posted on:  5/24/2006     revised: 3/8/2010

Is it worthwhile for a taxpayer to fight with the IRS after receiving a demand for additional tax payment?  This week the Wall Street Journal Tax Report column says that the Government admits that it made concessions and settled tax cases at less than full demand in 41% of cases. The article continued to say that this is evidence that taxpayers should not just "roll over" when the IRS makes a demand for additional payment. The article emphasizes that many of these cases involve tax shelter audits and high income taxpayers where there was clear evidence of "wrongdoing" on the part of the taxpayer. This editorial is not meant to comment on these types of cases since these audits are usually settled on an entirely different legal theory known as "hazards of litigation" that does not apply to the settlements that most individuals face when audited by the IRS. So what about ordinary middle income taxpayers facing an IRS demand?

In my experience with middle income taxpayers, fighting IRS demands has been far more successful than indicated in the Wall Street Journal. Of course, there are different types of IRS demands. The most common type is "omitted income". In this case a taxpayer forgets to include income from some source and the IRS adjusts income and tax accordingly. There are also cases where a taxpayer knowingly makes a false statement and the IRS correction is plainly justified. In these cases, there is nothing to argue; this was just a taxpayer fault. But is we ignore these types of cases and look at only those cases where the underlying tax facts are in dispute, the outcome is much different. These are not the types of cases that a non-attorney adviser would be particularly useful, so these are omitted from this discussion.

IRS takes the position, based on historical evidence from past audits, that most of their assessments for additional taxes are valid. The position is that the IRS is right and the taxpayer is wrong. Yet many taxpayers have a reasonable basis for the positions they take on their tax return, so there some justified basis for dispute.

I am only aware of two cases in my career where clients admitted that is was cheaper to pay the additional assessment than to fight - regardless of whether they were right or wrong. In more than 20 audit cases that I have handled, the taxpayer was able to successfully negate the IRS assessment. In all those cases the fee for the dispute was significantly less than the amount of the assessment, so the taxpayer came our ahead. Based on my limited experience, I would say that fighting IRS is effective in reducing the net amount of financial liability in about 9 out of 10 audit situations (excluding the cases discussed previously.

Regrettably, some of my audit experience is connected with my own personal tax returns. I am fairly aggressive with my tax planning but meticulous with recordkeeping and legal research. It is crucial to be knowledgeable of the law and mindful of the procedural issues of a possible audit. My federal tax return has been audited in seven out the last ten years. My audit for 2004 was settled in early 2006 and my 2003 audit was settled less than a month ago. In every case, my positions were upheld and no additional taxes were due. I am an unprofitable audit client for the IRS. I estimate that the IRS has spent more than $5,000 auditing me (based on about 80 hours at $65/hour) but these audits have not netted a single dime in additional tax revenue. I would not be so satisfied if I had to pay a tax adviser to represent me. Most advisers charge more than I do (I charge $150 but the advisers I use charge more than $200) but even at the lower number, it would have cost me over $3,000 to defend these audits over the ten year period. I did actually hire an attorney and another accountant for part of one of the audits but they charged me less than full fee as a professional courtesy and because I had a history of referring them clients .

In contrast, I find that most taxpayers are unable to successfully represent themselves in an IRS audit. This is probably due to a combination of lack of knowledge and psychological factors (both the taxpayer's internal thought patterns and the human nature of interpersonal behavior involving the auditor). It appears that professional representation is usually required in order to win a tax audit.

So what does it cost a typical taxpayer to defend a typical tax audit? Let's say that a typical demand for a middle income taxpayer is in the range of an additional $4,000 in taxes. The minimum cost of having an adviser review the case is $150. Representation brings the cost to at least $500. An average case probably costs $1000 in total fees. If the success rate is 66% (2 out of 3 cases successfully closed with no additional tax) then the average savings for fighting the IRS is about $2000 ($3,000 assessment minus $1,000 professional fees X 67%) .

I conclude that is worthwhile for the average person facing an IRS audit to hire professional help to fight the IRS, but my conclusion is based on entirely different economics than the logic used in the Wall Street Journal.

keywords: IRS, audit, assessment, penalty, dispute

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Copyright 2010 by Tony Novak. Originally produced and published for the "AskTony" column syndication prior to 2007. Edited and independently republished by the author in March 2010. All rights reserved.