You should start preparing for the audit after reviewing the IRS notice and identifying the type of audit. Before you prepare for the audit yourself, you should consider whether you can handle the IRS by yourself or if you need to engage a tax professional to help with the audit. If you are going to hire a tax professional, you should do so at this point. This decision in itself can be challenging.
Why Hire a Tax Professional?
There are several reasons why you may want to hire a tax professional to help with your IRS audit. For example, a tax professional who has tax experience and experience handling IRS audits may be able to obtain a more favorable outcome by helping to:
- Avoid direct questioning by the IRS.
- Know what can and should be said and disclosed to the IRS and when.
- Ensure that your rights are enforced and protected during and after the audit process.
They can also save you time and stress. This alone can be well worth the cost.
It should be noted that there are some taxpayers who will almost always need to hire a tax professional. This includes politicians, celebrities, accountants, and attorneys. IRS auditors almost always try to make examples out of these taxpayers. They do so to make headlines. Right or wrong, it is generally thought that these headlines help encourage voluntary compliance by others. If you are one of these taxpayers, you should seriously consider hiring a tax professional to help with your audit.
What Type of Firm Should You Hire?
There are thousands of tax professionals who help with IRS audits, appeals, and litigation. These tax professionals work for law firms, accounting firms, and even consulting firms. The firms include substantial firms in terms of headcount and revenues or small one-person shops. The firms have individuals who handle every type of client or tax issue or focus on one very narrow type of client or tax issue. If you are going to hire a tax professional to help with the audit, you should consider what type of firm the tax professional works for.
The type of firm you may want to hire, depends on where you are in the audit process and your tax return or tax issue complexity. My background can help you think about what firm you should approach. Here is a summary:
- I started working on IRS audits as a solo attorney. The audits usually involved working-class individuals and small businesses with one to ten employees. An IRS adjustment of something like $5,000 to $25,000 would have been a significant adjustment for my clients. The cases focused on basic tax issues, like mileage deductions, charitable deductions, and meals and entertainment deductions, and substantiation for these expenses. Most of the clients either did not have an ongoing relationship with a CPA or did not have a CPA willing to handle IRS audits.
- After a few years, I was handling audits for moderately wealthy individuals and slightly larger businesses. I did this work for my law firm, which had one other attorney, and then for a specialty business tax consulting firm. A significant IRS adjustment for my clients would have exceeded $25,000 but would have been less than $500,000. The tax issues shifted to more complex problems, such as self-directed IRAs, research tax credits, and depreciation issues. Most of these clients had established relationships with CPAs, but they needed or wanted outside counsel, given the tax positions’ complexity.
- After my time with the IRS, I started working for Fortune 500 companies. The IRS audits had a minimum materiality threshold of $10 million. Therefore, the IRS auditors would not look at an issue expected to generate $10 million or less in tax due. Many issues under consideration were in the $50 to 100 million dollar range, with a few in the billion-dollar range focused on the U.S. side of international transactions and complex financial structures. This included hedging transactions, accounting methods, and foreign tax credits. I worked on these IRS audits with the assistance of other tax professionals, including staff from large accounting and law firms.
- I am now back practicing law and have grown a slightly larger team of attorneys than in my first law practice. We generally work on IRS audits that could lead to $25,000 to $1,000,000 in IRS adjustments. Our cases focus on general business audits and specialty audits, such as research tax credit audits and estate tax audits. I tend to gravitate to the more complex tax issues, as I find them more interesting and challenging.
My experience and background should give you a sense of what type of firm you should approach, if you decide to hire a professional to help with your IRS audit. You will find firms that are similar to each of the categories above.
You should also consider the firm’s focus. There are tax firms that do not handle IRS audits. Tax resolution firms are an example. Many of the larger tax resolution firms may agree to take IRS audits, but they prefer not to. They focus on settling unpaid taxes. IRS audits are a distraction, but their clients often expect these firms to handle IRS audits. So, they handle them. However, it is usually not their focus. The same is true for accounting or CPA firms. Many focus exclusively on preparing and filing tax returns or providing tax planning and advice to clients. That is the extent of their services. They do not handle IRS audits, unless they have to keep good relations with their client. When hiring a firm, your task is to identify whether the firm you are considering handles IRS audits and if they actually want to do this type of work.
What Type of Professional Should You Hire?
In addition to the type of firm, you also have to consider the type of tax professional that is best suited to your tax issues. Tax professionals can be categorized by their licensing. The IRS limits who can represent you in an IRS audit includes:
- Attorneys – with an active law license from any U.S. state or possession
- Certified Public Accountants – with an active accounting license from any U.S. state or possession
- Enrolled Agents – with an IRS active registration
The type of professional you should hire depends on where you are in the IRS audit process and your tax return or tax issues’ complexity. If the IRS is likely to raise a legal issue, you should consider hiring an attorney. The same goes if you think there is a chance you may end up litigating the results of the IRS audit. This should be compared to a more routine audit for a tax return that has very little reported on it. If the auditor questions how you recorded expenses in your accounting system and how you carried that over to your tax return, you might consider using your CPA or accountant. If you need someone to dig through boxes of receipts and compile them so that the records can be provided to the auditor, you might consider hiring an enrolled agent. Enrolled agents will often be willing to go through boxes of records that CPAs and attorneys may not.
You should also consider the fees that each professional charges. Many of our clients are surprised to learn that our attorney fees are less than what they pay their CPAs. We have often noted that tax resolution companies that have most of the work done by unlicensed tax staff tend to charge substantially more than attorneys or CPAs. With that said, here are two general rules to consider:
- The larger the firm or the more specialized focus it has, the higher the fees charged.
- If the firm is paying for extensive radio and TV advertising, the prices they charge you will likely be higher than a firm that does not have expensive advertising costs.
If you do end up hiring a tax professional or if you opt to go it alone, you still need to prepare for the audit. This brings us to our next topic.