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Tax Audits: What to Do

If you get a letter from the federal or state IRS in the mail (which is the ONLY way the IRS will initially contact you), DO NOT PANIC.  Remain calm and proceed to your trusty tax advisor.

Step 1.  Read the letter.

IRS audits either begin as a request for more information to prove some sort of deduction or credit you claimed or income you excluded, or as a notice that your tax liability has been adjusted and how much you owe or are getting refunded.

You typically have 60 days to reply to the letter (depending on content and whether it’s federal or state).

Step 2.  Pass along requested information or something proving the original return was accurate.

You can either be represented by someone able to practice before the IRS (Enrolled Agent, Attorney, CPA), or you can represent yourself.  For the one you’ll send in your information and a power of attorney, for the other you’ll just send in your information.

Step 3. Appeal.

In my experience, IRS audits on people who don’t own large-ish to massive businesses with lots of moving parts and huge potential tax liabilities are hasty affairs, possibly ridden with mistakes.

For example, one state audit focused specifically on bond income that was mistakenly excluded from the state tax return.  The notification letter said the tax due plus interest was twice as high as what the client ultimately had to pay after appealing – though the client did owe tax on the amount incorrectly excluded, further examination revealed mathematical and other errors on the state’s calculation schedules.

The appeal highlighted the mistakes and resulted in a lower bill for the client.  Always have a tax person review IRS letters and advise on whether to appeal.

Step 4. Go from there.

Once you appeal, the IRS or state department of revenue will review and respond.  Much like the rest of the justice system, there’s multiple avenues and levels of appeals you can use if the first round doesn’t go your way.

How hard and how long you fight the IRS probably depends on how much money is at stake and how much your tax-person is charging for the work they’re doing.

REMEMBER: ‘Freak out’ is not one of the first four steps.  Maybe this is the millennial in me talking, but there are very few situations in which you have no options or no recourse.  Don't get me wrong, the IRS has the power to show up, take the shirt off your back, and then bill you for the difference later from debtors prison.  However, this isn't the typical scenario that plays out when you first get that audit letter.