It is becoming increasingly common for
businesses to be audited not just by the
IRS but also by state and local taxing agencies as well. Whether or not the taxing
agency is right, how the business handles
the audit and, if necessary, the appeal, will
have a tremendous bearing on the outcome.
“In addition to federal tax audits, state
and local taxing jurisdictions are becoming
more aggressive and sophisticated in finding both potential taxpayers (especially
those out-of-state) and potential taxes
due,” says David C. Blum, tax partner at
Chicago’s Levenfeld Pearlstein, LLC. “You
must be proactive and take every step of
the audit seriously.”
Smart Business talked with Blum for his
insight on handling tax audits and appeals
— referred to as “tax controversies.”
What are the steps in a tax controversy?
It starts when the taxing authority notifies
the taxpayer of its intent to conduct an
audit, usually via a ‘notice of audit’ sent
through the mail. The scope of the audit will
be set out in the notification. This will generally include who is conducting the audit,
the type of tax involved, tax years at issue
and the proposed start date of the audit.
In most instances, the auditor will go out
to the taxpayer’s business to review its
books and records. If the auditor determines that additional taxes are due, the
auditor will generally provide the taxpayer
with a notice of proposed assessment. At
that point, the taxpayer can choose to pay
the assessment or protest some or all of it
by filing an appeal. The form and procedure for a proper appeal, as well as possible settlement opportunities, will depend
on the particular taxing agency.
What should be the initial response to an
audit?
Upon receipt of a notice of audit, the taxpayer should contact its tax advisers. This
is because there are many things that a
business should and shouldn’t do before
and during an audit. In certain circumstances, an audit may be inappropriate or a taxing authority may not have constitutional authority to impose a tax in the first
instance thereby obviating the need for an
audit. A good adviser will be able to identify this. Additionally, there are things that
can be done during the audit to either eliminate a proposed assessment or to set the
tone and position it for a successful appeal.
What is the best advice during the audit?
Be prepared, responsive and cooperative.
The taxpayer should demonstrate a willingness to work with the auditor and provide him or her with the requested information. If an auditor feels that the taxpayer is hiding something or he or she is
not getting all of the requested information,
the auditor may be more willing to dig and
could become uncooperative or unreasonable for legitimate issues or concerns
raised by the business. Ultimately, auditors
generally have the power to subpoena
information relevant to the audit. So you
will likely have to provide the information
anyway.
How should you make sure that you are prepared?
The business should go over its books and records first and essentially do its own
audit. Next, the business should strategize
with its advisers with respect to any issues
or questions that an auditor may raise, and
if necessary, do the appropriate tax
research in advance. This way, if and when
the auditor raises the issue, you’ll have a
ready response. Also, by preparing in
advance, the business can focus on its
strongest arguments and explain its rationale and legal authority to the auditor if a
position is challenged.
What about the appeal process?
If the taxpayer has represented itself up
to this point, he or she is well advised to
involve a tax professional to navigate the
appeals process. Separate and apart from
the audit strategy, the taxpayer must have
an appeal strategy. This includes how and
where to appeal the audit, what issues to
focus on, what issues to concede (if any),
whether settlement is an option, how
much to offer and what are the hazards of
litigation.
Generally, you must first exhaust your
administrative remedies and then go to
court, but in other circumstances, you may
be able to go right to court and skip the
administrative appeal. The particular circumstances of each audit will dictate what
makes most sense. The answer will also
depend in part on whether the appeal
involves a federal or state tax issue.
Any final thoughts?
Nobody wants to be audited. Defending
tax audits can be stressful and challenging
for a business. A good adviser can help a
business navigate its way through the audit
and appeal process while providing some
sanity along the way. Being prepared and
proactively addressing each step of a tax
controversy could help avoid unintended,
adverse and costly consequences.
DAVID C. BLUM is a tax partner at Levenfeld Pearlstein, LLC in
Chicago. Reach him at (312) 476-7557 or by e-mail at
[email protected].