You’ve Got (IRS) Mail!
What Happens When Your
Tax Return is Chosen for Audit
by J. Virginia Peiser
Types of Examinations
The three standard types of IRS examinations are correspondence, office and field audits. A correspondence
audit is usually conducted for selected
issues on a tax return, such as interest deductions or charitable contributions. The IRS letter includes requests
for documents, known as Information
Document Requests (IDRs),5 identifying documents the IRS seeks by a specific
date. The revenue agent may allow additional time to produce the documents
for good cause. Eventually the agent reports proposed Income Tax Examination
Changes,6 known as a Revenue Agent’s
Report (RAR), specifying adjustments for
items that were uncovered by the audit.
T
he dreaded envelope from the IRS has come via
snail mail, the U.S. Postal Service. Your recent
income tax return was selected for audit. You
are requested to attend a conference with an IRS
revenue agent and bring documents regarding income
and/or deductions on your tax return. Now what?
The IRS is authorized to audit any person or entity liable for income or other federal tax.1 The time and place of
the audit must be reasonable under the circumstances.2
The IRS can examine any books and records, and it can
issue summons to the taxpayer or any third person with
information regarding the return under examination.3
The taxpayer must provide credible evidence supporting items reported on the tax return.4
The IRS conducts an office exam to review a greater number of issues, such as income and deductions on Schedule C for selfemployed persons, or numerous itemized deductions on
Schedule A.
The initial IRS letter requests the taxpayer to attend a
pre-set interview at the IRS office or to call to schedule
an interview.7 It includes IDRs for documents the IRS
seeks. After obtaining answers to relevant questions and
reviewing records, the agent prepares a proposed RAR.
The field audit is the most extensive (and intrusive)
IRS examination. The revenue agent typically requests
the exam take place at the taxpayer’s home or office. As
with other types of audits, after reviewing records and
other information, the agent prepares a proposed RAR
with income tax changes.
CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
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The goal of an IRS audit is to uncover unreported
income or overstated deductions. Unreported income
could include earned fees left in your client trust account, while improper deductions could be amounts
rounded to the next higher $100.
Mail Handling
Letters from the IRS should receive prompt and appropriate attention. Office employees should be instructed on who is the person to receive these letters. They
should not go to staff that may bury the letter or respond
on their own without understanding consequences. The
first contact with the IRS can impact the remainder of
the audit.
Taxpayer Interview
Both office and field exams include requests for taxpayer interviews. You have a right to professional representation at any interview.8 You also have the right
to make an audio recording of the interview upon prior
notice to the IRS.9 You should do so to keep an accurate
record of the interview.
Taxpayers often believe they can “explain everything”
to the revenue agent, so they avoid the cost of counsel at
the interview. Anything you say can and will be used
against you!
Promptly consult your tax advisor for your response to
the interview request. In almost every case, you should
have professional assistance at the interview. You may
not know the focus of particular questions, or how an
explanation can be misconstrued for an adverse tax result. Many tax practitioners do not let their clients attend these interviews. They advise the auditor that they
will forward any questions to the taxpayer and relay
back the answers.
Documents provided to the IRS should include only
the requested information. Bank statements supporting
expense deductions should have entries redacted that
are unrelated to the exam. The agent should not learn
where you dine or shop.
Privileges
For questions the IRS poses or documents it requests,
you are entitled to raise privileges, such as those against
unreasonable search and seizure, self-incrimination,
spousal or attorney/client. A privilege log for these documents should include the date, nature, parties, length,
general content and privilege claimed for them.
Statute of Limitations
Although the IRS typically gives limited time for responses, the only time constraint for completing the
audit is the three-year (or six-year) limitations period to
assess a deficiency.10 Months may pass from your submission of information to your receipt of the proposed
RAR.
If the statute will expire in a few months, the auditor will request that you consent to extend the limitations period. Consult your tax advisor as to whether you
should consent to an extension.
Revenue Agent Report (RAR)
After reviewing the proposed RAR, your representative can discuss changes with the auditor and sometimes submit additional documentation for specific issues. Once the auditor finalizes the RAR, you have three
options by the response due date.
The field audit generally should not take place at the
taxpayer’s location. The auditor can learn more than
necessary from observing furnishings, overhearing conversations or seeing unrelated documents. Any records
can be delivered to the representative’s office, and the
agent can examine them in this neutral location.
If you agree with the proposed changes, sign the examination report and return it to the IRS. The additional tax will be assessed. If you agree with the proposed
changes but are unable to pay the tax, sign the report
anyway and make separate arrangements for tax payments with the IRS collections department.11
Document Production
If you don’t agree with the proposed changes, you can
request a conference with the auditor’s supervisor or the
Office of Appeals by the response due date. The Office of
Appeals is quasi-independent of the IRS examination
process. Its mission is to resolve tax controversies without litigation, on a basis which is fair and impartial to
the government and the taxpayer.12
All exams include IDRs. Additional document requests may be made during the audit, if the agent finds
further issues to develop. You should keep a copy for
your records of all documents submitted to the IRS.
Summons can also be issued to third-parties, such as
2
your bank. However, the IRS cannot compel you to prepare new documents, including a tax return or a spreadsheet summarizing records.
MARCH 2015
An Appeals Officer may settle a case based upon all elements of an examination and may consider hazards of
litigation.13 Legal issues and questions of interpretation
are more likely to be resolved with the Office of Appeals.
If you do not respond to the RAR, the IRS will issue
a Notice of Deficiency based upon it. You have 90 days
to file a petition with the United States Tax Court.14 A
petition filed even a single day late will be dismissed,
and the IRS will assess tax based upon the Notice of Deficiency.15
The decision to request an appeals conference or file
a petition in Tax Court should be made after consulting
your tax advisor. But if your income and deductions are
properly documented and reported, you, too, can survive an IRS audit. s
1
Internal Revenue Code (hereinafter IRC), 26 USCS §7601.
2
IRC §7605.
3
IRC §7602.
4
IRC §7491.
5
IRS Form 4564, Information Document Request.
6
IRS Form 4549, Income Tax Examination Changes.
J. Virginia Peiser is Of Counsel with Archer Norris,
PLC, based in Walnut Creek. She represents investors
and owners of closely held businesses in tax, business
and estate planning matters and is practice group leader of the Archer Norris taxation and estate planning
practice. Virginia is a Certified Specialist in Taxation
Law, as well as Estate Planning, Trust and Probate Law,
by the State Bar of California Board of Legal Specialization. She has been a member of the Board of Directors
of the Contra Costa County Bar Association Taxation
Section since 1988 and has served four separate terms
as Chair of the Taxation Section.
This article was originally published in the March
2015 Contra Costa Lawyer magazine, a publication of the Contra Costa County Bar Association.
You can view the original here:
www.cccba.org/attorney/pdf/cclawyer/2015-03.pdf
or the online version here:
http://cclawyer.cccba.org/?p=9903.
7
For example, IRS letter 3572, requesting a call to schedule an appointment.
8
IRC §7521(b)(2).
9
IRC §7521(a).
10
A six-year statute of limitations applies to an income tax return
that omits more than 25 percent of gross income. IRC §6501(e).
11
Tax payment options beside full payment may include Installment Payment Arrangements (IPA) and Offers in Compromise
(OIC).
12
Internal Revenue Manual (IRM) 8.6.4.1, Fair and Impartial
Settlements per Appeals Mission; see also IRM 1.2.17, Servicewide
Policies and Authorities, Policy Statements for Appeals Activities.
13
IRM 8.6.4.1, Fair and Impartial Settlements per Appeals Mission;
IRM 8.6.4.1.1, Mutual-Concession Settlements; see IRM 1.2.17.1.6,
Consideration to be given to offers of settlement.
14
IRC §6213.
15
You then have an option to pay the tax and to sue the IRS for a
refund in either federal district court or the Court of Claims.
CONTRA COSTA COUNTY BAR ASSOCIATION CONTRA COSTA LAWYER
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