The audit starts with a letter IRS Form 4564. This is an Information Document Request and may be the first of several you receive. It will require you and your accountant to gather requested records for review by the IRS revenue agent.
The audit may be random in nature or it may have been selected because you are part of an industry the IRS is targeting or maybe one or more of your deductions are too large. You should not go to the audit alone. You should take your CPA at a minimum or your attorney with you.
The auditor does not negotiate and does not have the authority to negotiate. The auditor is just there to gather facts and documents. He or she will send out the document request, try to interview the taxpayer, subpoena records from the taxpayer and if necessary from third parties as well (such as your bank, employer, etc.) and will speak with your representative which can be your CPA, Enrolled Agent and/or attorney. When complete the IRS agent will discuss the findings with you or your representative if you have one. (It would be foolish not to have a representative since the representative has no emotion in the meeting and can discuss the matter with the agent. The representative can start by saying, “I am not authorized to make representations on behalf of the borrower but this is how I see it.” The main reason is without a prefaced denying authorization to say whatever will be said to the agent, the agent’s words can be held the same as if you actually said them.
If the result by the agent is something you and your representative do not like you do not want to try and persuade the agent to take a more favorable approach. The agent is not there to negotiate with you. Anything you or your representative say will be added to the agent report. Next the agent will have it in the file when forwarded to the IRS Appeals division and you will lose the force and effect of your arguments since the agent will include the reasons the IRS does not agree with you when you raised them at the audit stage. Since no new facts and therefore no new arguments because you gave them to the agent and they were incorporated in the report to the Appeals board, you have decidedly raised the risk you will lose on appeal.
You will generally get asked to sign an extension. This is where you say no! This gives the agent more time to find more facts and documents to substantiate the position the IRS has taken. Remember there is a three-year statute of limitations from when your tax was assessed. The IRS has to make the assessment within those three years barring certain things as fraud and tax evasion by not declaring the income in your return in the first instance.
If the Appeals Division does not give you a good result you will get a 90-day deficiency letter prepared by the appeals officer. If you turn down the officer, then an IRS agent will write the letter.
At this point you have 90-days to file a petition with the United States Tax Court. At this point you must use an attorney that is licensed with the court. This license is separate and apart from the state license given to the attorney to practice law in the state. At all times be courteous. In the course of representing clients before the IRS for various reasons, I have always found them to be courteous and most of all reasonable. Arguments in your favor presented courteously and logically will generally generate something in your favor. If your case is really strong, the agent, when the case gets to the appeals level or at the Tax Court level, might negotiate an offer of discount that could go as high as 80% or may concede the IRS case is not there and dismiss it. But above all do not be discourteous. I have always found them to be willing to negotiate.
If you get a letter for deficiency where you can argue the deductions are allowable as set forth above or where you are being dunned to pay tax arrearages, I have always found the IRS to be reasonable. They will generally negotiate terms of payment. One thing is very important. Do not agree to extensions. If an income tax deficiency is owed and it is more than three years since the IRS has assessed it, it can generally be discharged in bankruptcy. So if you receive an audit letter you want to see your CPA, Enrolled Agent or attorney immediately. Aside from the knowledge they have, they have one big additional asset you do not. They are not emotionally involved in the problem. Therefore they are better equipped to be part of the solution.