How to prepare for an IRS tax audit?

The traditional view of an IRS tax audit is a face-to-face contact with an IRS auditor. About one-third of IRS "tax audits" are in the form of letters asking for explanations of various tax items on a tax return or supporting documentation. If you receive a tax audit letter from the IRS, examine your records to determine the nature of the tax audit issue. The IRS may want to audit the entire tax return or could audit just a portion of it, for example, meals and entertainment or automobile and travel expenses. If the issue concerns documenting a tax deduction or a tax credit, send the IRS copies of the appropriate documents. Do not send the IRS originals, as they may get lost in the mail or at the IRS. If the tax notice concerns your entitlement to a tax deduction or questions a tax position taken on the tax return, consult your tax advisor before responding to the IRS. A satisfactory explanation can end the matter quickly. In any event, it is important to respond to the IRS in writing.

If only a portion of the tax return is to be audited by the IRS you should  bring only those tax records pertaining to that part of the tax return being audited by the IRS. A full tax audit will request all tax return information for that tax year.

IRS tax audits are often prompted by large business losses over a period of several years, raising the question of how the owner made a living during that time. Large tax deductions for travel, entertainment and automobile expenses that don't appear to relate to the company's sales volume also can trigger an IRS tax audit. Only about 2% of small businesses' tax returns are audited by the IRS nationwide.

There is also a Taxpayer Compliance Measurement Program (TCMP) IRS tax audit, which is the most thorough of all IRS tax audits. Persons selected for TCMP tax audits must verify all data on their tax return. This information could include birth certificates for children, a marriage license for a spouse, and complete documentation of all tax deductions taken on the tax return.

To prepare for the IRS tax audit, a business owner needs to recall the events of that business tax year, who was employed by the company at that time, and any problems encountered that tax year. The best way to prepare for any IRS tax audit is to do a good job of record keeping during the tax year prior to filing  your tax return. Then, if the tax return is selected for an IRS tax audit, the tax information needed to answer the IRS agent's questions will be at hand. As soon as notification of an IRS tax audit is received, contact the tax adviser who prepared your tax return. He or she can explain the IRS tax audit process and help you prepare for the IRS tax audit.

If you are audited by the IRS or are subject to an IRS tax collection procedure, you have a number of rights.

• You can have an accountant, lawyer or enrolled agent admitted to practice before the IRS represent you at an IRS tax audit. You also can tape record the meeting, but you have to notify the IRS 10 days in advance of the IRS tax audit.

• You have appeal rights in IRS tax collections, such as tax liens, tax levies and property seizures. For example, one possible reason to appeal an IRS tax lien is the IRS lacks critical information about your tax case. And you can seek hardship relief from the IRS if a property seizure would create a significant hardship. The IRS can waive tax penalties if you show you acted in good faith on the incorrect advice of an IRS worker.

By giving your accountant a power of attorney for the IRS tax audit you can be absent during the actual IRS tax audit, provided you don't receive a summons from the IRS. This can give your accountant more time to respond to tax questions from the IRS agent because your accountant may have to confer with you on some issues, delaying the progress of the IRS tax audit. This may also be a strategic advantage for you.

In most cases the IRS tax notice will indicate which area of your tax return is being questioned. Follow these guidelines to prepare for a face-to-face IRS tax audit:

• Bring all the documentation relevant to the tax item(s) in question, so that the evidence needed to support your tax case is available. Bring documentation only for tax items specified in the IRS tax audit notice.

• Organize the papers according to the tax items in question, and make copies of them.

• Bring relevant worksheets to show how the tax figures in question were calculated.

• At the IRS tax audit, do not volunteer tax information not requested by the IRS. Be cordial, but remember, "Loose lips sink ships".

At the end of the IRS tax audit, the IRS agent will cite any problems with the tax return.

After the IRS agent informally advises you of any tax adjustments needed on the tax return a formal report is filed.

If you owe money on one tax issue and the IRS owes money on another tax issue, the two tax  amounts can be netted. In a small number of tax cases, the IRS tax audit results in a tax refund for the taxpayer.