Audit

[dmj4]

Prior to an audit of 2003 return, I received a letter from auditor wanting copies of 2001, 2002, and 2004 tax returns. I have read other tax preparers say to not give these past returns to the auditor. What experince do any of you have in this area?

The auditor is also wanting balance sheet, trial balance, profit/loss statement, and general ledger. I do not do the bookkeeping for this client. She does her books by hand on a general ledger, but does not have the other statements. I don't think we should generate these items just for the audit. What do you think?

[Armando Beaujolais]

Prior to an audit of 2003 return, I received a letter from auditor wanting copies of 2001, 2002, and 2004 tax returns. I have read other tax preparers say to not give these past returns to the auditor. What experince do any of you have in this area?

The auditor is also wanting balance sheet, trial balance, profit/loss statement, and general ledger. I do not do the bookkeeping for this client. She does her books by hand on a general ledger, but does not have the other statements. I don't think we should generate these items just for the audit. What do you think?

Auditors will ask for everything including the kitchen sink. Every audit I've ever experienced involved requests for documents that had absolutely zero use for verifying the items being audited. Give an agent a fish and he'll eat for a day, teach him how to fish, and...something like that.

It depends on whether you need to rely on the good graces of an auditor to allow legitimate deductions that might not have perfect verification. If your client's records are solid, there's no reason to grant open access to unrelated documents. If the IRS thinks there's anything wrong with other years, they can get the returns, it's just a hassle and takes some time.

However, if there's depreciation, or other items carrying over, you probably need to produce those other documents to verify the tax year in question.

I do not take those off-year returns to an IRS audit, and do not have them on the premises when there's a field audit. If the returns get turned over, it's last in the process. For example, in my last audit the people were honest, the revenue agent knew that, and she accepted verbal testimony for verification of a few thousand dollars worth of deductions because the taxpayer didn't have good documentation. In that case I recommended that my client turn over the prior and future year returns to stay in the auditor's good graces.

In another case they were auditing a dependency exemption for year X and wanted years W, Y and Z returns to look at. It was presented by the agent as a demand, which is what they do. It was ridiculous, it got nearly ugly, but I stood my ground on behalf of my client. The agent knew the demand was baseless, and eventually allowed the dependency exemption with no changes.

As far as all the financial statements, that depends on what they're auditing. If they're auditing a Schedule C and demanding all that junk, I'd be inclined to take an entirely adversarial posture, depending on the strength of the client's documentation.

Just remember that revenue agents are accustomed to people bowing down to them like sheep and jumping when they say jump. Expect some discomfort if you're not going to give in to their whims. And also make sure it's ulimately your client's decision as to what approach to take. Just don't be foolish enough to think that agents are on your client's side, no matter how nonchalant the request for irrelevant information is.

[jainen]

Schedule C

Schedule C is a P&L statement, and many businesses don't need monthly or quarterly accounting. The balance sheet and trial balance are not source documents and you can argue they shouldn't count for much proof of any item. It is reasonable to ask the examiner exactly what is being questioned. If she won't tell you ahead of time then the file may have to stay open after the interview, always a powerful negotiating point for you. I think the IRS doesn't try for hobby loss very often, but if that is the issue then of course you will have to generate more records to show the activity was run in a business-like manner.

[dmj4]

Thanks, not hobby loss.

They do not have a hobby loss, they have a profit. I think the problem is that they have two businesses with high gross receipts and high expenses. The audit is for 2003. One of the businesses started on Jan. 1, 2002 and the other one started in Nov. 2002. The 2003 return was the 2nd year for both businesses and both did have a profit.

IRS has asked for :
1. copies of 2001, 2002, 2004 returns
2. preparer worksheets used in 2003 return.
3. balance sheet, trial balance, P/L, ledger
4. copies of employment returns and 1099's
5. bank statements thru Jan of the following year and documentation of all non-taxable
deposits made.
6. Gross receipts for both businesses
7. Cost of goods sold, beginning and ending inventory records, receipts for purchases
8. receipts for other expenses for both businesses
9. Depreciation Schedules

Except for the before and after tax returns nothing on this list seems unreasonable to me. This is a field audit. I have never had one of those. What can we expect? I assume she will be looking around for the assets and business practices. I also assume she will be trying to get the clients to talk too much by being extremely nice and complimentary of their set-up. She will be trying to get them to think she is so nice. I wish I could send them out of town, but they have two businesses to run.

The only other audit I have had, I was very cooperative with everything in the initial interview. Then when the auditor sent out the list of changes, with a tax bill, we disagreed about those. She called me everyday for a week and we argued back and forth. I sent her the IRS Code so she had to give up the fight. The only change she made was decreasing the vehicle use % (only thing she could find). We still got a refund due to changes I found prior to the audit, while checking the clients bookkeeping. I guess in that audit, I let the auditor underestimate me in the beginning. I didn't put up a fight until it was needed.
This audit is not going to be that easy. The nature of these businesses will provide much more chance of surprises.

Do they match the auditors up with the tax preparer. For instance, now that I have my EA is there less chance of getting an inexperienced auditor?

[jainen]

who do you think

It's not unreasonable to ask for your depreciation schedules and other preparer worksheets? Just who do you think is the subject of this audit? And this assumption that the IRS is very interested in your client's business "practices"--is that based on anything specific? You need to do quite a bit of prep work before you expose your client to inexperienced representation.

[dmj4]

Jainen..please, pass the sugar.

Hey Jainen,

Thanks, for your response to my question. You have a great deal of knowledge and I appreciate you sharing it.

What did you do on your first or second audit? Did you send the client to someone else because you felt that you were exposing the client to "inexperienced representation"? How did you ever gain your experience? I am doing "prep work" by attempting to gain insight from people like you, who have something to offer. Of course, that is not the only "prep work" I am doing.

I don't think it is at all unreasonable for the IRS to ask for the depreciation schedules or the worksheets like EIC. They did that with the other audit I went on. If this seems unreasonable to you, maybe it is just something the IRS does in my area that they may not do in your area. They want to see what assets comprise the deduction on the depreciation line as expense.

Why would I NOT assume that the IRS is going to be interested in their "business practices" and everything else, when this is a field audit. Besides, that statement was in a paragraph of questions regarding what to expect, besides the obvious. I was trying to determine what "tricks" might be in the IRS bag.

Your tax knowledge is impressive. However, from time to time a little sugar would be nice to go with that vinegar of yours. Thanks again.

[jainen]

Sugar

Like many accountants and enrolled agents, I wish we could work co-operatively with the IRS in supporting the tax system. It is the IRS that sets the adversarial tone. Certainly they can and should question anything that has internal inconsistency or is out of line with industry standards or is otherwise problematic. They do NOT have the right to go "looking around." I would be pretty worried about that chance of surprise you mention, so remember that you probably don't need to allow the examiner on the business premises.

You are joking about the EIC worksheet, right? First of all, it is a required form, but its purpose is to show that YOU did your job, not the taxpayer's eligibility which if audited needs to be proven with client records. Anyway if the audit is about businesses, then let's not get distracted by personal credits. Do your worksheets contain facts not supported by client records?

I don't do sugar much, it is true. Not because of sour vinegar, though. It's the bitter herbs.

[Snaggletooth]

Laundry List

Reviewing the "list" of things IRS has asked for:

1) 2001,2002,and 2004 returns. This is within the statute of limitations, and just
be prepared that anything they find "wrong" with the 2003 return, they will be
looking for the same type violations for their other years.
2) Your worksheets. You may have a misconception here -- they are not looking
for EIC worksheets, phase-out worksheets, SE tax worksheets, etc. They are
looking for extremely private records that YOU used to convert the client's data into
the tax returns. MAKE THEM TELL YOU WHAT LINE ITEMS are causing them
grief, and address those. Do not give them your private records carte blanc.
This is NOT reasonable.
3) Financial Statements. It's possible your client did not pay a CPA or accountant to
prepare Financial Statements. The Schedule C, or 1120, 1120S, etc. might be the
closest thing to Financial Statements that has been published. Again, make them
tell you what line items are causing the grief. Don't give them a hunting license to
chase just anything.
4) Employment Tax returns. They already have this information, and it's a certainty that
wage and tax deductions will be among the line items to be examined, so I would
have them ready.
5) Bank Statements? They can subpoena them, and I wouldn't resist here. As part of
your preparedness, you should review deposits which are not business receipts. This
is a big problem, since with a proprietorship, money often sloshes back and forth
between personal accounts and business accounts in no orderly fashion. Deposits
and disbursements often get transacted out of whichever account has money in it, and
I argue with my customers all the time not to do this. This will be a good lesson for
your client, and I wish some of my clientele had learned it years ago.
6) Gross Receipts from Both Businesses. This is almost universal they ask for this, so
don't resist. They will be looking for unreported income here, and the best practice is
for orderly banking (see #5 above) to be done in concert with adding machine tapes or
sequentially-numbered receipts.
7) Record of Purchases, and methodology for Cost of Goods Sold deduction. As part of
your preparedness, each purchase charged to purchases should have an invoice from
a vendor. If 2003 is being audited, they can easily look into the first few transactions
of 2004 to determine whether the physical inventory has been shortchanged.
8) Receipts for "other" expenses. I would tell the auditor he needs to be specific about
which "other" expenses are causing him grief, and be prepared to find supporting
invoices AFTER he has been specific.
9) Depreciation. Perfectly logical request here, as this should be supported by a list of
fixed assets. Anyone depreciating without such a list actually DESERVES to be
written up by an auditor, in my opinion.

In summation, I would balk on #2, #3, and #8. And absolutely #2 -- you should insist on
a subpoena before making this available to you.

Thought I would settle on specific answers to your questions. We get a little anxious to sound off on this board, and in so doing, fail to directly address the questions.

Good luck on your audit,

Ron Jordan

[dmj4]

Jainen and Ron

Jainen, yes I was joking about the EIC worksheet. The fact is, in this case, the EIC, and depreciation worksheets are the only two worksheets I have in my file. I do not do their bookkeeping, only their tax return. They sit with me and give me the figures and I put them on the return. They leave a few hours later with the return completed. The auditor has already stated that she will tour the facility on the first or second day. I thought the IRS has the right to do that. Is there any way that I can actually stop her from doing that?
Thanks again for your help, it is definitely worth the herbs!

They do not have P/L or balance sheet. He did get quite a few loans in 2003, but he says he did not have to have those items prepared for the loans. These are both Sch C businesses. Sorry, I keep forgetting to include that information.

Ron, I do appreciate your line by line reference and the time it took for you to list it. I care a great deal about not being blindsided in this audit. I care about the outcome for these clients, as with all my clients. Because I don't do their accounting, it seems that my potential for error will be decreased. I feel that my contribution to these clients, in this audit, is to make sure that the IRS follows the tax laws and not allow IRS access to things they are not entitled to, help them see what changes could come about based on any mistakes they may find in their own records, and not allow the IRS to intimidate them.

They are in the process of matching deposits in all their accounts and going back through all their records to make sure the line items IRS has requested match. They are also looking for any errors they may have made in adding and posting.

My clients are similar to your clients. Most are decent hardworking Tennesseans that have been coming to me since I started my business. In many cases I am doing the returns of all the family members. I grow through word of mouth.

Thanks again.

[geekgirldany]

Audit

My client's S-Corp audit is still not closed. I felt it was best for them to have a CPA represent them because I dont' have my EA yet and the client did not want to be there during the audit. I posted a thread about this awhile back.

As Ron states I believe they can ask for tax returns. Atleast two years forward and two years back. The auditor also asked me for any work papers I used to prepare their taxes. The only thing I had was a amortization schedules for their loans. So I gave them that. They did their own bookkeeping too.

As far as a tour of their work place. That is pretty common and should be allowed. I think if you try to fight it that it could make things a little too tense. Especially in the beginning of the audit. I wouldn't let the auditor go to their house. This one on my client was going too until I stopped it.

I'm proud that you stood your ground on your first audit.

[Mark Goldberg]

My thoughts

First, let me give credit to Ron. Your answer was very thorough. I suggest you do not bring the 2001, 02 and 04 returns to the first meeting. Save this for later. If all goes well you won't need them and if things go poorly then unless you can dance like Ali you will have to produce them. As for the visit to the taxpayers place of business the examiner is required to do this. However, I would not conduct any part of the exam there. If going over records needs to be done either do this in your office or the IRS office. Then the visit to the place of business will be a short walk through.

[jainen]

Tell me

Tell me what law or regulation requires the IRS to inspect business premises. The auditor must make reasonable accommodation for the taxpayer's convenience, which could well mean a different location such as a legal or accounting office, for example. Even if they want to audit "everything," that still only applies to the tax return itself and the taxpayer can decide how to support it. If the IRS has other information to investigate, they can develop that on their own. Of course, it is often in the taxpayer's best interest to do it the IRS way, but it isn't automatic.

[Snaggletooth]

Place of Business

Jainen, I believe they can eventually inspect a place of business, but not without a writ from the Treasury Dept, which they CAN get. I wouldn't think it to be in the taxpayers best interest to refuse to let them visit, simply because you don't want them to get arrogant about this audit. Better spoken, even more arrogant than they already are. I think if they were convinced the records were not at the place of business, they wouldn't want to waste time making an extra trip out there.

Warning to dmj4: auditors sent outside the IRS office to inspect something are usually looking for something in particular, and are MUCH MUCH sharper and arrogant than those who stay back at the office.

From the outset of this post, I haven't liked the direction this audit is headed. The "acid test" of what to provide an auditor should be a direct response to his questions with what we feel necessary for the auditor to do his job. We should understand what the auditor needs, and provide that very directly and punctually. The auditor should be very appreciative of us supporting his requests in a timely manner so he can then close out the audit and move on to someone else. Trust me, he DOES want to do this. Or at least he should.

However, for this audit, it sounds like the auditor has not been specific about what is to be examined. They seem to want EVERYTHING. There are two possibilities I think: 1) they want your client to voluntary expose every element, and they want you to assist them (rather than your client) to bring this about, OR 2) they are looking for something far beyond a routine audit -- possibly something criminal or fraudulent.

Again, good luck. Maybe some of the old pros can contribute further. Jainen may bring the vinegar, but everytime he posts, he gives you good subject matter to heed.

[dyne]

IRS Audits

For more than a quarter of a century IRS has stressed to it's Auditors and Agents that their
job is to examine the TAXPAYER, not the tax return. I believe that the Internal Revenue Manual
states that prior and subsequent year tax returns be inspected if the auditor or agent has reason to
suspect an adjustment may be necessary. Resisting furnishing these return copies will not endear you to the examiner.

[Armando Beaujolais]

The "acid test" of what to provide an auditor should be a direct response to his questions with what we feel necessary for the auditor to do his job. We should understand what the auditor needs, and provide that very directly and punctually. The auditor should be very appreciative of us supporting his requests in a timely manner so he can then close out the audit and move on to someone else. Trust me, he DOES want to do this. Or at least he should.

I disagree. The acid test for the representative should be whether the action helps the client, not the auditor.

It's naive to think the auditor's interest and the taxpayer's interests are one in the same.

While you're bending over backwards worrying about the auditor's job and "needs," who's looking out for the interests of your client?

That having been said, I am curious about the client's situation. Two businesses with employees, plant and equipment, income statements and balance sheets, professional bookkeepers or accountants, and we're talking about EIC here? I'm not saying it couldn't happen, it just seems like it would have to be the perfect storm to have all that financial activity and out of two business still be under the EIC max.

Job one should be to find out if there are any discrepancies in the client's records or tax reporting. Then you can decide if you want to lay down for the auditor or take an adversarial position in an adversarial situation on behalf of your client.