Speaker 1: Hello, and welcome to another episode of Tax Law Guy. Today we're going to be talking about IRS audits, and I have three practical steps for you on how to handle an IRS audit. So let's say you go out to get the mail and there is that letter from the IRS, the all-too-familiar logo, and congratulations, you won the lottery. Not the lottery you wanted to, but the IRS audit lottery. And so let's talk about IRS tax audits. All right, so if you're audited, you're actually in a pretty exclusive group. Roughly one out of every 400 returns results in an audit, so it's a pretty rare group. So when you get that letter and it's time for an IRS audit, there's three practical things that you can do on how to handle that. The first is understand the depth of the audit. So what kind of audit is it? Is it a correspondence audit, where they're asking for specific documents? And so that's the typical mailed audits, where they are going to send it to you by mail. They're looking at something very specific and you have to provide substantiation for that. And typically, those are going to be the simplest of the audits, where you are just going to provide what they requested and send that off. So knowing what type of audit it is, is very important. The next level is going to be an office audit. These are pretty rare, especially in the COVID era, but that's where they're going to have you come in to verify your income, your deductions, possibly any credits that you've taken. Many times those are now still done at home and remotely or by the phone. The third type, and this is the most extensive, this is a field audit. That's where a revenue officer is literally going to look at every part of your books. They're going to go through everything on the return and it's very time involved, very intensive, and those are very rare, typically only for taxpayers who have business entities or have returns with a lot of cash transactions. So once you determine the type of audit, the next thing is to determine exactly what the IRS is questioning. That's a very important question because you don't want to provide the IRS more than what they're asking for. And the audit, the type of audit, once you figure that out, you're going to be able to look at it and determine what they're asking for. What are they challenging, if you will? Is it a charitable contribution deduction or is it other itemized deductions? If you take the child tax credit, is it specific to the child tax credit? And so you're going to want to answer the question that they are asking in a very concise manner. Please don't give them more than what they ask for. Be very careful that you don't open up another issue, okay? And we see that quite a bit where you provide them everything but the kitchen sink and it leads to an investigation of other areas that were not part of the original audit. If it is an in-person office audit or a field audit, again, those are rare right now. The IRS really does not do those because of the COVID protocol, but you are going to want to have representation with you. They're going to scrutinize what you say. They're going to look through everything with a magnifying glass, if you will, and you're going to want to have representation available. The IRS will give you the right to have representation and I strongly suggest that you use it. You do not want to be answering questions to a revenue officer or a field agent without counsel readily available. Many times when we get involved in an audit, we're able to push back and where the IRS just wants you to either get on the phone or come in for an in-person interview and just kind of fish around for information. We like to push back on that and really get them to narrow the scope of the audit. That's one thing that we typically will negotiate with the IRS, especially in a situation where the statute of limitations is closing in. We'll at times extend the statute of limitations in return for the IRS agreeing to narrow the scope of their audit. You may say, why would you ever do that? Well, if you're up against the statute of limitations, the IRS will just assess the maximum tax they think they can just to get the assessment on the books. And then if you're going to appeal it, you have to extend it anyways for purposes of the appeal. So there is a certain strategic decision there where we may preemptively agree to extend the statute of limitations, but we're going to want something in return to cooperate in that manner. And typically that's going to be narrowing the scope of the audit. So the third thing, again, knowing what type of audit, knowing the questions that the IRS is asking and what they're looking at specifically. The third thing that is critical is the documentation. And so documentation is going to save the day. And it's very important that the information you provide, again, answers the questions, what they're looking for. It's very important, as I already mentioned, that you don't give them more than what they want, but the documentation does have to substantiate what they are asking. If you, for example, claimed a...let's say you itemized and you claimed a large charitable contribution, you better have the required documentation. When it comes to large cash contributions, you're going to have to have a contemporaneous letter or statement from the nonprofit substantiating that donation. Furthermore, that documentation better have the required language on it. Using that as the example, a nonprofit has to stipulate, assuming it's completely accurate, that you didn't receive any benefit for that charitable contribution. That has to be on the statement. And you may say, well, this was from two years ago. I don't have a statement. I'll just go and get the statement from the nonprofit. That's not going to cut it. It has to be contemporaneous. Generally speaking, it has to be before you file your return or the return was due, whichever one comes earlier. So, you have to make sure that you have the documentation to support your response to the audit. And that's where having a tax attorney involved can be very helpful, because we know what the IRS is looking for. We actually have copies of the IRS Field Audit Manual, where the IRS has a checklist of what they will accept for purposes of an audit, what they're looking for, and also red flags so that they can expand the scope of their audit if something comes up. There are a lot of issues that can happen during an IRS tax audit, but if you're going to handle it yourself, please remember these three practical steps. Know what type of audit it is. Know the questions that the IRS is asking, specifically what items of income or deduction or credit they are looking at. And then make sure that you have the proper documentation to support your position. And when you send that in, if it is a mail audit, make sure that you send it certified. Keep copies for yourself. You want to clearly show that you responded in a timely manner, especially when it comes to appeal rights. Talking about appeal rights, even if you decide that, you know, hey, you know what, the IRS is right, you want to appeal that audit for purposes of reducing the penalty. The IRS, if they assess you additional tax as a result of an audit, they may assess you the 20% understated income penalty. In appeals, you can have most of that, if not all of it, abated or removed. Especially if it was an honest accident on your part, you weren't trying to state your income incorrectly, it was just a mistake. And so you want to take advantage of that. What's the worst that they can say? No. So if you are under an audit, reach out to us today. We'd love to kind of give you our opinion of it. Many times we've told clients in the past that, hey, this is such a minor audit, as long as you provide the documentation, you should be fine. And we'll give you an honest opinion of whether or not it makes sense to engage counsel for the audit. But, again, as I mentioned, keep those three things in mind the next time you face an IRS audit. All right. Thanks for watching the Tax Law Guy. We'll see you next time.