IRS Audits – What Do You Do?
We’ve been hearing a lot about IRS audits again lately. In recent months, mainstream media picked up a story regarding the audit of a farm family in Texas. The funding of the agency to hire new auditors has more recently been tied to some House bills intended to aid the current conflict in the Middle East. The thought of an IRS exam strikes fear in the hearts of many, but in most cases, it should not.
The first thing to consider is what one should NOT do:
- Get upset
- Worry
- Ignore the notice and hope it goes away
- Call the agent
- Call the agent and be disrespectful
Unfortunately, the IRS has a job to do too. And while no one wants to go through an audit, the fact of the matter is that sometimes individuals are just selected at random. Statistical formulas and comparison to “norms” are used by the IRS to make audit selections. At times, there are certain areas, for instance uniform capitalization of inventory, that are designated focus areas from which taxpayers are pulled. Underreporting of income is a trigger. The IRS crossmatches reporting documents to items reported on your tax return. For instance, if your local coop provides a 1099-PATR reporting your grain sales and a farmer fails to report those on their income tax season, the IRS will pick up on this and it will certainly trigger a notice if not an exam. Overall though, audits are not generally considered common.
So what should a taxpayer do if they receive a notice of exam in the mail (that’s the only way they come by the way)? First of all, if you have a CPA that prepares your return call them. Do not call the IRS directly. If you prepare your own return, engage a local CPA to provide support for the audit. The CPA should make the initial contact with the IRS. The CPA can then work out scheduling and the location of the work. Generally, the IRS likes to take a tour of the business, which in my experience amounts to a couple hour visit to make sure that the business exists. For one audit, I literally had the agent follow me 30 miles out of town to show him one of the fields the farmer worked. That was it…tour over. All of the other work can be performed in the CPA’s office, assuming the taxpayer’s books and records can be brought to the office. It is not typical for the IRS to perform an audit in a home. Also, keep in mind that agribusiness is very unique and that most IRS auditors are not from an agricultural background. They can require a bit more education on the front end to understand the nuances of the industry and educating in a helpful way is far more productive than the alternative.
If you had a year where there were a great deal of repairs and falling outside the “norm” triggered the audit, it does not mean that the repairs are not valid expenses or that the IRS will disallow or that you should not deduct in future years. The point is to have your records in good order regardless of whether or not you are concerned about getting audited. It is far more comforting to be able to provide the auditor the information they requested in good order as opposed to providing them a mess that gives them a reason to question the accuracy of the return. Let the CPA handle the meetings, questions and flow of information. This is what they do every day…and they can remove the emotion that a taxpayer often feels from the fear of undergoing this process. If an issue arises, the agent’s decision is not set in stone. The Taxpayer has the right to challenge the position as part of the audit or even appeal it after the adjustment is made. The Taxpayer Advocacy Service is also available if the taxpayer does not feel as though they have been treated fairly.
Once in my career, I encountered a taxpayer that did have something to hide and had been fraudulent is his recordkeeping and reporting. Fortunately, the agent was extremely reasonable and the taxpayer came clean with the issues very early in the process. He likely could have done jail time…but ended up with writing a check for the tax, interest, and penalties. If a taxpayer is in this situation, they should be transparent with the CPA representing them upon notification of the exam. A tax attorney should be contacted in situations like this as well. The attorney can be kept up to date and will continue to work in the background until their direct participation becomes necessary.
To sum it up, if you receive a notification of an audit call your accountant and let the accountant handle the process. Do NOT attempt to handle on your own. Go through your return with the accountant, who will be able to identify potential items of interest to the IRS so that you can be prepared. Keep good records in anticipation, take reasonable positions on your income tax return, and above all, do not overreact.
Kelly Jackson Hardy is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers, privately-held elevators and supply dealers, and cooperatives. Kelly is a principal with CliftonLarsonAllen in Princeton, Illinois, as well as a regular speaker at tax and estate planning seminars. Kelly was raised on a hog, row crop and cattle farm in central Illinois and has been involved in the ag industry her entire life. Kelly, her husband, and two sons are active in 4-H and operate a small feeder calf operation and pumpkin business.
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