Most individuals and small business owners think about taxes once a year sometime between February when tax documents come out and April 15. A letter from the Internal Revenue Service or the New York Department of Taxation and Finance often means the taxing agency has more questions and a tax audit could be following.
While audits are rather rare, the frequency increases with the more money earned. The IRS conducts approximately 76 percent through correspondence audits. The agency may be seeking additional information. Examples include documentation to support a large medical expense deduction or receipts to support business expenses for a LLC or DBA business using flow through taxation. An in-person audit usually only occurs for broader inquiries.
The New York agency lists some of the reasons for a state audit, which include:
- Failure to report sales or income or file a return
- Excessive credits claimed
- Misuse of exemption certificates
- Incorrect or fraudulent refund claims
- Differences found when comparing information from other sources such as the IRS, other businesses and employers
The state also commonly uses correspondence audits. Requests may relate to one or more returns filed in the previous three years.
Several tips apply for federal or state requests for more information or in-person audits.
Open the letter
A letter that gets lost in a pile of mail or sits unopened can make matters worse. Usually, the IRS asks for a response within 30 days. A deduction may be disallowed, if the proper documentation is not sent and then the IRS will attempt to collect on any additional taxes owed.
Gather documentation related to the request
Keeping tax-related documents for at least three years allows easy access if questions arise. The first step after reading the letter is to locate the pertinent documents. Replacing lost documents may be necessary. A lost receipt for a large contribution to the Red Cross or another charitable organization can often be replaced by contacting the organization.
Seek representation from an experienced advocate
From the tax audit through possible litigation, there are strict timelines. In a New York state case, for example, a party has 30 days from an administrative law judge determination to seek review by the Tax Appeals Tribunal. Retaining a New York tax appeals attorney for advice at the audit stage may avoid the need for a trial or appeal. If litigation becomes necessary, deadline compliance and strategy are important.
An IRS audit and investigation for the willful failure to file certain forms such as the Report of Foreign Bank and Financial Accounts (FBAR) can result in a felony charge that carries a maximum sentence of five years in prison and/or a fine up to $250,000. Even the negligence in failing to maintain business expense records can result in monetary penalties.