So You Got a Letter from the IRS

A letter about a tax audit. — (Image credit: Getty Images)

Uh-oh.

You’re flipping through your mail and the return address on one letter makes your heart rate quicken — and not in a good way. It’s from the Internal Revenue Service.

When you open the envelope you see what you dreaded most: The IRS wants to audit your return. (Don’t think it can’t happen to you. The IRS seems to have gotten back to work after a spring lull, and I’ve recently gotten several frantic calls from clients who have received audit notices.)

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Your mind races, and your palms sweat. Did you do something wrong? Did you leave anything out? Why are they coming after you? How are you going to be able to defend yourself against the United States government?

Let me offer the most straightforward piece of advice I can: Take a deep breath, exhale slowly and set the letter aside. Do something else for a while. Finish some chores. Walk the dog. Go for a run. Once you’ve calmed down, you can focus on the letter.

Did the IRS make a mistake (not you)?

For starters, there’s a chance the IRS flubbed. Remember, it’s a massive government agency handling millions of tax returns. It’s understaffed, underfunded and staffers are overworked. They can — and do — make mistakes. You or your tax preparer could also slip up. The agency sent out about 1.9 million notices about math errors last year on 2018 returns. Maybe yours is one of those.

An IRS reviewer may also have missed seeing your correct information in the spot they thought it should have been in, even if you included it elsewhere on your return. They may not have applied a payment that you already made. They may have transposed some numbers or gotten a date wrong. Believe me, it happens.

Pull out your tax return and check for those clerical errors first. After that, thoroughly review the letter.

What year is the IRS reviewing? What exactly are they asking for? What are they claiming is missing from your return?

Letters resulting from a 1099 audit often include a “notice of proposed adjustment.” The “adjustment,” of course, is the additional money the IRS says you owe them, including the penalty and interest that’s been assessed.

An IRS letter may also state your tax return has been chosen for an additional investigation or audit, and it may give specific categories the agency wants to review from either a business or the taxpayer’s personal records.

This is where taxpayers’ hearts begin palpitations, and there’s a simple reason why: Most don’t have a clue about what’s actually in their return because they hire others to do it, and sign off without reading it. Given that professional tax experts sometimes miss details, it’s likely laypeople miss them as well.

Misread, overlooked, unclear

Chances are there’s a logical explanation that addresses the IRS’ concerns.

Send your tax preparer a copy of the IRS letter and ask for an explanation. There’s an excellent chance they will have answers that will satisfy the IRS. If you prepared your return yourself, look for the same issues a preparer would: A date may have been misread, information that is being requested was, in fact, included in the return or the time period wasn’t clear.

The IRS is not in the business of chasing people for amounts that aren’t due. If they’re satisfied you’ve paid what you owe, they will move on. Be patient as this may take some time to work through with the IRS. You will often wait for replies from the department for months at a time.

Make Sure You Have Proof to Support Your Charitable Tax Deductions

If there are remaining issues, there’s a good chance they may be a consequence of tax items from a prior year that impacted the current year’s return. This means the IRS may be scrutinizing whether you incorrectly applied tax deductions or credits disallowed on previous returns to the current year. They make more tax revenue if carry forwards can be disallowed, so of late they have asked taxpayers to provide the original source information for the deduction or credit, even though the statute of limitations related to that particular item may have long since passed.

President Donald J. Trump, for example, is the midst of a battle with the IRS over a $72.9 million tax refund claimed and received after prior losses.

Remember: Credit card receipts don’t count

To address these questions — now and in case of future audits — keep your receipts and records for six years at a minimum.

And this is crucial: The IRS does not accept credit card receipts in an audit. Even if you regularly use a company credit card to pay business expenses, the IRS requires the original vendor receipt. This is one of the most common errors I see among my clients.

I strongly recommend getting an app that allows you to take a picture of the original receipt using your phone and maintain a record of all the receipts on your credit card. At the end of the year, you can download a PDF report that is easily archived.

Keep contemporaneous records along with the receipts to indicate how each expense benefits the business in case you’re called on to justify it.

It’s entirely possible the dreaded audit letter can be resolved relatively painlessly. Just never forget the IRS is always trying to collect money. It is not trying to reduce your tax bill to the lowest amount legally possible. Mistakes they notify you of will almost always be in their favor.

When you have stellar records, you know you’ll be able to resolve what is often a small error. And your heart won’t race (as much) when you see that dreaded envelope in the mailbox.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Bruce Willey has been working with small to midsize businesses across the country for more than a decade, helping them navigate business and tax law in a variety of situations. His services include assisting with business start-ups, operations, growth, asset protection, exit planning and estate planning.