How to Survive an I.R.S. Tax Audit

Every taxpayer or business fears getting a letter from the I.R.S. announcing it has been chosen for a tax audit. This article explains a few critical things to remember during the course of an audit to survive with the least financial pain and with the least mental anguish.

My belief and practice is to always start a tax audit with professional courtesy and to comply with all revenue agent requests that are reasonable and legal. Sadly, many revenue agents engage in abusive and/or illegal behavior. When this happens my belief and practice is to swiftly put an end to all abusive behavior, and where appropriate, to punish the revenue agent by exposing abusive behavior to the appropriate I.R.S. managers.

Many taxpayers and business people think that challenging abusive revenue agent behavior will result in retaliation and a larger tax bill. Although this belief is pervasive, it rarely is true. Years of experience have confirmed my belief that the more a taxpayer fights the system, the less additional tax the taxpayer will pay as a result of an audit. Now let's discuss how to survive a tax audit.

1. Never Speak Directly with the Revenue Agent

Revenue agents always ask to speak directly with the taxpayer and seek to do so before the taxpayer has hired a lawyer or other representative. This is part of the revenue agent's intentional plan to get more tax dollars. A taxpayer has nothing to gain and everything to lose by talking directly to a revenue agent. Let your hired representative do the talking. Never forget that revenue agents are trained to elicit harmful taxpayer statements that are then used against the taxpayer to assert more tax, interest, and penalties are due.

Resist the urge to "come clean" with the I.R.S. Taxpayers often wrongly think that by consenting to interviews and answering revenue agent questions directly, the revenue agent will be kinder, gentler, and will not be as aggressive. This is usually a fatal mistake and often results in a larger tax bill. The more a taxpayer speaks to a revenue agent the more money he or she typically ends up paying to the I.R.S. A lot can be learned from that large fish on the wall of your friend's office. Ask yourself what every fish on the wall has in common - the answer is an open mouth - don't suffer the same fate as the fish on the wall.

2. Never Fall Victim To A Revenue Agent's Favorite Dirty Trick - An Administrative Summons

An administrative summons is a procedure the I.R.S. uses (often illegally) to obtain testimony, to obtain records, and to obtain other information. Revenue agents are legally entitled to reasonably examine a taxpayer's records to determine if the tax reported on the income tax return is correct. As long as their requests stay within the limits of law, within the limits of their Internal Revenue Manual (the I.R.S. policy manual), and are reasonable, there is no need for the I.R.S. to use an administrative summons. Too often, revenue agents illegally use an administrative summons as a dirty trick to scare the taxpayer into consenting to an interview. The law says that taxpayers are allowed to have representatives and do not have to speak to revenue agents.

Here Is What To Do. Where the revenue agent improperly uses an administrative summons, I routinely tell the revenue agent the administrative summons is illegal and I will not comply with it. I do this because I know that an administrative summons is not self enforcing - meaning, the revenue agent has no power to enforce it. If the revenue agent wishes to enforce the administrative summons, he or she must first get manager approval, and second convince an assistant United States attorney to file petition in the United States District Court seeking a judge's order to comply with the administrative summons - an extremely rare occurrence. Even in the rare occurrence where an assistant United States attorney does file a petition for enforcement, the taxpayer will have the opportunity to argue in Court why the administrative summons is illegal and should not be enforced. In other words, it takes a United States District Court judge's order to make an administrative summons legally enforceable - which almost never happens. Thus, never fear an administrative summons when you have sufficiently provided the I.R.S. with the information it is entitled. It is also important to punish revenue agents that wrongly serve an administrative summons on taxpayers - this helps to keep them in line for the rest of the audit.

3. Do Not Consent To An Extension Of Time To Legally Charge Additional Tax.

Generally, the I.R.S. has three years from the filing of a tax return to charge additional tax, interest, and penalties (called the statute of limitation on assessment). Because most audits start about 18 months after a tax return is filed, and because audits tend to take a long time, the I.R.S. usually asks for an extension of time to charge additional tax, interest, and penalties if the three year statute of limitation on assessment is less than six months away. Although many tax practitioners advise taxpayers to sign an extension of time to give the I.R.S. more time to audit and charge more tax, interest, and penalty, I think it generally is a huge mistake to do so.

The prevailing, though flawed view, is that if a taxpayer does not agree to extend the statute of limitation on assessment, the I.R.S. will issue a 90-day letter (see section five for an explanation of what this is) and the taxpayer will be forced to either seek settlement with the I.R.S.'s administrative appeals division or file a petition in the United States Tax Court. First of all, why give the I.R.S. more time to make your life miserable? Don't - it is better to get rid of the revenue agent and end the audit. More importantly, it is better procedurally to force the I.R.S. into taking a formal written position in its 90-day letter (explained below)
which it will do just before the statute of limitations on assessment expires.

Thereafter, a good lawyer will settle the case long before it would be necessary to litigate the case in the United States Tax Court. This is true because (1) the I.R.S.'s administrative appeals division's marching orders are "settle the case", and (2) if a United States Tax Court petition is filed, the I.R.S.'s lawyers (called district counsel) are short staffed, hate to work past 5:00 pm, and hate even more to argue a case in Court - thus, a good lawyer can settle 99% of all cases after a United States Tax Court case is filed. So tell the I.R.S. "NO" when it asks for an extension of the statute of limitation on assessment.

4. Never Forget The Revenue Agent Has No Power To Charge Additional Tax, Interest, And Penalties.

Revenue agents often brag about the all the "power" they have to charge additional tax, interest, and penalties. I have heard many brag "I usually get at least $50,000 of additional tax per audit." The fact is that revenue agents have no power to charge or collect any amount of additional tax, interest, and penalties. They usually get more tax out of taxpayers by abusive behavior and by bluffing the taxpayer into settling an issue that any good lawyer could defeat in appeals or in U.S. Tax Court.

A revenue agent has no power to charge additional tax without the taxpayer's consent, without the taxpayer's representative's consent, and before a judge orders that additional tax, interest, and penalties are due. When revenue agents threaten huge tax bills against my clients, I remind the revenue agent that all he or she can do is to offer their opinion on what additional tax is due - in other words I tell the revenue agent he or she has no power and they can forget about bluffing me, and in effect, my client. At the conclusion of an audit where the taxpayer disagrees with the revenue agent's "proposed" tax bill, the taxpayer can continue to fight and most often obtain a much more reasonable settlement by continuing to fight the system. When the taxpayer will not agree with the revenue agent's "proposed" tax bill, the revenue agent is forced to write up a report on what he or she thinks the additional tax should be, and mail a 90-day letter [explained below]. Thereafter, the revenue agent is off the case for good - they have no power.

5. If You Want To Pay Less Tax Than The Revenue Agent Asks For After The Audit Concludes, Then Fight On --The Most Common Result Is You Pay Much Less.

A taxpayer almost always pays much less tax, interest, and penalties when the taxpayer (a) disagrees with the revenue agent's "proposed" changes resulting from an audit, (b) then attempts to settle with a more reasonable I.R.S. appeals officer, and (c) sues the I.R.S. in the United States Tax Court if no settlement can be reached at the administrative appeals level.


Briefly, here is the typical procedural steps in an audit: (1) the I.R.S. selects a taxpayer's income tax return for audit, (2) the audit concludes, (3) the revenue agent proposes changes and asks for a certain amount of additional tax, interest, and penalties, (4) the taxpayer disagrees with the revenue agent's proposal, (5) the revenue agent mails a 90-day letter called a Notice Of Deficiency, (6) within 90 days, the taxpayer either settles the case with an a I.R.S. administrative appeals settlement officer, or alternatively, files a petition in the United States Tax Court (suing the I.R.S.), and (7) long before there is the need to litigate the case in the United States Tax Court, the government will settle over 99% of petitions filed. I always tell my clients that the more they fight the system, the less they will typically pay. Why? - because the I.R.S. hates to litigate cases and would rather concede audit issues in favor of the taxpayer than litigate the case in Court.

Throughout the entire process - audit - disagreement - administrative appeals - filing a United States Tax Court Petition - then arguing with district counsel, the taxpayer can make as many offers to settle as desired way before the need to litigate in Court ever arises. The end result - the taxpayer almost always saves a lot of money. Give the I.R.S. a hell of a fight - and they will almost always concede!