What to do if you are audited by the IRS

PERSONAL FINANCE

April 15, 2001|By EILEEN AMBROSE

THE TAX season will officially end tomorrow for most Americans, but a small number of filers will have to relive the process perhaps months from now when their returns come under an audit.

Granted, the percentage of IRS audits has fallen off under the agency's stagnant budget and shrinking work force. The IRS last year audited 0.49 percent of individual returns - about one out of 200 returns - compared with 1.68 percent five years ago.

The reduction, some tax experts fear, encourages taxpayers to cheat. But others say now is not the time for taxpayers to get careless or cut corners.

The IRS is hiring more auditors, and face-to face audits will likely increase. Even more audits are expected if the White House's budget increase for the agency is approved.

Plus, the slowing economy and the passage of an across-the-board tax cut may cause the IRS to step up audits to make up for lost revenue, suggested Jacob Friedman, a tax lawyer at Proskauer Rose in New York.

It's natural for the heart to pound a little faster when you discover you've been chosen for an audit.

"You are in a world of numbers that the average person isn't conversant with. You feel nervous. You don't know if this is the tip of the iceberg," said Joe Cleary, a retired guidance counselor in Long Island who received an audit letter several years ago.

Cleary suspects he came under IRS scrutiny because of his accountant, who had a liberal interpretation of deductions.

The IRS audited three years of Cleary's returns, disallowed some deductions and agreed with others. Cleary paid the taxes owed and no longer uses the accountant.

"You should be about as nervous as you are when you go to the dentist," Sam Serio, an IRS spokesman and former auditor.

Of course, palpitations may be reduced if you understand how an audit works and your rights.

The IRS can audit returns filed within the past three years, but will dig into filings as old as six years if you underreported your income by more than 25 percent. If there's evidence of fraud, there's no time limit for an audit.

Audits are triggered in various ways. Sometimes the IRS will target a certain occupation or industry, or an informant tips off the agency to potential fraud, Serio said.

More often, an audit is triggered by a taxpayer's "discriminant function," or DIF, score. "It's the IRS equivalent to the Coca-Cola recipe. It's top secret," said Phillip Pillar, a senior manager at Ernst & Young in Philadelphia and a former IRS lawyer.

Each return gets a DIF score. A high score means the taxpayer's deductions or other claims fall outside what's considered normal for someone with similar income, occupation and filing status.

A computer spits out returns with high scores. IRS staff screen these to decide whether an audit is necessary.

More than half of the audits are done via mail, while others require a face-to-face meeting with an auditor in an IRS office, Serio said. Sometimes, usually with a business, the IRS auditor will visit the taxpayer.

If you're confronted with a mail audit, it's important that you respond to the auditor's request for information.

"You'd be surprised how many people get themselves in a jam with the IRS because they don't respond," said Claudia Hill, of Cupertino, Calif., who is an enrolled agent, a tax practitioner licensed to prepare taxes and represent taxpayers before the IRS.

You also have the right to request to talk with the IRS auditor in person.

Send photocopies of requested documentation and keep a record of what was sent and where, and, the name of any IRS auditor you may end up talking to, Hill said.

If you complied but haven't heard from the IRS within the promised time, contact the Taxpayer Advocate Service (1-877-777-4778), Hill suggested. It's the group charged with ironing out problems when they can't be resolved through the usual means.

If you're called in for a face-to-face audit, you can go by yourself, take an accountant or other expert with you, or send a tax professional in your place provided you give that person power of attorney to handle the matter.

When going it alone, reread the tax instructions for the areas that will be audited or get IRS booklets on the subject so you will be familiar with the law, Friedman said.

Bring any records requested and documentation of deductions or income being questioned. Be organized. "If you have a shopping bag, you might pull something out inadvertently that the IRS agent wasn't even going to ask about, but now you caused yourself another problem," Pillar said.

And never volunteer information, which can invite more questions. "You won't want to say, `I'm surprised you asked me about this. I thought you were going to ask me about that,' " Pillar said.

If you're butting heads with the auditor or reached an impasse, you can ask to see the auditor's supervisor. Sometimes, but infrequently, a new auditor may be assigned, Serio said.

Or, if you find that you're over your head, you can stop the audit and hire a professional to represent you.

If you disagree with an auditor's finding, you have the right to appeal the decision with the agency's appeals office. Most appeals are settled and sometimes taxpayers may end up owing less, Pillar said.

You can also bypass the appeals office altogether or appeal its decision by going to the U.S. Tax Court, the U.S. Court of Federal Claims or the federal District Court in your area.

If you file in Tax Court, you won't have to pay the disputed tax bill beforehand, Pillar said. Before seeking relief in the other courts, you must first pay the tax, file a claim for a refund, and if the IRS rejects it, you can then file your appeal, Pillar said.

It's rare that cases go to court, but when that happens, you should hire a professional for advice on the appeal and where best to file it, Pillar said.

Do you have a personal finance issue of general interest that you would like to see addressed in this column? Contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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