IRS Audits

For most people and most entities, their chances of being audited in any one year are probably only one percent or less.  However, if you are one of the lucky ones selected, the statistics no longer matter. It is now a dangerous reality, for several reasons.

First of all, the tax code throughout its thousands of pages contains many terms such as "intent", "primary purpose", "effect", etc.  Those are terms which we think refer to some thought process in your brain.  Wrong.  As far as the IRS is concerned, intent really means "what an auditor, when, as and if you are audited, decides your intent was, based on the paperwork he has in front of him at the moment".

The typical auditor often only takes about a minute or less to decide what your "real" intent (in his infallible opinion/judgment) was.  This means that preparation and organization on your part before the audit is critical, so that the auditor can accurately and immediately perceive the substance of the particular transaction being examined.  Being sure to document fully and unarguably the business reasons (as opposed to tax reasons) you entered into any transaction can, by itself, make a huge difference.

Since the IRS requires your information not only to be correct, but to be documented to its satisfaction, you are dealing in a de facto "guilty until proven innocent" environment, which is an unfamiliar world for many people.  Incomplete or sloppy documentation is often the main reason why taxpayers have to pay large amounts of additional taxes, interest and penalties.  It also often leads to the IRS agent expanding the audit to other entities and/or years – after all, you have proven yourself to be fertile territory.  The IRS’ stated audit function is not to correct tax returns.  It is to raise revenue.  Forget that at your peril.

I have gone through many audits with taxpayers where the preparation to audit ratio was greater than 10:1.  In other words, more than forty hours of preparation for a four hour audit.  When significant tax consequences are at stake, this kind of preparation is only wise, and fairly typical.

If one of your tax returns has been selected for audit, please do not take it lightly.  Many IRS auditors, especially revenue agents, are very good at sniffing out and raising issues that are not specifically asked about in the notices they send you.  The world has changed -- tax violations now often have criminal sanctions attached to them, so for many people an IRS audit is the closest they will ever come to going to jail.  I have taught classes on audits and audit preparation, and the feedback has been gratifying.  Consider letting me know if you have some concerns in this area.