By Frances A. Tomes, Esq. New Jersey and IRS Tax Audit Attorney

Receiving an IRS audit notice can be scary. It can also be confusing. The most important thing is not to panic and not to start sending documents right away.

First, find out what the IRS is looking at. Read the notice. Check the deadline. Review the tax return. Gather the records. Then decide how to respond.

For business owners, this is especially important. A tax audit can involve much more than one receipt or one deduction. It may involve bank records, payroll, business expenses, sales, or several tax years.

At Tomes Law Firm, we help New Jersey taxpayers understand what the IRS is asking for before they respond.

The early part of an IRS audit matters. Once documents are sent or answers are given, it can be much harder to correct mistakes.

What Should You Do First After Receiving an IRS Audit Notice?

Start with these basic steps:

1. Read the whole notice.
2. Find the response deadline.
3. Identify the tax year being audited.
4. Find out what the IRS wants to review.
5. Review your return and records before sending anything.
6. Decide whether you need professional help.

The IRS may conduct an audit by mail or in person. The IRS also has the right to ask for records that support income, deductions, and credits claimed on a return.

What I Look for When I Review an Audit Notice

When I review an audit notice, I am not just looking at the deadline.

I want to know what the IRS is examining.

I also look at:

• What tax year is involved?
• What income or deductions are being questioned?
• What records has the IRS asked for?
• Does the same issue appear on other tax returns?
• Do the books, bank records, and tax returns match?
• Are important records missing?

For a business owner, these questions can be more important than simply finding receipts.

For example, if the IRS is questioning business expenses, I want to know whether the same type of expense was claimed in other years. If the IRS is reviewing income, I want to see how the bank deposits, bookkeeping records, and tax return compare.

The goal is to understand the problem before the IRS goes deeper into the records.

Three Things I Would Not Do Right Away

There are three things I usually would not recommend doing before the audit is understood.

Do not call the auditor and start explaining everything before you know what the issue is.

Do not send a large pile of records without reviewing and organizing them first.

And do not assume that your accountant or tax preparer has every document the IRS may want.

Preparing a tax return and defending that return in an audit are not always the same job.

Do Not Give the IRS a Document Dump

A common mistake is sending the IRS every document you can find.

That may feel safe.

It may not be.

The IRS tells taxpayers to organize audit records by year and by type of income or expense. The IRS also recommends including a summary of the transactions. Organizing records can help prevent mistakes and misunderstandings.

That is important.

An auditor should not have to search through hundreds of pages to figure out which document supports which deduction.

A Real Client Experience: A $129,000 Deficiency Reduced to Zero

I have seen what can happen when a taxpayer gives the IRS a large amount of information without organizing it.

Paul came to us after handling an audit on his own.

He had given the IRS what was basically a document dump. He had many business records, but they were not organized in a way that showed how they supported the expenses claimed on his tax return.

The IRS did not go through the records and build the case for him.

Instead, the IRS disallowed the business expenses and issued a Notice of Deficiency of about $129,000.

By the time we became involved, the audit had already become a much bigger problem.

We requested audit reconsideration. That is a process that may allow the IRS to look again at an audit when the taxpayer has information that was not properly considered the first time.

Then we started rebuilding the client’s proof.

We organized the expenses.

We matched the records to the deductions.

And we had to explain something that many business owners do not understand:

A ledger is not always proof of an expense.

Our client believed the business ledger should be enough because it showed that the expense had been recorded.

But we needed the actual invoices and other supporting records.

Once we obtained the proper documents, organized them, and showed the IRS how they supported the business expenses, the result changed.

The approximately $129,000 proposed deficiency was reduced to zero.

That result depended on the facts and records in that particular matter. Results in other cases may be different.

But the lesson is important.

Do not assume the IRS will sort through a pile of records and figure out your case for you.

A QuickBooks Ledger Is Not Always Enough

Many business owners tell me: “It is in QuickBooks.” Or: “It is on my general ledger.”

That helps, but it may not be enough.

A QuickBooks entry may show that the business recorded a $5,000 payment to a vendor.

But the entry may not show:

• What was purchased.
• Why it was a business expense.
• Whether the expense was actually paid.
• Whether part of the expense was personal.
• Whether the amount was deductible.

Businesses must keep records that support income and deductions reported on a tax return. Taxpayers have the responsibility to prove certain items claimed on the return.

That is why an invoice, receipt, bank record, canceled check, contract, mileage record, or other supporting document may matter.

The IRS Auditor Is Not There to Build Your Case

This is one of the most important things for a taxpayer to understand.

The auditor works for the IRS.

The auditor is not your bookkeeper.

The auditor is not your accountant.

And the auditor is not your lawyer.

If you claimed a business expense, you should be ready to show why that expense should be allowed.

A strong audit file creates a clear path: tax return -> expense category -> summary -> supporting records

If the return shows $30,000 in one type of business expense, the records should make it easy to see how that $30,000 was calculated and what documents support it.

That is much stronger than giving the auditor a box or folder full of papers.

What Is an IRS Information Document Request?

During an audit, the IRS may send a written request for documents.

You may hear this called an Information Document Request, or IDR.

The IRS can ask for records that support income, deductions, and other items reported on a return.

An IDR should be taken seriously.

But it should also be read carefully.

The goal is to answer what the IRS is asking for and provide the proper documents in an organized way.

It is not to send everything you have without reviewing it first.

What Records Can the IRS Ask For?

The records depend on the type of audit. They may include:

• Bank statements
• Receipts
• Invoices
• Canceled checks
• Accounting records
• Payroll records
• Forms W-2 or 1099
• Contracts
• Mileage logs
• Credit-card statements
• Point-of-sale records

Taxpayers should keep records long enough to prove the income and deductions shown on their tax returns.

If records are missing, do not automatically give up.

Sometimes records can be rebuilt using bank records, vendor records, customer records, emails, or other sources.

But the records should be reviewed before they are sent to the IRS.

Why Can a Business Audit Be More Complicated?

Business records are connected.

Bank deposits may relate to sales.

Sales may relate to bookkeeping records.

Payroll records may raise questions about employees or independent contractors.

Business expenses may raise questions about whether the expense was truly for the business.

For example, a restaurant may have cash sales, credit-card sales, tips, payroll, and sales tax records.

A contractor may have subcontractors, vehicle costs, tools, and cash payments.

A trucking business may have mileage, fuel, travel, and owner-operator issues.

One question can sometimes lead to another.

That does not mean every audit will grow.

It means business owners should know what their records show before the IRS starts reviewing them closely.

Should You Talk Directly to the IRS Auditor?

You can represent yourself in an IRS audit.

But that does not always mean you should.

The Taxpayer Bill of Rights gives taxpayers the right to hire an authorized representative. Taxpayers also have the right to challenge the IRS’s position and appeal many IRS decisions.

A simple audit may be easy to handle.

A business audit can be different.

An auditor may ask a question that sounds simple, such as:

• “How do your customers pay you?”
• “Who performs this work?”
• “Why do the bank deposits not match the return?”
• “What was this payment for?”

The answer may lead to another tax issue.

That does not mean you should hide information.

It means you should understand the question before answering it.

Can the IRS Audit Other Tax Years?

Possibly.

The IRS generally has a limited period to assess more tax, although there are exceptions. Taxpayers also have the right to know the time limits that apply to an audit.

That is why I look at whether the same issue appears on other tax returns.

If the IRS questions one type of deduction in one year, and the same deduction appears in several years, the possible problem may be larger than the first notice suggests.

It is better to see that issue early.

An IRS Audit Notice Is Not the Same as a Tax Bill

An audit notice does not automatically mean you owe more tax.

An audit can end with no change.

The IRS may also propose changes that the taxpayer agrees with or disagrees with.

If you disagree, you may have rights to challenge the result or appeal.

That is why it is important not to assume the worst at the beginning.

What If the Audit Already Went Bad?

Do not assume that nothing can be done.

In some situations, audit reconsideration may be available.

Audit reconsideration may allow a taxpayer to ask the IRS to review an assessment again when there is new information or when information was not considered during the first audit.

That is what happened in the client matter described above.

The better answer, though, is to try to avoid reaching that point.

Our client’s proposed deficiency went from about $129,000 to zero, but getting there took another IRS process and a great deal of extra work.

For Business Owners, an Audit Costs Time Too

There is another cost that does not appear on an IRS notice.

Your time.

If you own a restaurant, construction company, trucking business, store, or other New Jersey business, an audit can become a second job.

You may spend hours finding old records.

You may have to call vendors.

You may have to get bank statements.

You may have to rebuild old expenses.

You may have to answer questions from the auditor.

Every hour spent on the audit is an hour you are not running your business.

What Is the Best Way to Respond to an IRS Audit Notice?

Start slowly and carefully.

Read the notice.

Check the deadline.

Find out what the IRS is examining.

Review the return.

Review the records.

Organize the proof.

Then respond.

Do not panic, but do not improvise either.

Understand what the IRS wants. Understand what your records show. Then make sure the documents actually prove what you are asking the IRS to allow.

At Tomes Law Firm, our team helps New Jersey individuals and business owners deal with IRS audits, tax disputes, and other tax problems.

If you received an IRS audit notice and do not know what to do next, call 732-333-0681, 833-4IRS-TAX, or visit tomeslaw.com.

Frequently Asked Questions About IRS Audits

Does an IRS audit mean I did something wrong?

No. An audit means the IRS wants to review part of a tax return. It does not automatically mean the IRS has found fraud or even an error.

Should I send the IRS all of my records?

Usually, you should first review what the IRS asked for and organize the records that answer that request.

Is a QuickBooks ledger enough for an IRS audit?

Not always. A ledger shows what the business recorded. The IRS may also want invoices, receipts, bank records, checks, contracts, or other documents that prove the expense.

Can I have a lawyer represent me in an IRS audit?

Yes. Taxpayers have the right to retain an authorized representative when dealing with the IRS.

Can an IRS audit end with no extra tax due?

Yes. An audit may end with no change when the taxpayer proves the items being reviewed.

What is audit reconsideration?

Audit reconsideration is an IRS process that may allow an audit result to be reviewed again when there is new information or information that was not previously considered. It is not available in every case.

Can the IRS look at more than one year?

It can, depending on the facts and the legal time limits that apply. That is why it is important to look at whether the same audit issue appears on other returns.