As tax attorneys in Phoenix, we regularly represent clients before Internal Revenue auditors during audits. So, what exactly is a tax audit? In this piece, we'll discuss what to anticipate during a tax audit.
Individuals are responsible for their own tax filings in USA. In other words, it is the responsibility of each individual American to accurately and completely report all of their income on their T1 or T2 tax return each year. USA's self-assessment income tax system relies on the Internal Revenue conducting tax audits and issuing tax assessments to ensure its continued success. Most Americans are honest when filling out their tax returns, but some are not. Internal Revenue is inspecting submitted tax returns for mistakes, disputable positions, and intentional misstatements.
Definition of Tax Audit:
The purpose of an audit of a taxpayer's income tax returns and supporting documents is to ensure that all relevant income and expenses have been reported and are supported by relevant documentation. A tax auditor from the Internal Revenue will want to see your business's or personal bank statements, as well as any receipts you have for business expenses. In most cases, a corporation will need to produce its minute book to back up dividends or bonuses. There could be forms to fill out. Any false information, regardless of how it came to be, can and will be used as evidence against the taxpayer.
Most audits check for conformity with the provisions of the Income Tax Act, in the case of income or payroll deductions, or the Excise Tax Act, in the case of GST/HST.
Methods Used in American Tax Audits
Auditors from the Internal Revenue frequently conduct online research to gather additional evidence, and the information a taxpayer provides during an audit may be at odds with what they find when they search Google. This data will be used for follow-up questions, including those from third parties. Social media accounts that are open to the public can be mined by the USA Revenue Agency for evidence against a taxpayer. In a public forum, Internal Revenue officials have discussed utilizing taxpayers' social media accounts in this manner. The Internal Revenue tax auditor may investigate a taxpayer's situation if the taxpayer's lifestyle does not match their reported income.
When conducting an income tax audit, the Internal Revenue typically conducts a compliance review for GST (and HST); if issues are discovered, the case is typically referred to a GST/HST auditor for a more in-depth GST/HST audit. As with audits of GST/HST, an income tax compliance review may be conducted. After July of 2010, audits of both income taxes and GST/HST were conducted separately. As a result, large GST/HST issues may go unnoticed during income tax audits and vice versa if compliance reviews are not routinely performed.
Statistics from Internal Revenue Audits
Every year, Internal Revenue provides a report to the federal government. A new one came out in January of 2016. Although the Internal Revenue Annual Report 2014-2015 includes audit statistics, they are not as detailed as in previous years.
No data pertaining to micro, small, or medium-sized businesses were provided. The Internal Revenue states that their review of 12,981 files involving international and large business activity and 9,440 files involving aggressive tax planning resulted in the identification of $1.4 billion in fiscal impact. Over $448 million in monetary impact was discovered through Internal Revenue audits of 6,540 income tax and GST/HST underground economy files belonging to international and large businesses. There were fewer audits conducted across the board in 2014–15 compared to the previous year. The outcome of the revised budget plan, presumably.
Tax Audit Causes
There are multiple potential triggers for an audit by Internal Revenue. Some examples are:
Investigations into the Business Sector
Chosen attempts
Tips from Outside Sources
Anecdotal evidence of prior noncompliance
Analysis of whether or not all T-slips have been reported by comparing return data with information obtained from external sources
Since 2011, Internal Revenue has been conducting audits of high-net-worth individuals and families by sending out questionnaires seeking details about all entities under their control, including companies, trusts, etc.
To discourage unreported cash sales, Internal Revenue has also been focusing increased audit resources on the shadow economy.
When conducting a tax audit, what information should you expect to be requested?
The goal of an audit of a taxpayer's tax return is to identify any mistakes that may have been made. Some common problems that may crop up during an audit and lead to a tax assessment, penalties, and even a referral for a possible tax evasion investigation are as follows.
Misrepresentation of Costs
Exaggerated Savings
Income Tax Refunds That Were Overclaimed
Earnings that are either understated or nonexistent
Under-the-table transactions
Income from the web that is not being declared
Offshore banking and undisclosed wealth
Confidential offshore holdings
Undocumented deductions, such as those for charitable contributions, are not allowed.
Business-related personal expenditures
Any shareholder loans that are not repaid within two fiscal years of the company will be considered delinquent.
Legal Authority for Internal Revenue Audits and Internal Revenue Audit Procedures
The USA Revenue Agency (Internal Revenue) is authorized to conduct audits by law under Section 231.1 of the Income Tax Act. In particular, it allows auditors to access and review any records they want, including digital ones. Although a tax auditor may occasionally use Section 231.2 to issue a "demand" or "requirement," in most cases, s.231.1 will do the trick.
The Internal Revenue has the authority to conduct audits of any taxpayer it chooses, but the courts have ruled that this does not give the agency carte blanche to conduct arbitrary or capricious audits.
According to Internal Revenue Audit Manual 9.12.3, audits are generally restricted to the most recent year for which a return has been filed and assessed, plus the prior year for which a return has been filed and assessed, with some exceptions. An auditor can be made aware of this policy in an effort to narrow the scope of their tax audit, but it cannot be used to challenge a tax assessment in court. This one-year-plus-one-year rule obviously does not apply if Internal Revenue has reason to suspect that income has not been reported. In most cases, they will examine a time frame of three years.
The Internal Revenue "must follow it absolutely" by issuing a tax assessment for all otaxes owing, so long as they don't intentionally violate the Act, which is highly unlikely. While tax auditors do have some leeway in deciding whether or not to assess a given amount, once it has been correctly assessed, neither the Tax Appeals Officer nor a judge in Tax Court can reverse the assessment on the basis of equity, fairness, or compassion.
To Help You Pass Your Tax Audit, Contact a Tax Attorney in Phoenix
All day, every day, our leading Phoenix tax attorneys defend clients against USA Revenue Agency tax auditors. A taxpayer always has the right to legal counsel. In right 15 of the Taxpayer Bill of Rights, it is stated explicitly that "If you need help managing your tax and benefit obligations, you can appoint a representative. Once you give us permission to communicate with this person, we will be able to share information about your situation with them." Never meet with a Internal Revenue auditor without bringing a qualified Phoenix tax attorney with you. Any false information, regardless of how it came to be, can and will be used as evidence against the taxpayer. The auditor will also take notes, but there is a chance that they will misinterpret or incorrectly record the taxpayer's responses. A tax attorney in Ontario will have their own records to dispute the auditor's findings. As soon as a Internal Revenue tax auditor contacts you, contact our Phoenix tax law firm for assistance.
