Everyone hopes to avoid a tax audit but sometimes it happens anyway. An audit always starts with a written notification by mail from the IRS, state, or local tax authority. It might just be triggered by a simple computer-generated “mismatch” error or it might be the beginning of one of the more rare types of audits. Here are the basics you need to know when you first receive an audit notice to get through it with minimal damage:
1) THIS IS NOT A DIY PROJECT: Hire a representative right away to respond to the first notice. Do not wait or ignore the notice. It almost never makes sense to answer the notice yourself. Too many times the taxpayer makes matters worse though their direct communication with the auditor who is trained to look for opportunities to expand the investigation. Hire an professional. In many cases the taxpayer either misunderstands the audit notice or does not make a connection with what triggered the action.
2) WHEN TO HIRE AN ACCOUNTANT: If you are sure that you have no criminal exposure; in other words you have not substantially unreported your income or deliberately taken fraudulent action; if this is likely only a matter of questioning the accounting and reporting, then hire a CPA or Enrolled Agent. Typically the taxpayer thinks they did nothing wrong but was unfamiliar with tax law or relied on bad information in reporting income. (Most audits fall into this category).
3) WHEN TO HIRE AN ATTORNEY: If you might have significant unreported income, if you know that you did something wrong or have potentially fraudulent positions on a tax return then hire a tax attorney. The attorney then hires the CPA or Enrolled Agent to handle the audit. This is important to preserve the attorney-client privilege and extend it to the accountant-client relationship. It is important to consider this question at the beginning of the audit work, not later when things get nasty.
4) CONFIDENTIALITY: The most common question asked in this situation is whether an accountant who discovers tax fraud is required to report it to the IRS or tax authority. The answer is NO, the accountant is required to report it to you. You are responsible for deciding what to do with that information.
5) STRESS MANAGEMENT: Tax audits can be long, expensive and stressful. In fact they can be life-altering. There are many cases where an audit distorts decision-making and disturbs other relationships. Discuss this with your representative so that you have communication on the personal as well as the technical aspects. The relationship you maintain with your representative, rather than the action of the tax authority, will have the most impact on minimizing your stress.
6) MANAGE EXPECTATIONS: Consider that stress is better managed if you have a realistic expectation of the time, cost and outcome of the tax audit. Don’t naively underestimate the impact. Update that expectation periodically as more information becomes available.
No matter how stressful the situation may get, there is “life after audit”. You just need to get to that place as quickly and painlessly as possible.