Don't Let Tax Audits Shake You Up

[Retired To Win]

I have gone through 3 tax audits-by-mail in the last 12 years.  And based on those experiences, here is my challenge to you: don't let a tax audit shake you up*.

In my first audit, the agency challenged the taking of an IRA contribution deduction based on the contention that one couldn't make contributions in the same year to both a 401(k) and an IRA.  But that was not quite so.  In certain situations, you could.  And I submitted documents to show that this was indeed my situation.  Case closed.

I can't remember right now what the second audit-by-mail was about, but I resolved that one too.

Six weeks ago, here they were again asking for another $2991 on our 2012 tax report based on the contention that we had a bunch of unreported but taxable income from limited partnerships in which we owned shares.  Again, not quite so.  I responded that all those shares were owned by our IRAs, and not by us as individuals and that therefore the income from those partnerships did not belong on our individual tax reports and no additional tax is due.  I just got their reply back: send us copies of the K-1 forms showing the shares were owned by the IRAs and we'll "finish processing the file."  Piece of cake.

Just so you'll know: my first reaction upon seeing the IRS return address on the initial envelope is always concern, my second reaction upon reading the first paragraph of the letter is always alarm, and the third reaction when I finish reading through the letter is a semi-scornful shake of the head.  There's always a leap to an unwarranted conclusion, there's never any real research into the situation, and there's always a guilty-until-proven-innocent approach.  But don't let that throw you.

If you are right, stand up for yourself.  If you aren't sure, do the research that the agency has left undone and you may very well find a solution (like I did with the IRA contribution case).  Just one thing:  make sure you keep ALL your records and worksheets -- and even scratchsheets --  for at least 8 years.

And don't let them shake you up!

Anyone else have a similar war story to tell?

*but bear in mind that I am not a tax professional and I am not giving tax advice here.  :O

[Rural]

I had one very similar; just took a letter quoting their own rules back to them.

[Cpa Cat]

I have been through three audits personally and more than a few professionally, as audit support. I've honestly never encountered a "by mail" audit that was a big deal.

I've had one office audit where during the interview, the IRS auditor got a bit beligerent with the taxpayer and the taxpayer responded with something along the lines of "I wouldn't expect a civil servant like you to understand our business practices - it's obviously above your paygrade."

Never do that.

The auditor was pissed. The lawyer ended the interview early because the auditor was so angry. The incident did little to establish cordial relations.

[Gin1984]

I have been through three audits personally and more than a few professionally, as audit support. I've honestly never encountered a "by mail" audit that was a big deal.

I've had one office audit where during the interview, the IRS auditor got a bit beligerent with the taxpayer and the taxpayer responded with something along the lines of "I wouldn't expect a civil servant like you to understand our business practices - it's obviously above your paygrade."

Never do that.

The auditor was pissed. The lawyer ended the interview early because the auditor was so angry. The incident did little to establish cordial relations.

I understand that must have caused issues but that is hilarious.  Was the taxpayer right though?

[Cpa Cat]

I've had one office audit where during the interview, the IRS auditor got a bit beligerent with the taxpayer and the taxpayer responded with something along the lines of "I wouldn't expect a civil servant like you to understand our business practices - it's obviously above your paygrade."

Never do that.

I understand that must have caused issues but that is hilarious.  Was the taxpayer right though?

Actually, yes. It was eventually moved up the ladder to a senior auditor who had a better handle on the issues.

But not before our junior auditor caused a headache by making it her mission to aggravate the taxpayer. He received so many demands for additional information that he filled two of those big 3 inch binder with the letters. Many of them were duplicates, because she would repeatedly ask for the same information.

[Gin1984]

I've had one office audit where during the interview, the IRS auditor got a bit beligerent with the taxpayer and the taxpayer responded with something along the lines of "I wouldn't expect a civil servant like you to understand our business practices - it's obviously above your paygrade."

Never do that.

I understand that must have caused issues but that is hilarious.  Was the taxpayer right though?

Actually, yes. It was eventually moved up the ladder to a senior auditor who had a better handle on the issues.

But not before our junior auditor caused a headache by making it her mission to aggravate the taxpayer. He received so many demands for additional information that he filled two of those big 3 inch binder with the letters. Many of them were duplicates, because she would repeatedly ask for the same information.

Ok, I am even more amused now.  Was her behavior ever reported/punished because of duplication?

[Cpa Cat]

I understand that must have caused issues but that is hilarious.  Was the taxpayer right though?

Actually, yes. It was eventually moved up the ladder to a senior auditor who had a better handle on the issues.

But not before our junior auditor caused a headache by making it her mission to aggravate the taxpayer. He received so many demands for additional information that he filled two of those big 3 inch binder with the letters. Many of them were duplicates, because she would repeatedly ask for the same information.

Ok, I am even more amused now.  Was her behavior ever reported/punished because of duplication?

The attorney told the taxpayer to keep all of the letters (hence the binders) so that they could decide whether or not to pursue the matter after the audit was finished.

It took awhile for the audit to get escalated to the correct person, and when it did, that auditor asked for all of the information again because NOTHING was on file. Of course, the reaction to that was "WTF, we've sent everything right down to a blood sample - in triplicate! Go ask the original auditor for it!" It turns out that she had quit her job - I'm guessing she wasn't cut out to be an auditor. 

The items that had been sent to her were not found.

Once it was over, it just kind of ended up being a funny story and no one addressed it formally.

[jennifer.rowecassiman]

We got a letter last year. I had made a lump deposit of $20k to my taxable account that paid $150 in dividends a few years ago. The IRS letter stated I needed to pay taxes on the $20k, when really I just needed to pay taxes on the $150 (I forgot to claim). Wrote them back and they dropped it.


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[oldtoyota]

The IRS said I did not have a child and owed them money for the deduction I had received. I told them they were incorrect. Case closed.

[brooklynmoney]

I had a mail audit a few years ago. They thought I had unreported foreign income from a foreign mission/embassy. It took FOREVER to gather all the ridiculous paperwork they were after (there was of course no unreported income  it was totally ridiculous that they would even think there'd be any). In the process of reviewing my return for the foreign income issue they had found another "issue" with a business expense that ultimately I just gave up fighting because responding to the original request took so long and my CPA charges about $200 an hour and he said it wasn't worth it for me to hire him to fight it because the amount I would owe would be less than what I would have to pay him. So mostly I was mad that I received such a stupid request and then exasperated with the amount of work/time I had to spend responding to said request. I was never really worried during the process.

[Retired To Win]

I had a mail audit a few years ago. They thought I had unreported foreign income from a foreign mission/embassy. It took FOREVER to gather all the ridiculous paperwork they were after... In the process of reviewing my return for the foreign income issue they had found another "issue" with a business expense that ultimately I just gave up fighting because responding to the original request took so long and my CPA charges about $200 an hour...

I am thankful that I have always been able to handle these things myself by investing some time into researching the IRS regulations that have applied to each particular situation.  (The "search" box on the IRS site works pretty well.)  It's partly my nature, and it's partly that I am not paying anybody $200 an hour for anything unless I absolutely positively can't do it myself.

It's also helped me a lot that I keep those darn tax records for a long time, and I keep them organized.  This recent go-around with the IRS on my 2012 return would have been a bitch to tackle in terms of gathering the documentation they wanted.  Except that I already had ALL of it in my 2012 tax return file.

Yippee!

[Beridian]

In 2012 my (now ex) wife took an early 401k distribution and did not tell me.  So we underpaid and under-reported income.  We paid the difference promptly once I was alerted to problem.  Ever since then I have been on the IRS shit list.  The following year the ex took a Roth IRA distribution as part of the divorce settlement.  It took several exchanges of letters to prove to the IRS that the IRA was a Roth and was not subject to penalty or counted as income.   The following year they questioned my credit for college tuition.  I sent them the 1098 from my school.  Not good enough, I had to actually get the admission forms and credit card statement to prove that I actually paid the tuition (we are talking about a few hundred bucks here, probably cost the IRS more to investigate it than it was worth).

So anyway it now appears that my IRS record has an asterisk next to my name and I look forward to many more years of close scrutiny.  Oh-well, all I can do is keep excellent records and play along.  If you can prove your case they back down.

[JLee]

This thread scares me because I have terrible tax records.

I also haven't done anything complicated....but still. I'll have to make sure to keep everything I get just in case. I wasn't aware they bothered with auditing for a few dollars in tax - amazing they have that much time on their hands.

[Retired To Win]

This thread scares me because I have terrible tax records.

I also haven't done anything complicated....but still. I'll have to make sure to keep everything I get just in case. I wasn't aware they bothered with auditing for a few dollars in tax - amazing they have that much time on their hands.

It's not about a "few dollars," my friend.  This last go-around, they wanted almost $3000.  Even the first time they came at me, when all that was in question was an IRA contribution, they wanted $1250 plus.  You gotta remember that when they come at you for more money, you are being affected at the top tier of your personal income tax rate.

[beltim]

This thread scares me because I have terrible tax records.

I also haven't done anything complicated....but still. I'll have to make sure to keep everything I get just in case. I wasn't aware they bothered with auditing for a few dollars in tax - amazing they have that much time on their hands.

If you do the math, the roughly 200,000 fewer audits the IRS plans to do the year, and corresponding $2 billion in additional uncollected taxes, means that the average audit that they won't do would bring in about $10,000.
http://money.cnn.com/2015/01/15/pf/taxes/irs-tax-audits/

[beltim]

Oh, here's more direct data: in 2013, the IRS did about 1.4 million audits and recovered $53 billion in revenue.  So that's about $38,000 per return.

http://www.irs.gov/PUP/newsroom/FY%202013%20Enforcement%20and%20Service%20Results%20--%20WEB.pdf

And the higher your income, the more likely you are to be audited.

[Rural]

And the higher your income, the more likely you are to be audited.

Guess I'm safe, then. :-)

[Retired To Win]

And the higher your income, the more likely you are to be audited.

Guess I'm safe, then. :-)

I just read in the current issue of The Kiplinger Tax Letter that -- counting audits in person, by correspondence, and via computer notices -- last year's examination rate of returns by the IRS reached 4% of all filers.

So, no... you're not THAT safe.  :(

[Apples]

My family's business got audited several years ago.  We have a farm, that is an S corporation.  We are also part of a local co-op processor.  We are also owners of another business.  We also have rental income.  You'd think the IRS would send an auditor that knew what they were talking about, right?  Nope.  Fortunately my mom keeps excellent records, but oh.my.god.  We were explaining farm exemptions for certain things, how deferred (might be the wrong term) income from the co-op works in being reported/taxed, etc.  It was a nightmare and took several months.  We sent and re-sent dozens if not over a hundred different forms and documentation.  In the end we had to change a few of our practices (by which I mean literally 3 out of possible hundreds, and even those were probably debatable).  The man knew nothing about agriculture.  Which, if we were a bakery or something I wouldn't expect him to know how to make bread, but agriculture is it's own entity when it comes to taxation.  And people wonder why farmers are generally known to be Republican :p "those darn bureaucrats aren't worth the ground they're standing on, where do they think they can just go around taxing all my hard earned money; at least I know what I'm talking about".  Imagine a crotchety old man please :p

[Mississippi Mudstache]

Two years ago, we got a letter stating that we owed $1100 in taxes and penalties on our HSA distributions in 2010. Except that our HSA distributions were all for medical expenses. Fortunately, we had detailed records, and it only took one letter to fend them off.

[catccc]

My first year I filed in Pennsylvania, I got a letter from the state because I didn't include my pre-tax 401K contributions in my income.  Boy was I disappointed to find out that my new residence didn't allow 401K contributions to reduce taxable income!  It won't be taxed when it comes out at the state level, though.  So if anyone is looking for a state that doesn't tax retirement distributions, consider PA.

[Sid Hoffman]

I'll start by saying that the first time I got audited, I didn't know what was going on because the IRS doesn't tell you you're being audited.  You get a letter saying you've been found guilty of fraud and need to pay a certain amount plus a penalty amount or federal agents will take you to jail.  It doesn't say "Hey, we think there's an error and would like to look at this with you."  Nope, it says "You're a criminal and we caught you.  Pay up or go to jail."

Nothing will make an honest man mad faster than being falsely accused of a crime and threatened by those with the power to destroy.

The IRS said I did not have a child and owed them money for the deduction I had received. I told them they were incorrect. Case closed.

Mine was similar.  They accused me of tax fraud by not paying taxes for a class-action lawsuit I was part of.  I sent them a nicely worded letter with photocopies of my tax return that very clearly showed that I reported the income AND actually overpaid my taxes on it by $1.  Three months later I never get any apology letter or anything saying "Oh, sorry for the confusion, you were right, we falsely accused you of a crime."  Nope, I just got a short letter stating that my case was closed with no additional balance due.  It was a pretty anti-climactic end to something that genuinely infuriated me.

[Retired To Win]

...They accused me of tax fraud by not paying taxes for a class-action lawsuit I was part of.  I sent them a nicely worded letter with photocopies of my tax return that very clearly showed that I reported the income AND actually overpaid my taxes on it by $1.  Three months later I never get any apology letter or anything saying "Oh, sorry for the confusion, you were right, we falsely accused you of a crime."  Nope, I just got a short letter stating that my case was closed with no additional balance due.  It was a pretty anti-climactic end to something that genuinely infuriated me.

Yes, that short "case closed" letter is all I've ever gotten from the IRS.  It's the same as when an overzealous sheriff deputy once threatened to handcuff me if I kept insisting that I was not the guy he was looking for.  Once he realized he was making a mistake, there was no apology there either.  Just a curt "thank you for your cooperation" (WTF!!) and off he went.

Let's just be happy they DO go away.

[Sibley]

My parents got a letter last summer on their 2012 return - under reported business income. Turns out my dad screwed up (early dementia sucks). Since I'm an accountant I got to deal with it.

Many hours walking mom through what I needed, amended 1040, letter of response, and a check to the IRS later... all set.

Dad is permanently fired from doing the taxes and I got hired. He didn't even argue, and he did before this happened. I think it scared him.

[RunningWithScissors]

Hubby had a hassle with the CRA (Canada Revenue Agency) which nearly cost him $8000.  In the CRA's defence, it was legit since his divorce papers identified his ex as custodial parent, when the kids had always lived with him.  Although both he and his ex sent letters explaining the situation, as well as his lawyer who botched the divorce decree in the first place, he actually had to go to court, stand in front of a judge and have an official variance filed in order to satisfy the CRA. 

This took months to sort out as he had to go through the entire process of filing the suit, serving his ex, booking court time and waiting for most a day to present his case.  All the while, the CRA was sending increasingly threatening letters.  No fun. 

[forummm]

In my first audit, the agency challenged the taking of an IRA contribution deduction based on the contention that one couldn't make contributions in the same year to both a 401(k) and an IRA.  But that was not quite so.  In certain situations, you could.  And I submitted documents to show that this was indeed my situation.  Case closed.

Really? I didn't know there were situations (other than having an income above the deduction limit) where you couldn't do both.

[happypup]

I had this happen this summer - got a letter about my 2012 return quibbling over a grad school stipend. It really wasn't taxable but I guess they initially thought it was. It only took one response and they dismissed the whole issue. Though I sort of expect to get the same letter again in a few months since I got the same stipend in 2013 and reported it the same way. I wonder if documentation that they dismissed it once before will be sufficient, or if I'll have to get a new set of letters / docs (the old ones specifically addressed the 2012 money) from my school?

[beltim]

I had this happen this summer - got a letter about my 2012 return quibbling over a grad school stipend. It really wasn't taxable but I guess they initially thought it was. It only took one response and they dismissed the whole issue. Though I sort of expect to get the same letter again in a few months since I got the same stipend in 2013 and reported it the same way. I wonder if documentation that they dismissed it once before will be sufficient, or if I'll have to get a new set of letters / docs (the old ones specifically addressed the 2012 money) from my school?

Interesting - why wasn't it taxable?  The only exception I know of is if the stipend was smaller than the tuition. 

[ltt]

We've been through one audit over the adoption tax credit---think about the IRS tax scandal over the past few years.  Many, many adoptive parents were getting audited over the credit.  Sent in all the documentation/receipts they wanted, everything was in order, case closed, we received the money with interest.  As I recall, and I'm trying to remember off the top of my head, I don't even think there was a way to appeal in case they decided to deny it.  I still get disgusted thinking about it. 

[happypup]

Interesting - why wasn't it taxable?  The only exception I know of is if the stipend was smaller than the tuition.

Sorry, I mis-remembered what the problem was. The stipend was indeed taxable, and I made the correct estimated payments throughout the year, but the audit from the IRS was because they thought it might be self-employment income and so they wanted a couple extra thousand for self-employment tax. The university provided a letter indicating that the stipend was a student award, not payment in exchange for services rendered, and that settled the issue.

[beltim]

Interesting - why wasn't it taxable?  The only exception I know of is if the stipend was smaller than the tuition.

Sorry, I mis-remembered what the problem was. The stipend was indeed taxable, and I made the correct estimated payments throughout the year, but the audit from the IRS was because they thought it might be self-employment income and so they wanted a couple extra thousand for self-employment tax. The university provided a letter indicating that the stipend was a student award, not payment in exchange for services rendered, and that settled the issue.

Oh, got it.  Yes, that makes perfect sense.  Thanks!

[ria1024]

I've had one audit by mail; the IRS said I owed them an additional $3K because I'd claimed a mortgage interest deduction but hadn't paid any mortgage interest.  This was for a slightly lower amount of mortgage interest than I'd had on my return the previous 2 years.  Strangely, they'd gotten the paperwork for interest on the escrow account from the credit union without any problems . . .

It was a really annoying 3-4 hours of my life spent researching how to respond to the letter properly (fill out the front part of it, and you've just agreed that you owe the money and will be paying them back), writing up my response, photocopying everything (keep all your paperwork neatly filed), and sending them a certified / return receipt letter saying I didn't owe them anything, here's the form from my credit union showing the mortgage interest. 

It also cost about $5 to send my response with all the appropriate receipts and proof of mailing, because I'm not stupid and I'm not about to give them the chance to claim I never responded.

A couple months later, I got a letter back saying I didn't owe them anything after all.

[shotgunwilly]

The IRS said I did not have a child and owed them money for the deduction I had received. I told them they were incorrect. Case closed.

What the fuck?! Do they just make shit up now on a long shot that people will pay extra taxes?

[zephyr911]

Damn straight!

I didn't work any audits in my years as a volunteer, but the one year I actually did paid tax prep, several of my clients did get audited. They were generally self-employed and claiming large refunds. In almost every case, if you simply provide the requested documentation, the case is closed and the end results do not change. If your numbers were bad, they may just fix them for you.

Worst case, if you really committed fraud... well, you're probably not on this forum. Mustachians don't need to cheat the system to get rich, so I assume most of you aren't rying.

[Jesstache]

I'm in the process of responding to a by mail audit also.  Letter claims I did not claim my self-employment income of $3510.  I did but it shows up under my husband's SSN  as "spouse income".  This MAY require an amended return but no change in payment.  It also states that I did not claim $11,000 in medical payments from the company I do engineering work for...  this is a huge "WTF?" on my end.  The company verified they did not send anything other than the one 1099 for $3510 to the IRS under mine or my husband's SSN.  SO... yeah, they're not getting the $7000 they say I owe them... We'll see if they agree. 

[Cpa Cat]

The IRS said I did not have a child and owed them money for the deduction I had received. I told them they were incorrect. Case closed.

What the fuck?! Do they just make shit up now on a long shot that people will pay extra taxes?

It's unlikely that this is just random made up stuff. Probably what happened is that Oldtoyota either made an error (child's SSN wasn't correct) or that someone else also filed a return with Oldtoyota's child's SSN on it (possibly not even associated with his child - could have been a typographical error, for example).

Beep boop beep - the IRS computer flags the returns and everyone has to prove they had a child.

OR - Oldtoyota claimed the EIC and got pulled on an EIC audit. EIC audits aren't terribly uncommon - especially for people who have self-employment income.

Just speculating, of course. But usually there's a reason for an audit - rightly or wrongly. Very few of them are just plain random. And rumor has it that the random ones are often training audits to train new revenue agents. Hee hee. Super fun for the taxpayer.

[MonkeyJenga]

I'm crossing my fingers that I don't get hit with an audit for my large amount of non-cash donations. I spent months purging personal items and bringing them to a high-end thrift store, partly because I figured the tax deduction would be easier to claim than trying to sell everything. I have receipts for everything but an audit still wouldn't be fun.

[Retired To Win]

I'm crossing my fingers that I don't get hit with an audit for my large amount of non-cash donations. I spent months purging personal items and bringing them to a high-end thrift store, partly because I figured the tax deduction would be easier to claim than trying to sell everything. I have receipts for everything but an audit still wouldn't be fun.

In your shoes, I would send ganged up copies of the receipts along with your return.  What's the worst that could happen?  That they'll round-file the papers?

[Cpa Cat]

I'm crossing my fingers that I don't get hit with an audit for my large amount of non-cash donations. I spent months purging personal items and bringing them to a high-end thrift store, partly because I figured the tax deduction would be easier to claim than trying to sell everything. I have receipts for everything but an audit still wouldn't be fun.

Remember that the IRS primarily chooses audits based on the predicted ability to generate revenue. Suppose you donated $2,000 of non-cash items. That's worth, maybe $400 is tax revenue -if- you can't back it up.

Meanwhile, some guy just claimed a $500,000 non-cash donation of "art" to his Church.

I did know someone who got audited because he claimed to have donated $50,000 in books to the library. He beat the audit.

[MonkeyJenga]

Cpa cat: 50k in legitimate book donations? That's impressive. Do you know if he had thousands of regular books, or just a few valuable, appraised first editions? My donations weren't at that level, and even if I do get picked and need to revise my estimates down, the tax burden won't increase much. So that's somewhat reassuring.

Retired to Win: I suppose I could, but in this case I'm going to give them what they ask for, and nothing more. I don't want them to start evaluating my valuations if they wouldn't otherwise.

[Cpa Cat]

Cpa cat: 50k in legitimate book donations? That's impressive. Do you know if he had thousands of regular books, or just a few valuable, appraised first editions? My donations weren't at that level, and even if I do get picked and need to revise my estimates down, the tax burden won't increase much. So that's somewhat reassuring.

Retired to Win: I suppose I could, but in this case I'm going to give them what they ask for, and nothing more. I don't want them to start evaluating my valuations if they wouldn't otherwise.

It was kind of a shady deal. He was an artist and they were art books that he had authored in the 80s (so they -were- super rare first editions... but of books that no one cared about). 5 @10k each. And then an art dealer friend had appraised them. But somehow it passed muster.

[MonkeyJenga]

Cpa Cat: interesting... So you're saying I should have my thrift store art appraised by my friend at thousands of dollars, then donate it? Actually this brings up a long-term arbitrage opportunity: I make some art, self-publish a limited edition run, wait 30 years, have my copies appraised, donate. Keep the cycle going with new books every year.

Just kidding, IRS!

[Cpa Cat]

Cpa Cat: interesting... So you're saying I should have my thrift store art appraised by my friend at thousands of dollars, then donate it? Actually this brings up a long-term arbitrage opportunity: I make some art, self-publish a limited edition run, wait 30 years, have my copies appraised, donate. Keep the cycle going with new books every year.

Just kidding, IRS!

Who is the IRS to argue with the pricelessness of your art?!

[MonkeyJenga]

Excellent point. How dare they denigrate the value of my hypothetical future contributions to the art world!