Tax Season and Tax Audits

Today marks the "official" end of busy season for most CPA firms and other tax professionals. Now all we have to do is deal with returns our clients agreed needed to be extended. Since those extensions are for six months, there will be another mini-busy season ending on October 15th.

Returns get extended for a number of reasons, most of them related to missing information that should be provided to our clients by partnerships, small business corporations (S-corps) and investment managers. Procrastination being what it is, many of those returns will not be completed until this autumn.

Another source of business for tax practitioners is IRS audits. Tax audits are most often handled by mail and are, reasonably enough, called correspondence audits. The IRS sends a letter to the taxpayer (called a CP2000 or 30-day letter) informing the taxpayer that he, she or they failed to include some income on their tax return of a recent year and assessing taxes, interest and penalty for that omission. The taxpayer has 30 days to respond. If the taxpayer doesn't respond, a 90-day letter is issued. At that point, the taxpayer has 90 days to resolve the issue with the IRS or to file a petition with the United States Tax Court.

Too many people respond by writing a check. If the amount is significant, don't do that. The amount the IRS wants is often more than the taxpayer owes. For example, suppose you bought some stock a few years ago and paid $3,000. In 2010, you sold that stock for $2,000 but forgot to report the sale on your tax return. When the IRS notices, they will send you a bill for back taxes on the full $2,000 as if it were ordinary income -- about $500 for most people plus a year's interest ($15) and penalties ($15 minimum, maybe another $100 for being negligent) for a total of as much as $630. However, instead of owing more taxes, this taxpayer is owed a refund for the missing $1,000 capital loss ($150 to $250 for most people). That's a swing of over $780 to $880. And, that is why, when the IRS says you owe more money, you should seriously consider hiring a tax professional (Certified Public Accountant or Enrolled Agent) to resolve the issue, particularly when you know there are unreported costs associated with that income you forgot to report.

Correspondence audits are sent out year round. More detailed audits tend to occur more often in the summer and fall when either the taxpayer is invited to the IRS office (an office audit) or the IRS visits the taxpayer (usually a business) at the taxpayer's location. In both cases, the taxpayer should engage the services of a tax professional to represent his or her interests.

Again, the IRS has ways of learning about income you may have omitted from your tax return. They don't have a way of determining the deductible costs you incurred creating that income. Do not automatically write a check but, also, do NOT ignore correspondence from the IRS. Deal with it and deal with it by the specified deadline.