Sam Brotman, JD, LLM, MBA July 2, 2020 25 min read

Frequently Asked Questions About the IRS Audit Process

FAQs

What Type of Penalties Could I Face in an Audit?

The penalty structure in an audit can range anywhere from five percent, all the way up to a 75 percent. It depends on the conduct and the course of dealing during the audit and how the material is presented. The most common penalty is the negligence penalty, which is about 20 percent.

If at all possible, you want to avoid that negligence penalty and knock this thing down to an accuracy penalty, which is about 10 percent. An accuracy penalty is usually the best-case scenario because the accuracy penalty is mandatory for adjustments that are $5,000 or greater.

For more serious cases, the goal in the audit is to mitigate the civil fraud penalty, which is 75 percent. In addition to the 75 percent penalty on top of the tax that you owe, civil fraud prevents certain resolutions within IRS collections. 

That is why it is really important to avoid the stigma of fraud going forward in your IRS matter. In the event that a civil fraud penalty is issued, the most likely course of action is an IRS appeals. 

One of the important things to think about when you are hiring a representative or when you are making the decision on who to represent you in the audit, is how you are going to deal with the issue of penalties and mitigate them as much as possible.

What If There Is a Serious Error on My Return and I Get Audited?

If there is a serious error on the return, the first thing you do is you need to get an attorney, not a CPA, and not a tax preparer. The reason you need an attorney is a serious error on the return carries potential criminal liability and/or at least what we call a civil fraud penalty. 

You need an attorney to be able to communicate the full extent of the error and because an attorney's communication is protected under attorney-client privilege. You do not have that same relationship with your CPA or with another tax preparer. 

Number two, is once you identify the error, determine whether or not the auditor's going to catch it. If the error is fairly obvious, then you are better off admitting it to the auditor and avoiding the willfulness penalties or avoiding the impression that there is any fraud.

If the error was a simple mistake and there is no criminal liability, then the decision needs to be made on whether or not you are going to disclose that to the auditor or not. If you do not disclose it to the auditor and the auditor catches it later, there could be consequences in the terms of penalties. 

However, if you get out in front of the issue and disclose it, although you are on the hook for whatever the taxable adjustment is as a result of the error, you may be able to leverage it to your advantage. 

Serious errors are no laughing matter. It is important that you deal with it, honestly and appropriately before the IRS makes the decision on what your ultimate disposition is.

What Happens If I Owe Money to the IRS After the Audit?

If you owe money at the end of an IRS audit, it is like owing liability on your taxes. You can pay the liability in full, you can work out a payment plan or you can go in collections and work out a resolution.

Generally speaking, what happens is, the auditor will close the audit and a bill will get issued. If you do not appeal that bill, you will go directly into collections. The best thing to do is to speak with the auditor and see if you can negotiate a straight hand-off to collections. 

It is not possible in all cases, particularly where the liability is small, but if you discuss things with the auditor, they may be able to shortcut the process into collections and work out a resolution of the liability. 

This also tends to happen in cases where there are large dollar amounts due at the end of the audit. The auditor will pass you off to a revenue officer. You will start working with that revenue officer immediately to try and collect the liability.

In either case, if you owe money, do not worry. There are a lot of things that you can do on the IRS's side to mitigate that liability and to work out terms that you can potentially deal with.

What Happens If I Get Audited and Don’t Have Receipts?

If you do not have substantiation, then do not panic because there are many ways to substantiate an expense. What the IRS code technically requires is that in order to take a business expense, for example, that the expense has to be incurred in the tax year and it has to be ordinary and related to the business.

Technically, In order to prove that the expense was incurred in the tax year, the code does require receipts. But the phrase that we use around the office is — we like to point to the integrity of data.

One of the best things that you can do if you are missing receipts or if you have other substantiation issues, is just try to build a body of work.

For example, if you do not have any receipts, go through your bank statements, identify the charges that you do have and show the supporting charges. If you have expenses on there that are like from Target or from the grocery store, those could be questionable. 

You might want to leave those expenses off because as long as you can substantiate things to a reasonable perspective and do your best to tie the expenses in, there are a lot of things that you can do to get credited for those categories, even when you are lacking documentation.

What Is the Brotman Law Strategy in an IRS Audit?

The strategy that we have in the firm for IRS audits is essentially what I call, see the playing field. It is really important in an IRS audit is to understand what you are dealing with going into the audit. When we look at a return in the context of an audit, we are constantly trying to figure out what about this return is special? Why did it get audited? Where does the IRS see the large propensity of an adjustment?

In doing that and identifying the areas we think are at most risk, that is where we devote our focus and attention to the audit. We certainly want to prepare for everything, but by concentrating on the areas that we believe the auditor is going to focus on, we can help mitigate a lot of the client's risks.

The goal is to control the scope of information and make as good of a presentation as possible to the auditor in order to get out of the audit as quickly as possible. We are trying to maximize efficiency, we are trying to minimize risk, and we are trying to conclude the audit as quickly as we can. That is the way our firm handles IRS audits.

Can I Go to Jail for Errors on My Tax Return?

Yes, you can, but with the caveat stated that most people do not go to jail because of errors on their return. Criminal prosecutions take willfulness. There has to be some deliberate action on your part to mess with the return or to conceal income or hide expenses in some way. 

If there is no evidence of willfulness, prosecution is probably not likely. In the course of the investigation, the auditor is looking for things called badges of fraud. They are looking for evidence that you manipulated the numbers on your return in order to lower your taxable liability.

If the errors are serious enough, it will trigger a referral to the Criminal Investigation Division (CID) of the IRS. While the chances of jail are not likely, if you have a serious error on the return and the IRS suspects willfulness, it can and will trigger a criminal referral, which is something that you do not want to deal with.

Criminal matters are very difficult to deal with, and they cause a lot of problems having a CID agent investigating your file. The easiest thing to do is defeat the presumption that there is any willfulness associated with the error and move past the issue as quickly as possible during the audit.

If I Amend My Taxes, Am I More Likely to Get Audited?

Yes, unfortunately you are. Because by amending your taxes, you are going ahead and admitting that a mistake was made on the original return.  It could be an innocent mistake or it could be a not so innocent mistake, but highlighting that for the government means that there is an error on the return. 

The good news is that if you identify the error, take steps to correct it and that the explanation you attach to the amended return is sufficient. Once it gets to the human reviewer, the human review would probably look it over and say, “Oh, I understand what happened,” and they might move on. 

Consequently, if there are significant adjustments or errors, then the amended return might fall under some scrutiny. You take the risk when you amend returns by highlighting things for the government and potentially dragging yourself into an audit.

This is particularly true when you are amending multiple years of returns. However, I would not say that should stop you from amending returns, even if you are increasing your audit risk. There are certain ways to present amended returns that will fall under less scrutiny. 

At the very least, the attorney can help understand how you can reduce the likelihood examination is going to pick up that issue. That is what I would recommend when you are dealing with an amended return situation.

If I Get Audited, What Is the Likelihood I Will Get Audited Again?

It depends. The first thing it depends on is what are you being audited for? Are you being audited for a one-off mistake? Are you being audited for a serious under-reporting of income or an overstatement of deductions? What is the issue? 

Then based on how the audit goes, what is the correction? Is it a substantial correction? Is it a minimal correction? Are you getting penalized? Were there fraud issues involved? Audits are meant as a check. Again, the IRS is verifying that the story you are telling the government is an accurate story.

If there is a reason for the government to believe that the same story may continue in the future, then you will probably pop back up on the IRS's radar again. If you have a history of noncompliance, if you are under-reporting cash or something like that, the IRS will probably take a look at the return. 

Understand that the IRS operates based largely on statistics. They will compare the return that was audited and the adjustment that was made, to a later year’s return. If there are any similar issues on that return to the first return, the IRS will decide whether or not they want to get audited.

If you go through an audit, you have pretty much learned your lesson and you never want to go through it again.

The best thing that you can do to protect yourself from being audited again is to learn from your mistakes the first time and to minimize those mistakes going forward in the future.

Can I Just  Pay the IRS and Get Them Off My Back?

No, because it does not really work like that. If you are selected for an audit by the IRS, then they want to do an investigation to some varying degree into the information that you have reported on your tax return. Not complying with that investigation or trying to obstruct it in any way by not responding to the auditor or doing any number of things to impede their investigation, or just calling them up and saying, “Send me a bill,” is not really a good strategy.

Number one, if you call the auditor up and ask them to send you a bill, then they are going to disallow everything that they could possibly disallow and send you the largest tax bill that they can in order to protect the interests of the government. It is not like they are just going to say, "We are going to limit it to this issue." 

They are going to disallow everything because they do not have any basis or any support. By doing that, you are cruising for a much higher liability than you are probably entitled to.

Number two, is if you have a complicated issue or if there is something that the IRS really feels is there. For example, if you do not report $30,000-$40,000 on a tax return for income, then the IRS is not just going to let it go. There are penalties involved with the unreported income. There are penalties involved with overstating deductions. The IRS is just going to say, "Well, if we catch you, just go ahead and mail us a check and everything will be fine." No, the IRS is about compliance.

If you do not comply with the tax laws by filing returns that are inaccurate or if you are overstating things or understating things, the IRS is going to punish you. It is not something that is just as simple as writing a check and being done with it. You have to play ball with the audit whether you want to or not.

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How Do I Beat IRS Examinations at Its Own Game?

Here are some of the tactics that we use when dealing with IRS examinations in order to get the best results for our clients. I am not necessarily recommending as a layperson that you try to follow these strategies by yourself. I am simply letting you know, because I want you to see the playing field in terms of how IRS audits actually work and some of the tactical maneuvers that we use to get the best results for our clients. 

Again, with an IRS audit, particularly a field audit, you want to make sure that you are handling the situation with an appropriate amount of deference. Usually, with field audits you want to get an attorney involved as quickly as possible.

Stay One Step Ahead of the Auditor

Here is the way we handle the situation. Number one, when dealing with an examination issue, we are trying to be at least one step ahead of the auditor. We are creating a very defined path to lead the auditor down. 

It takes two things. Number one, you need a clear indication of what point you are starting on in the audit. Number two, what are the facts? Based on the information I have about my current situation, what are the likely outcomes? 

Have a Clearly-Defined Path

You want to get yourself in a clear position, then you want to understand what the next step is going to be and what your exposure is. Based on those two points, you want to plot a path. You want to map out the audit. 

You are going to have sequences in the audit process that you are going to go through. You are going to, for example, have a meeting with the auditor and you are going to present documents to the auditor. Your presentation should match your goal.

Then every step along the way should match what you are trying to accomplish. In some cases, we are trying to not disclose information to the auditor. We will do everything we can, even at the risk of making our relationship a little bit difficult with the auditor. 

We will not tell the auditor everything about a particular course of action because if the auditor were to discover it, the client would walk into a big problem. One of the other things that we utilize is what we call a Trojan horse. 

If we realize that the client's going to get caught in a certain area, then we can use that. We will offer it to the auditors so they can make an adjustment and in exchange, we will focus the attention of the auditor on that particular area and move them around another issue.

The Appeals Route

The other thing that we do is leverage our relationship with IRS appeals. There are different ways to handle the audit; you can either be cooperative or not. Generally speaking, it is better to win more flies with honey, but at the same time, sometimes you have to be a little tough with the auditor.

But, you have the appeals division, you have the ability to file a tax court petition, and you have the ability to speak with the audit manager and the territory manager. You have all these different avenues that you can pursue in order to get the best result.

Your end goal may not be through the audit division. You may get your end goal through appeals, in which case your best move may be to get out of the audit as quickly as possible and correct everything once it is gone to appeals. It is a factual decision. It is based on strategy and it is based on trying to navigate through the process, but that is the easiest way of moving along and that is how you beat examination.

It Is in Your Hands

You have the power in an audit. It seems like the auditor’s in control, but they are not. You control the moves — you make a move, the auditor has to make the move. They are constantly reacting and they are constantly responding to your moves. 

That is really how you beat examination at its own game. Again, I recommend that you get an attorney involved. The strategy component of it is very, very important in the context of an audit. 

By following some of these steps, and viewing the audit “big picture,” not just step-by-step, you are going to be a lot more likely to achieve the result that you are looking for at the end

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

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