A recent report by the IRS Oversight Board indicates that 64 percent of taxpayers fear being audited by the IRS. Should they? The following statistics were published by the Treasury Inspector General in its report released July 18, 2011.
The IRS is in place to uphold the integrity of, and ensure compliance with, our tax code. One of the agency’s goals is to reduce “the tax gap”—a term used to describe the shortage of what the government should be collecting versus what they are collecting. In the most recent available study, the IRS estimated the tax gap to be roughly $345 billion or 16 percent of the total taxes it was entitled to collect.
Much of the tax gap is the result of errors caused by the complexity of the tax code. Unfortunately, the tax code is not getting any easier; The American Recovery and Reinvestment Act of 2009 when combined with the Affordable Care Act represent the largest set of tax law changes in 20 years. Even without such significant tax revision acts, the constant and dynamic shifting of power in our government nurtures a complex and confusing tax code.
Although “down-sizing” has become common place in private business, the IRS is not following suit. IRS collection and enforcement personnel have grown by 19 percent since 2008 and more than 3,300 revenue agents and tax compliance officers were added in 2009 and 2010.
So what does this all mean for you? The answer is an increase in the number of IRS examinations. For example, during 2010:
Ø The number of individual examinations increased 23 percent from 2006 to 1 out of every 90 returns filed
Ø C corporation return examinations increased by 5 percent from the previous year to 1 out of every 72 returns filed
Ø S corporation return examinations decreased by 6 percent compared to 2009 to 1 of every 270 returns filed but have increased nearly 25 percent from 2006 to 2009
Examination rates were the highest over the past 5 years, and will likely increase due to fine tuning of the agency’s approach and increased efficiency of its recently hired agents.
The increase in investigations, along with the seemingly ‘no nonsense’ approach the IRS has been criticized for taking, has led to a significant increase in the use of various collection enforcement tools:
1) Liens are up 74 percent since 2006
2) Levies and seizures are up 4 percent compared to the fiscal year ended 2009.
So, with the increased number of examinations occurring, what should a business owner do if he or she receives a notice of examination?
1. Contact your professional tax advisor as soon as you have been notified of an examination. What you do not want to do is ignore the situation until the last minute. Once contacted, your tax advisor will likely prepare a power of attorney (POA) for the year in question. The POA will accomplish two things: a) it will allow your advisor to deal directly with the IRS on your behalf and b) it will enable your tax advisor to receive duplicate copies of correspondence the IRS issues pertaining to the examination. The POA will assist in limiting your involvement with many of the details of the examination.
2. Be prepared to provide substantiation in an organized manner. Since the “burden of proof” is on you, you should be prepared to provide documentation of deductions and positions taken on the tax returns. Supporting documentation and accurate accounting records, note agreements for loans between the company and related parties, and up-to-date corporate/business minutes documenting business decisions are just a few of the documents that will become the backbone for a solid defense. Having the information in a simple to understand format and making the examiner’s job easier never hurts.
3. Answer questions truthfully and be concise. When you are asked a question, answer the question truthfully and answer only the question that you have been asked. Going into long, elaborate answers on another subject can lead an examiner down a path that could prove to increase the scope of the examination. “Yes” and “no” are acceptable responses.
4. Don’t panic and play it cool. As noted earlier, there is a connotation of fear associated with an IRS examination. Examinations should be handled in a professional manner. Examiners are professionals too and they want to do their job efficiently and effectively. Being cantankerous will not get you far in the process and will likely make the situation more inconvenient and lengthy.
5. If you do not agree with the proposed adjustments, first discuss your concerns with the examiner to ensure that they are working with the correct facts. If there is still a disagreement, the next step should be to discuss the situation with the IRS manager that has been assigned to the case. Unfavorable changes can be appealed within the IRS, and at the appeals level, you deal with different people who take a fresh prospective. In each situation, you should consider the cost and benefit of continuing to further the disagreement.
It is expected that the IRS will continue to increase examinations and collection efforts into the future. With budget shortfalls and increasing debt requirements, the Treasury will continue to seek out taxpayer compliance as a means to raise revenue. The steps outlined above can be used as part of a strong defense if an examination is imminent. Will you be prepared if they come calling?
Content contributed by Bob Taylor, CPA, Partner with Potter & Company, P.A., a locally based certified public accounting firm offering core services of professional accounting, business consulting, and financial analysis. For more information, contact him at 704-662-3146 or visit www.gotopotter.com.