A few years ago, a young entrepreneurial couple started a home business. They were enthusiastic about their business, which involved personalized gifts. Most of their clients were within driving distance. So, for customer relationship building and speed of delivery, they delivered every possible client’s gift.
The IRS Comes Calling
When the notice came in the mail, the couple panicked. The announcement gave the date and location for their audit.
They collected and organized everything that related to their business. They had no idea what the auditor was looking for. Not knowing what was needed, they created an enormous pile of materials.
They had filed on time every year, following the rules precisely with their accountant overseeing the filing. They were afraid to ever ask for an extension. What could be the problem?
Thankfully, they had kept detailed records about their business, and went into the tax audit confident that they would be able to answer all of the auditor’s questions. However, things did not go exactly as they suspected.
Meeting the Auditor
Walking in the auditor’s small office was scary. But, she looked like a kindly grandma. As she started questioning, it seemed she was more like a shark. She seemed to take pleasure from the attack, but they answered each question as calmly and fearlessly as possible.
According to the auditor, both of them could not claim the mileage deduction for their deliveries. They explained that they both made deliveries in their vehicles. Since they had other jobs, whichever of them could make the delivery did.
As the meeting progressed, they wondered why the auditor was so ferocious about their small business, which had only made a few thousand dollars. They were doing everything they could, legitimately. They were accustomed to doing the right thing. A few weeks after the interview, the couple received the auditor’s disposition: she determined that they owed the IRS several hundred dollars, due to taking too large of a deduction for mileage.
Next Round Goes to …
The couple’s accountant advised them to contest the auditor’s decision, as they had followed IRS rules in taking the deductions. They scheduled another meeting to discuss the finding. While intimidated by the auditor, they remained calm, confident in the fact that were telling the truth and had their accountant’s assurance that the taxes had been filed correctly.
When the auditor refused to reconsider the disposition, the couple asked to schedule a meeting with their auditor’s supervisor. She did not appreciate that, as lower level auditors were generally told not to let things get kicked “upstairs.” Firm in their request, they did not back down. She said they’d hear from the IRS. Leaving the office, the couple heaved a sigh of relief, but also knew that they needed to have the meeting with the supervisor as soon as possible, because if the IRS upheld the auditor’s decision, additional interest would be piled on top of the amount they owed, which included penalties.
Still, they persisted in keeping a positive outlook. At some point, the husband was offered an out-of-state job. However, the looming audit left them questioning whether they could they move. After a few calls, they found out they could request the case be transferred to their new state. They requested the transfer, and took the new opportunity.
Patience and Persistence — the Name of the Game
Once settled in their new home, the couple decided not to continue their business in the new state. Still, though, they waited for word on the results of their appeal. Even though they no longer owned their business, there was always the unsettling threat of a new appointment with the IRS.
After months passed without any updates, they began making calls to find out what was happening. It took several weeks, but they finally reached someone in the local IRS office who knew about their case. “Oh, we dismissed that case some time ago,” said the IRS minion.
While initially frustrated by the lack of communication from the IRS, they eventually breathed a sigh of relief and were able to move on, confident in their compliance with the IRS.
What They Learned
This is just one example of a tax audit — and one that went well for the taxpayers. Not everyone has such a positive outcome, of course, but there is a lot we can learn from this frustrating and stressful experience.
- Adhere to IRS deadlines. By filing all your taxes, all extension requests, and other paperwork on time, you can avoid costly penalties. For example, filing tax extensions on time provides an automatic six-month extension without penalty, provided that you pay the estimated tax liability on time. Requesting an extension also does not increase your likelihood of an audit.
- Remain focused. Answer the auditor’s questions truthfully, but do not provide any more information than is asked for or that is necessary. Only bring documents pertaining to the year being audited, or that were specifically requested by the IRS.
- Involve your tax professional or accountant. He or she can answer questions that you may not be able to, and will be able to provide you with counsel and insights that can help improve the outcome. Most tax professionals will provide audit services free of charge as part of the fee for managing your taxes.
- Be honest. Be sure that you have the proper documentation to support your answers.
- Expect that you will have to pay something to the IRS after the audit. While there are cases in which taxpayers have been cleared of any wrongdoing (such as in this tale) or even received a refund, that is the exception rather than the rule. Typically, audits are conducted because the IRS believed that you underpaid your taxes, so it’s very likely that they will find something.
- Don’t hesitate to appeal. If you feel like the auditor has treated you unfairly — even if you are still in the middle of the meeting — you have the right to stop the meeting and request counsel or a tax pro. If you feel that the auditor was incorrect in his or her assessment, and you have documentation to prove it, then you can appeal the decision. Be tenacious, but also patient.
The good news is that audits are less likely than ever before. Thanks to IRS budget cuts, audit possibilities are about 1 in 120 households or 0.8 percent. There are certain red flags that can increase the likelihood of an audit, including owning a small business and taking mileage deductions, but if you are honest, maintain excellent records, and work with a tax pro, you should not have any trouble.
And if you do find yourself in line for an audit, don’t let it discourage you. Despite their troubles with the IRS, the couple started another business — and now they keep even better records, still tell the truth, and are persistent.