal protest letter. If your tax deficiency is less than $10,000 this is a fairly simple process.  If it is more than $10,000, you will have to provide more documentation.  Either way, your protest letter will clearly state that you disagree with the IRS’s conclusions, and offer reasons why.  Your attorney will request the IRS auditor’s file where you may gain insight regarding the decisions that the agent made in your case.  At your appeals hearing, you and your tax attorney will meet the appeals officer in his or her office. You present your case, note the disputed items, and answer the officer’s questions.  You can usually negotiate a settlement on the spot. The appeals officer will prepare IRS Form 870, Consent to Proposed Tax Adjustment. It may be some time before you receive this document by mail.

If the appeals process is unsatisfactory to you, the next step is to appeal to either the Tax Court or District Court or the U.S. Court of Appeals. The primary difference between these options is that for Tax Court, you do not have to pay your deficiency before you appeal. In District Court or the U.S. Court of Appeals you do. For most of our clients, these are not practical options as the court costs and legal fees that will be incurred to litigate the case are too large relative to the size of the tax deficiency.

Fast Track Mediation

In lieu of appealing within the IRS or litigating in a court proceeding, there is also the process of Fast Track Mediation.
This is another means of case resolution within the IRS which is governed by Revenue Procedure 2003-40. Basically if the issue is eligible for the Fast Track Mediation Program, a Fast Track Settlement Appeals Official serves as a neutral party. With the Fast Track Settlement, a negotiated settlement is arrived at. Revenue Procedure 2003-40 instructs taxpayers who wish to submit a case to the program to contact two IRS employees to ask questions or to see if their case is suitable for the program. This program is quick and much less expensive than a court proceeding.

This sums up the options available for making an appeal.  Read more about settling tax deficiencies with the IRS here.

When You Need Professional Representation

We advise taxpayers to hire a tax professional to represent them in all but a desk audit and for all appeals processes.

David Kass is both an experienced tax attorney and a CPA.  Esta Kass has been a practicing CPA since 1977 and is extremely innovative, creative, and ingenious in adopting tax law to the situations in which her clients find themselves.  Please contact Kass & Kass to schedule a consultation. A brief introductory consultation is available for a nominal charge.