Click here to enlarge imageIt pays - literally - to know your audit triggers. Several doctors commented on "red flag" items that can trigger an IRS audit. These items includes unreported income, tax shelter losses, offshore transactions, complex investment and business transactions without adequate documentation, large deductions relative to the doctor's income, and sloppily prepared tax returns.
Our basic advice is for doctors to report all income and be aggressive in taking deductions. One doctor responded, "Avoid red flag deductions at all costs." We feel this advice is overly conservative and recommend doctors claim all legitimate deductions, even in red flag areas. Take them, but make sure that your deductions are properly reported and thoroughly documented. Keep good records.
Maintain good records
Doctors should make sure that they have proper backup for each and every deduction claimed. One surveyed doctor gave this excellent advice: "Keep meticulous records, receipts for all deductions, credit card statements, automobile log, trip and continuing education itineraries, meal receipts, and everything else."
Another doctors adds, "Have a talking argument for all deductions claimed in gray areas. Write out your argument and place it with that year's tax records incase it's needed."
Be organized and prepared
One doctor noted the necessity for proper advance planning when claiming deductions. He states, "Plan, plan, plan! Learn what to deduct and keep excellent records, and then deduct aggressively.
Another doctor recommends keeping meticulous records. Be prepared to support all deductions with outside sources, such as letters, documents, and legal case precedents. Another doctor advises his colleagues to review those tax returns selected for audit for potential areas of vulnerability. This allows the doctor to gather the necessary records to support the deductions taken before the IRS review. "Good organization and preparation saved us several thousand dollars in additional taxes," he notes.
Respond promptly
Upon receiving an IRS notice, many doctors choose to ignore it, and hope it will go away. Unfortunately, that won't happen. Failing to respond in the time allotted typically results in disallowance of all deductions as well as additional interest and penalties.
"Don't panic," advises one doctor. "Start reviewing your tax return and supporting records for the year in question, and determine whether you wish to retain your CPA, tax attorney, or other professional to represent you."
Contest notices
In many cases, the IRS conducts a correspondence, or mail audit. The agency will simply bill the doctor for additional taxes, interest and penalties after reviewing the tax return. While some 50 million of these notices are mailed annually, as much as 50 percent contain errors.
Doctors are urged to not write a check until all records have been thoroughly reviewed. If you did make a mistake, the best option is to simply pay up as quickly as possible to prevent interest from accumulating. However, if you have information that you feel proves the IRS notice is wrong, simply return a copy of the notice with a letter, along with copies of documentation that supports your position. It is important to act and get the matter corrected as expeditiously as possible.
Use professional assistance
If your IRS audit involves only requests for documentation to support claimed deductions, or involves less than $5,000, you may wish to handle the audit yourself. However, most doctors surveyed recommend having a CPA/tax attorney handle it all. They agree that the benefits of professional representation far outweigh its costs.
Retaining an outside CPA or other tax professional, for example, can provide a reasonable basis for a time extension since the advisor must be educated on the issues. This strategy also allows the doctor to get a troublesome field audit transferred from the office to the advisor's place of business. This not only removes the distraction from your practice, but prevents the IRS agent from stumbling onto additional issues (business car, family members on the payroll, etc.).
Using an advisor can prevent the doctor from volunteering information that is not requested or offering information that could prove damaging to the case. A professional advisor can also help minimize auditor's requests by demanding that all information requests be submitted in writing.
Finally, since agents are pressured to close cases quickly, the inevitable delay associated with a representative working the case can convince the IRS that further scrutiny will not be cost effective.
Contain the audit
Many doctors recommended that their colleagues do everything possible to limit the scope of an audit to minimize the potential damage. Most stated that while doctors should cooperate, they should only provide the specific information requested.
Doctors also unanimously recommend letting the representative do the talking, thereby avoiding volunteering information that could prove harmful to the case.
Know your rights
Doctors recommend that their colleagues know and exercise all of their rights. For example, you do not have to show up for an office audit on the date the IRS assigns if it is inconvenient, or if further time is required to gather records. In either case, time extensions are readily available
The IRS agent must explain your rights to you in the event of an audit. Another reader added, "Don't get rushed, confused, or intimidated! If there is a personality clash between doctor and/or his representative, and the auditor, contact the supervisor and request the auditor be replaced."
Doctors also have the right to stop representing themselves and retain professional assistance at any time. They have the right to tape record all proceedings if they wish, and to keep copies of all documentation requested by the IRS agent to provide an audit trail.
Many doctors have been asked to voluntarily furnish tax returns from other tax years not directly under examination. Since this information is already within the possession of the IRS, there's no requirement that the doctor turn it over.
Doctors are often asked to complete Form 4822, Statement of Annual Estimated Personal Family Living Expenses, as part of the IRS examination. Usually, the IRS requests this form when it is trying to build a criminal tax fraud case against a doctor for unreported income. Since the IRS has the burden of proof in such situations, the doctor does not have to complete this form.
Finally, doctors and their advisors may be able to negotiate a reduction in interest in the vent the IRS audit drags out unnecessarily. Filing Form 843 allows doctors to reduce their tax bill for interest "caused by IRS error or delay."
Reconstruct records where necessary
In many cases, audited doctors receive requests for records that they do not have. Many will simply throw in the towel at this point and pay unnecessary taxes.
Several doctors recommend using the Cohan Rule to reasonably approximate legitimate deductions for such things as petty cash, tips, delivery charges, small tool and supply costs, cleaning and maintenance charges, etc. Reconstructing records is generally allowed, especially if such records were destroyed by fire, lost to theft, or are unavailable for a valid reason.
For example, one doctor received a gift of real estate but lacked records on the original cost. The doctor, using courthouse property records, determined the original purchase date. He then calculated the original cost by working back from the property's current value. He used a real estate appreciation index to "guesstimate" the cost and determine the gain after selling the property.
Stock tracking services can provide the cost basis for shares purchased or received as a gift from years back. Mutual fund service representatives can in some instances provide information on the original cost basis for purchases with additions for reinvested gains and dividend distributions.
Building contractors may be able to provide information regarding the cost of improvements to a home or business property where detailed records are no longer available. Property tax offices also typically record the dates and reasons for increases in real property values.
Negotiate everything
Many doctors urge their colleagues to negotiate everything when dealing with an IRS audit. The amount of information requested, the dates and times for audit meetings, as well as the scope of the examination, are all negotiable. Avoid capitulating to the demands of the IRS agents involved.
Surveyed doctors also recommend not accepting or negotiating adjustments while the IRS audit proceeds. Too many concessions result in a surprising large tax bill. It's best to simply wait until the end of the audit and negotiate total dollar amount. Since most IRS auditors want to close the case as quickly as possible, offering a total dollar amount at the end provides an incentive to "take the money and run."
Finally, if you disagree with the amount offered as an adjustment, demand that the auditor reviews the data supporting your claims and justify all the conclusions. Doctors and/or their representatives can ask for a meetingwith the auditor's supervisor. Since this will involve an additional delay, it may facilitate a speedy compromise.
This article was reprinted with permission from The Blair/McGill Advisory, a monthly newsletter dedicated to tax, financial planning, investement, and practice-management articles exclusively for the dental profession. For more information on The Blair/McGill Advisory, call (704) 424-9780.
