HOW I SURVIVED A TAX AUDIT
By: Joe Anthony
The envelope is of the plain, white, business-window variety, with an IRS return address. I open it while heating my dinner and freeze at the first line: “We selected your Federal Income Tax return for the year shown below to examine the items listed…”
I sit down very slowly. Dinner could burn. I was being audited.
The IRS audits about one of every 100 returns, but your chances of being audited vary widely. For returns filed in 1989, if you earned less than $25,000, the odds are about one in 170. If you made $50,000 or more, about one in 55. If you filed a Schedule C with gross receipts of $100,000 or more, one in 26.
Most people who are audited wind up writing a hefty check to Uncle Sam. Only seven percent of audits result in refunds; 73 percent result in more taxes, and 20 percent produce no change. The average tax plus penalty is an unsettling $4,290.
“Why are you being audited?” several friends asked. I didn’t know, and nobody could tell me. The IRS decides who gets audited by mathematical formulas and inspections of returns. My number just came up.
Some audits look at just one or two items-mortgage-interest deductions, for example, or charitable contributions. In my case, the agency requested information to support all the deductions I claim as an independent writer: travel, meals and entertainment, supplies, telephone and utilities, business use of my home, and office expenses.
I decide to have my tax preparer, Don Spina of Culver City, Calif., represent me. The IRS allows lawyers, CPAs and enrolled agents – people who have passed an IRS exam – to speak-for you at an audit.
The case against representing yourself is simple. “When an auditor asks you the reason for a transaction, you have to answer,” says Richard Lockwood, a CPA in Fountain Valley, Calif. “That can tie you up in heated discussions.”
Your representative won’t fall into the trap of speculating on reasons behind your actions. “I just say I’ll find the answers,” says Lockwood. “That gives me time to think about the tax implications. And I’m emotionally detached from an audit. That’s a distinct advantage.”
Lesson One: In the world of tax audits, too much knowledge-or emotion-is a dangerous thing.
I gather receipts and other documents that support my write-offs. That part is easy: I keep a log of all expenses, along with a calendar listing my work projects. Good thing too – there’s no way I could have reconstructed my financial history without these records.
Lesson Two: Keep good records and save them. Three years can pass from your filing until the IRS audits you. During that time, your records are your lifeline.
There are numerous ways to substantiate deductions: canceled checks, receipts, expense logs, business calendars. I plan to submit multiple records that can be cross-referenced. Spina tells me to give him just my sorted receipts for each category, with totals attached. “That should be all they need,” he says. “If not, we can come back.”
That means if you aren’t sure what records to bring, you can enter the first session virtually empty-handed and ask, “What documents are you interested in? If I don’t have those, what other records will be adequate?”
Lesson Three: You can return for a second audit session if you don’t have the necessary documentation during the first.
The IRS office is quiet. No groans of pain from behind closed doors.
My bespectacled auditor is like somebody’s grandfather. He says the IRS doesn’t mind at all when audited returns check out. That means people are filing accurate and honest returns. But when an audit reveals discrepancies and additional taxes and penalties, “We’re happy to see that taxpayer’s return year after year. Polite laughter all around.
Five minutes into the audit it becomes clear why taxpayers shouldn’t represent themselves. In fact, I’m not even introduced to the auditor. But I wonder what I might sputter in response to the auditor’s questions to Spina:
* Referring to deductions for publications: “That’s an awful lot of books he buys, don’t you think?”
* Looking at long-distance phone bills: “How do we know these are connected with his work?”
* Shuffling through hotel receipts: “Does he have to take all these trips?”
Put to me directly, those questions would provoke a complex explanation of what a writer does and how he does it – which could lead to all sorts of other questions. Spina answers as succinctly as possible, referring to documentation for specifics.
“Don’t volunteer anything,” says Jim McGrath, a CPA in Rockville, MD. “Answer as many questions as possible with a yes or no.”
Spina responds to the speculative questions by saying he doesn’t know exactly how I do what I do, but all the necessary documents are there on the auditor’s desk.
Lesson Four: An audit is a stressful, adversarial proceeding. If you go alone, be prepared to defend every financial decision you made.
Spina tells the auditor that his client found an additional $800 in deductions to which he’s entitled (I had added incorrectly when first calculating my deductions). “Well, let’s see,” the auditor intones.
A pattern is quickly established: the auditor asks about a category of deduction; Spina hands him a stack of receipts and waits for more questions.
My return is examined very thoroughly. Then the auditor adds up the receipts to see whether the total matches my declared deduction. It does.
Lesson Five: An audit is a stressful, adversarial proceeding. If you go alone, be prepared to defend every financial decision you made.
The auditor doesn’t just look at the numbers. Examining my deductions for a home office, he looks at drawing of the dimensions of my house, proof that I’ve properly proportioned my “office rent” deduction. In my file for meals and entertainment, he studies the backs of all receipts to see whether I recorded with whom I had dinner and what my business purpose was.
Lesson Six: Take a few seconds to note on our receipts what an expense was for. An auditor really will take the time to check it.
The auditor picks specific deductions for questioning – the down payment on a computer, an unusually expensive dinner, phone bills (to see whether I improperly deducted the monthly service cost). Looking at my receipt for a plane trip, he says, “This was a holiday weekend. Does he travel for business on a holiday!”
“I don’t know,” says Spina calmly. “I can ask if you’d lie.”
In three hours of audit time, the auditor doesn’t specifically say there’s a deduction he won’t allow. But now he looks at Spina. “Well, I’ve got him down for $600 in unallowable deductions” – in other words, before my additional $800 in deductions would even be considered.
Lesson Seven: The auditor doesn’t have to be immediately specific about what he will and won’t accept. And the results can be suprising.
“The auditor has a lot of power,” Spina says. “He may decide there are deductions he can’t allow and then use that as a bargaining chip to get a better deal for the IRS. But the power goes both ways.”
The discussion that follows is a language apart – call it “audit shorthand.” There’s a translation: Spina says his client wants an additional $800 in deductions. The auditor says he cannot recommend that to his supervisor. They go back and forth with polite explanations and defenses; then the auditor gets up to make copies of a few documents.
He returns and begins filling out a form. “I am going to recommend no material change.”
Translation: No additional taxes are due.
A week later, I receive the audit report in the mail and ask Spina what I should do. He says I can appeal for the $800 in extra deductions. He thinks I’ll get it if I do.
But Spina points out we’re not talking about a lot of money. And if I appeal, I have to pay Spina for more of his time. Of course, the auditor knew all this when he made his decision.
Lesson Eight: Those IRS folks are pretty smart.
What does Spina advise? “Sign the form. Put the whole thing behind you.” I sign, agreeing to the audit results.
Financial cost: My tax preparer’s $350 fee.
Personal cost: About 20 hours of anxious preparation and a few sleepless nights of worrying.
The final tally: No change. And an enormous sense of relief.
(The above material appeared in the April 1991 issue of Reader’s Digest.)
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