What happens if your tax return gets audited, and you don’t like the results?
Are the results of a tax audit final? While a tax audit appeal is possible, the process is complex. Specific steps must be followed to the letter for the IRS or any state governmental tax authority to allow your appeal. In some cases, litigation may be the only option for getting an audit decision repealed.
Here's what to know about appealing a tax audit decision.
What to Expect from an IRS Tax Audit
Tax audits exist to find improprieties in tax filings. While some audits are triggered randomly, most are activated when a taxpayer claims a large number of charitable deductions, reports heavy losses on a Schedule C, deducts a high amount of business expenses, claims a home office deduction, or aggressively uses round numbers on a return. In some cases, simply operating a business in an industry with high amounts of tax fraud makes a business owner vulnerable. The takeaway is that taxpayers are simply at the whim of the IRS.
In addition to facing the IRS, California taxpayers must comply with three California taxing authorities called the California Department of Tax and Fee Administration (CDTFA), Employment Development Department (EDD), and Franchise Tax Board (FTB). The reason why a taxpayer's right to appeal an audit is so important is that an auditor is likely to find wrongdoing nestled within any tax return if they're willing to look hard enough. Yes, a tax agent can act like a dog with a bone when no obvious wrongdoings are present. This is where a taxpayer gets into a situation of being unfairly scrutinized.
What Happens During a Tax Audit?
During the process of a tax audit, an auditor will request access to financial records and receipts. This can include bank statements, payment receipts, accounts payable records, payroll records, and accounts receivable records. Auditors will also try to detect proof of unreported earnings by looking at a taxpayer's personal lifestyle and assets to detect “signs of wealth” that don't match up with income.
How Far Back Can Tax Audits Go?
While audits typically involve returns filed within the last three years, it's possible for the window to be expanded to six years if substantial errors are identified. Many taxpayers simply allow the auditor to take the lead. They also incorrectly assume that they have nothing to worry about because they've done nothing wrong. Taxpayers should know the following rights after being notified of an audit:
- A right to professional and courteous treatment by IRS employees.
- A right to privacy and confidentiality about tax matters.
- A right to know why the IRS is collecting information, how the IRS will use the information, and what will happen if the taxpayer fails to provide the information.
- A right to representation.
- A right to appeal.
After investigating your tax situation, an auditor will make a determination. Some audits result in a “no change” status. This means that the taxpayer has successfully substantiated all items that were reviewed during the audit. However, it's also possible that an auditor will determine that your financial records show that you failed to pay all that was owed on a tax return. When this happens, a taxpayer may be slapped with a tax bill with penalties.
More information here:
Should I Appeal My Tax Audit?
Auditors aren't infallible. If a taxpayer disagrees with the findings of an auditor, they have a right to formally disagree with the results by using an appeal. The essential reason to file an appeal is that a taxpayer feels that the results of an audit are inaccurate. In some cases, this inaccuracy comes down to a motive on the part of the agent to unfairly scrutinize a taxpayer to the point of inequity. Be prepared to bring strong tax arguments. Trying to “play word games” with the IRS is an easy way to end up with tax evasion charges. In fact, the IRS publishes a list of frivolous tax arguments to preempt unfounded justifications for why a person might claim they don't need to pay taxes.
But what’s the best way to determine whether your appeal has a chance of working out in your favor? A reputable tax attorney will not recommend pursuing an appeal unless:
- The law and the facts are on your side.
- Sufficient evidence exists to prove that the law and facts are on your side.
- It makes economic sense to fight the appeal. i.e., you will be better off financially taking on the fight.
More information here:
How to Appeal a Tax Audit
Taxpayers are legally entitled to appeal both state and federal audits. Once you've decided that you want to pursue the appeals process, this is the point where bringing in a tax lawyer to assess your options becomes important. Your legal counsel will advise you on how to file a tax court petition. What's even more important is that your legal counsel will be frank with you about the pros and cons of filing a petition based on the specifics of your appeal.
The IRS and California governmental tax authority both send formal assessments when audits are concluded (all states follow similar procedures in conducting an audit). These assessments outline audit findings, any additional taxes owed, and any imposed penalties. Put down the pen if you wish to appeal your findings! The first step to initiating an appeal is to not sign the audit report. After mailing back a federal audit report without a signature, taxpayers should receive a second letter called a “30-day letter” that provides them with 30 days to file a protest.
While individuals owing less than $2,500 can request a standard appeal, amounts over $2,500 require something called a small case request letter to be written to the IRS. Amounts over $25,000 require submission of IRS Form 12203. An experienced tax attorney is likely to advise you to take all three measures when owing any amount to reduce your chances of having your appeal disregarded. It's also possible that an IRS auditor may toss something called a 90-day statutory notice of deficiency your way. If this letter is received, it's essential to file a court petition within 90 days of receiving the letter to avoid having your appeal denied outright.
Auditors often bet on a taxpayer's confusion, lack of knowledge, and desire to avoid more stress when making unfair assessments. Those who do appeal often see significant reductions in taxes, penalties, and interest. Yes, there are also some risks that go along with appealing an audit. For instance, you could end up owing more in interest if a case is lost even though payment on the balance owed is suspended during the appeal process. Running through different scenarios that can play out after an appeal is filed with a tax lawyer can help you to make an informed decision.
Have you ever had to go through a tax audit? Did you appeal the findings? What was your experience like? Comment below!
[Editor's Note: David W. Klasing Esq. CPA M.S.-Tax is a dual-licensed California attorney and certified public accountant in the practice areas of taxation, estate planning, and business law. During his 20-year career, Klasing has used his extensive knowledge of federal and state tax codes to provide professional tax, accounting, and business consulting services for businesses and individuals. In addition to holding a Juris Doctor from Western State University College of Law, Klasing also holds a bachelor’s degree in business administration from California State University, Los Angeles and a master's degree in taxation from Golden Gate University. He is a former chair of the California State Bar Association. This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]