Preparing For An IRS Audit: Part Two

By Dr. Peter Ikre

Being audited by the Internal Revenue Service (IRS) is not the end of the world for the individual or business concerned. With the IRS taking a more aggressive posture concerning tax returns, the prevailing assumption is that the affected population will continue to grow in an exponential fashion. According to Rosenberg (2005), it is only a matter of time for a business to receive an audit notice from the IRS if it remains in operation long enough. The agency is under increasing pressure to narrow the tax gap (difference between government revenue and expenditure). It is believed that the deficit is due in part to unreported income or underpayment of taxes by small businesses (p. 236). The purpose of the prelude is to encourage individuals and businesses alike to develop a mind-set appreciative of the need to practice proper documentation of tax-related materials toward the annual tax filing exercise. Another rationale for the preamble is to alert taxpayers that there is a price to be paid for presenting questionable documents to the taxing body. In part one of this 3-part series, I promised to revisit the

controversy surrounding the necessity for representation during the audit process. 

There are several perspectives as to the relevance of having someone represent a taxpayer in the event of an IRS examination. Some contend that the cost-benefit of a do-it-yourself (DIY) approach may be detrimental to the overall interest of the taxpayer. DIY may work in certain situations requiring mail correspondence (aka correspondence audit) with the agency. However, simplicity of the process does not always guarantee success. Besides, the situation may change at any time from a correspondence audit to an office audit in which case you may need the service of a certified public accountant (CPA), attorney, or an enrolled agent (EA) for representation before the IRS. In a study to ascertain the significance of representation in IRS office audits, Nichols and Price (2004) observed that the tax deficiencies of taxpayers with representation reduced by an average of $1329 compared with those without representation. In addition, in percentage terms, the difference between the potential tax deficiency and the final or negotiated tax deficiency amounted to a 40% reduction. Nichols and Price (2004) concluded that having someone represent you (tax representation) in an office audit significantly reduced the final tax assessment both in dollar terms and as a percentage of the

potential deficiency. However, the investigators cautioned that taxpayers should perform a cost-benefit analysis to determine whether expected savings from representation outweighs the cost of hiring a professional (pp. 65-66).    

Finally, as part of the ongoing effort to enlighten the public, especially immigrant communities about taxation, henceforth, every presentation will feature a segment debunking misconceptions regarding tax issues. During the 2012 tax season, I encountered a single lady eager to maximize her refunds while doing so within the boundaries of the law. I applied all the tricks in the books but to no avail. She was left with a paltry refund due to her single filing status with a middle-income and no dependents. I told her that she was fortunate to have something back due to her Schedule E expenses (homeowner/rental expenses). While ruminating on the next line of action, I serendipitously inquired about her parents. She told me her father resided in a nursing home. Apparently, she takes care of him and spends a lot on his care. Up till my encounter with her, she never claimed him as a dependent. She attributed this to the fact that they did not live together. It is a myth to think that taxpayers cannot claim their parents as dependents because they do not live together. Parents do not have to live with their children to be claimed as dependents. Of course, you can claim your parents as dependents if

you live apart from them. In my client’s case, her status changed from single to head of household after claiming the dad. In the end, she got a well-deserved tax refund. She thanked me profusely for the turn-around. Next time, I will conclude this series on IRS audit with further insights from the business environment.

References

Nichols, N. B., & Price, J. E. (2004). Does representation matter in IRS

       office audits? The Journal of the American Taxation Association, 26(1),

       65-66. 

Rosenberg, E. (2005). Small business taxes made easy: How to increase your 

       deductions, reduce what you owe, and boost your profits (2nd ed.).

       New York: McGraw-Hill.

About the Author:

Dr. Peter Ikre has more than 25 years experience in Healthcare, Accounting, Taxation, Business Management and Financial Consulting both internationally and locally. Dr. Ikre is currently a tax expert and loan modification specialist at Investigroup.  He can be reached directly at 9083421160 (cell); 9083441806 (alt.); 9086884778 (ext. 106) – office; email: pikre@investigroup.org