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Income and Payroll Tax Audits

Facing an income, payroll or sales tax audit can be a frightening experience. There are numerous audit techniques used by government tax auditors to detect additional income and nondeductible expenses. It is imperative to be well prepared for any audit. This website explains the most common audit techniques used by the government.

 

 

Income Tax Audit

The federal and state tax authorities look for unreported income and excessive deductions using a variety of intricate accounting techniques and methods such as:

1. Unexplained bank deposits that will be taxed as unreported income;
2. Standard of living test that analyzes sources and uses of cash to prove how much income the taxpayer must have earned to pay those expenses.
3. Skimming gross proceeds from the business can be detected using markup analysis techniques, income averaging, and reconstruction of income based on other sales records;
4. Verify ordinary and necessary business deductions, even when there are no receipts;
5. Reduce the taxable gain on the sale of assets by proving the correct basis using actual records or, if unavailable, reconstructing the basis using other methods of proof; and
6. Verify all cash income and cash expenses through independent means.

Schedule C - Business Tax Audits

The IRS and state income tax authorities attempt to locate undisclosed income and disallow business expenses. To prepare efficiently, it is necessary to

1. Compare total gross bank deposits to sales to prove gross income is accurate;
2. Business expenses must be analyzed for reasonableness and whether they were required in the business;
3. Assure the government will not re-characterize business expenses as non-deductible personal items. This is especially true for business use of your automobile and other personal property, travel, entertainment, and depreciable assets; and
4. Utilize external sources to prove cash expenditures, even though the receipts are unavailable.

Employment or Payroll Tax Audit

Government tax auditors attempt to reclassify independent contractors as employees, thereby collecting unpaid payroll taxes, penalties and interest. This can be overcome by:

1. Persuasive use of the 20 factor test for determining whether the employer controls the manner and means of how the worker accomplishes the desired result;
2. Effectively using lower Section 3509 rates when the employer had a good faith belief the worker was not an employee; and
3. State payroll tax audits generally involve whether the worker has a state license and separate business rather than the 20 factor tes

Risks During an Audit

During the initial personal interview, the IRS will ask you how much cash you had on hand at the beginning and at the end of the year. Your testimony will be used against you later in the audit when they conduct a standard of living, or a sources and uses of cash test. This is especially true if your personal living expenses exceed your income, or if you cannot prove actual personal living expenses.

A second major area of concern are when the auditor asks questions at the initial interview that go to the heart of the audit, before reviewing the documents. Most taxpayers mistakenly believe that if they answer the questions quickly and provide a reasonable explanation that the auditor will not look into the issue and the audit will be closed early. On the contrary, these answers will be used against the taxpayer later to discredit his testimony and to prove the taxpayer had criminal intent to evade taxes. Thinking that since you have nothing to hide, you can speak freely-is far from the truth. The auditor's job is to discover unreported income and non-deductible expenses, not to see if you have anything to hide.

A third major risk area is that a vast majority of all criminal cases are referred from civil audits. If the government discover intentional irregularities, they may refer the case to the Criminal Investigation Division for prosecution. It is imperative to understand the importance of specific intent questions asked by the auditor, and know how to deal with them.

A fourth major risk area is to disallow expenses due to a lack of receipts. This may be overcome by not only the original receipt, but also by verification by third party sources, testimony of others, and reconstruction of income or expenses.

A fifth risk area is underestimating your opponent. Keep in mind that this is the auditor's area of practice. They may be referred to as bean counters, but they have acquired years of schooling and experience in these auditing issues. They are very savvy in proving additional income, or disallowing expenses. If your area of expertise is not in auditing, then it is best to have a professional represent you.

Pitfalls of IRS Appeals

IRS Appeals Officers have years of tax and accounting education. The IRS requires numerous hours of continuing education classes put on by the IRS that teach Appeals Officers the IRS's interpretation of the Code, Regulations, and case law. As a result, they are very knowledgeable about the technical tax intricacies--as interpreted by the IRS National Office. They may be called bean-counters, but this is their area of practice. If you do not practice in this area, it is a good idea to hire a professional. The IRS Appeals Officer will ask you questions at the initial interview that will lock you into a specific theory of the case, and preclude other more viable theories. It is important to know which questions to answer, and when to answer them. Your answers to questions from the IRS Appeals Officers will be disclosed to the IRS District Counsel's Office and used in their preparation at trial against you.

Advantages of Hiring a Tax Attorney

This tax law firm is extremely aggressive during an audit, and will represent you to the best of our ability. The primary advantage of hiring a Tax Attorney is that we will prepare diligently for the audit. We will collect and analyze all relevant documents before the audit. We will also determine all areas of concern and prepare diligently to discuss those areas with the auditor. Thorough preparation is the key to many audits.

The second primary advantage of hiring a tax attorney for the audit is that we will guide the auditor to areas of little or no audit risk, and sway them away from the areas of concern. We know how to answer the difficult questions, and which questions not to answer.

You will be hiring the negotiating skills and savvy of an educated tax attorney. This tax law firm has successfully represented hundreds of taxpayers and entities in all types of tax audits. In order to gain a significant advantage on a tax audit, it is imperative that you are represented by a tax attorney who has more education and experience than the auditor himself. This tax law firm will take an aggressive stance in representing you in all aspects of the tax audit.

The attorney-client privilege gives the taxpayer a significant advantage over the auditor, by allowing the attorney to review the evidence prior to submitting documents to them. It also allows the attorney to only answer those questions that benefit the taxpayer.

Past Experience

This tax law firm has represented hundreds of individuals, corporations, partnerships, trust & estates, and fiduciaries in all tax matters including income tax audits, payroll or employment tax audits, trust, estate and fiduciary audits and sales tax audits. Common types of tax audits are as follows:

I have represented numerous taxpayers in Schedule C - business tax audits. This includes proving unexplained bank deposits, reconciling gross income to sales, supporting business expenses, proving travel, meals & entertainment expenses, supporting depreciation and amortization expenses, and proving all expenses where the taxpayer lacks receipts through other forensic accounting methods and testimony.

Potential Criminal Conduct Tax Audits (Eggshell Audits)

This tax law firm has successfully represented many taxpayers who have engaged in potential criminal conduct such as skimming profits from a business fail ing to report income from business transactions, conduct an inner-bank and inner-company loan scheme, and cashing customers checks at their bank without reporting the proceeds.

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