How To Protect Clients From an IRS Auditby
An IRS audit is a common fear of business clients, especially if they fall into the “target” groups of Schedule C filers, pass-through entities and millionaires.
Although most clients may never have to experience an IRS audit, professionals need to hope for the best, prepare for the worst and put clients’ minds at ease.
There are three useful informational resources accounting professionals can rely on for audit guidance:
1. IRS Documentation
The IRS publishes forms, instructions and other publications written in an easy-to-understand manner. The guides are not overly technical, are very readable for clients and are helpful for understanding essential information. Because the documents are not a “substantial authority,” CPAs may need something more to advance an argument with the IRS. However, it may be an excellent place to start because the IRS will likely follow its own documentation.
2. Treasury Regulations
The U.S. Treasury Department will write a temporary regulation (good for three years) following Congress’s passing of a new statute. Although regulations and statutes have similar authority, a statute will prevail if there is any conflict between the two.
Proposed regulations have less authority than final and temporary regulations. Practitioners can rely on proposed regulations as a statement of the IRS’s official position on an issue. They can be persuasive with the IRS, but not so with the courts.
3. Tax Code
Rely on the tax code as the best authority in a case with the IRS. With a “statute” (a tax code provision) as backup that accurately reflects the situation, a practitioner should be able to win the case upon citing it. However, if the case is in direct opposition to the tax code, avoid the fight and try to settle for the least amount possible.
Be advised that tax code verbiage is sometimes too general to support tax strategies completely, additional types of back-up authority may be needed.
The Internal Revenue Bulletin publishes official pronouncements from the IRS. They are known as “the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures.”
They are technical and difficult to understand; therefore, consulting other resources to comprehend may be useful. The four types of publications are:
- Revenue Ruling — A summary of a case transcription that shows how the IRS applied the law in a specific situation.
- Revenue Procedure — The use of a particular revenue procedure to administer the law by updating dollar amounts for inflation and explaining processes for making elections or filing forms.
- Acquiescence and non-acquiescence by the IRS — A statement issued by the IRS indicating its agreement or disagreement with a tax ruling.
- Notices and Announcements — Information disseminated by the IRS regarding their official position on recent issues.
The courts do not treat IRS documents as binding authority. However, the IRS rarely argues a court position that contradicts something it wrote in its published documents.
Protect Clients and Avoid Audits
Here are some things that can help put clients’ minds at ease while protecting them from being audited:
- Be sure to report all income, including stocks, cryptocurrency transactions, trades, 1099s, 1099-INTs and W-2s.
- Only itemize if paperwork and receipts are available for back-up.
- Be mindful that the IRS will notice if a client’s business reports a loss for several consecutive years with no other income sources.
- Support charitable donations over $250 with receipts.
- Be aware of the client’s marital situation. If divorced and both are claiming alimony payments with different numbers, they could hear from the IRS
- Claim Earned Income Credit (EIC) for clients.
- Keep expenses consistent, especially for gig workers and the self-employed.
Once the IRS audit results come in, it’s essential to keep the client calm and to help him/her understand the next steps. In most cases, the client will owe back taxes plus any additional interest to the IRS. They can often set up a payment plan.
If the client wants to appeal the results, that’s possible through the Alternative Dispute Resolution (ADR) escalation process. However, should the case go to court, the best tax authority resources are statutes, regulations and prior court cases.
The original article appeared in the January/February 2021 issue of New Jersey CPA Magazine.