What to Do When the Taxman Cometh

by Gail Osten

Other than taxes themselves, nothing strikes terror in the hearts of taxpayers more than
the possibility of receiving a letter from the IRS—a Notice of Deficiency (NOD)—that signals an audit. If you've ever been in that situation, you know the gut-wrenching feeling.

Fact is, the audit rate has risen during the Bush Administration—and not just for millionaires' returns. Individuals with incomes exceeding $100,000 are roughly twice as likely to be approached by the taxman than people making less. Congress perceives that there's a huge tax gap and has charged the IRS with closing that gap through increased reporting standards and compliance.

According to Scott Singer, a tax principal for DiGiovine Hnilo Jordan + Johnson Ltd., a Naperville firm that's has been handling tax matters for clients for some 35 years, the exam activity has definitely ramped up and "in our opinion, is very adversarial."

Singer notes that wage earners with a regular paycheck aren't as likely to be audited as a sole proprietors or S-corporations, where the perception is that there may be money under the table not being reported.

The first thing to know if you receive a NOD is that, although intimidating, it does not mean that you're necessarily going to owe more taxes. The NOD is a proposal, and the "deficiency procedures" are the means by which a proposal is made. The IRS considers this a final offer, but you don't have to.

Take note of the amount of time you have to submit your "evidence" of compliance. Don't be late, yet know that it could take several months for IRS to get back to you. The NOD will indicate where the IRS believes the deficiency is, and you can send copies (certified mail) of any supporting receipts, canceled checks, etc., to the IRS center that has sent you this missile to prove you are in tax compliance. If you keep getting notices, don't have a stroke. It's a hurry-up-and-wait scenario. Remember, you do have the right to dispute an IRS notice without retribution, so don't be cowed. If you merely pay for the perceived deficiency without raising a stink, it may signal additional audits in years to come. ("Got a hot one with this guy, Harry. Let's audit him this year, too.")

If you are faced with the dreaded face-to-face audit, bring only the information you need to the meeting, rather than dragging extraneous documents that could potentially signal a new area of concern. At the interview, keep your answers short and to the point. Don't let them see you sweat.

Singer suggests that you have every document well organized, and know what the document standards are. "Reconstructing activity after the fact as compared with contemporaneously preparing documents at the time the expense was incurred," says Singer, "generates either good will or ill will on the examiner's part. It has a heavy bearing on how the exam will go. If they smell blood, they start circling. If it's straightforward, it makes the exam go faster and cleaner." He also emphasizes that you need to know your tax law as you can't depend on the IRS to tell you. "If you don't know the tax law, get a CPA involved, especially if the CPA has offered an opinion." Under the hot lights of IRS, you need to be prepared.

Often the biggest problems is determining if it's going to cost more to fight the IRS than just pay the tax, but consider this very carefully. You're swimming with the big fish, and you don't want to be the bait.