Preparation for an IRS audit starts at tax filing time
By AdvocateDaily.com Staff
U.S. taxpayers living in Canada may be audited by the IRS at any time and for a number of reasons — but the best time to start preparing for the audit process is not when the notification arrives, but when the original tax return is filed, Oakville-based U.S. tax attorney (NY, DC) Alexey Manasuev tells AdvocateDaily.com.
As Manasuev, principal of U.S. Tax IQ, explains, while there are some simple cases and scenarios, U.S. tax is a complex area — and U.S. international tax is even more complicated, especially in view of tax reforms introduced in late 2017.
“It’s overwhelming for both individuals and businesses, but it’s even more so for U.S. citizens and green card holders who reside in Canada and outside the United States. For them, compliance and dealing with U.S. international tax issues are quite complex and costly.”
At the same time, he says, many taxpayers think about tax return preparation as a stand-alone 'commodity,' which wouldn't generally consider any potential audits.
Audits, says Manasuev, can happen as soon as a couple of months after the IRS processes a tax return, or up to three years later, which is within the general statute of limitations. Exceptions to this include cases where there has been fraud, or where a return was not filed when required. The audit process can take anywhere from four to six weeks to a few years.
“Many tax return preparers just fill out the returns and file them, as if they were closing their eyes and throwing a dart without knowing where it’s going to land, and 99 per cent of the time, it actually ends up in the right place.”
The taxpayers in these cases often aren’t paying for analysis, research, or for the preparer to document the tax position taken — which Manasuev says is key when it comes to defending an audit if one arises.
“In the future, if the IRS were to audit them, they would actually end up spending much more money on defence, because they would have to develop those positions at the time of the audit. When you document your tax filing position for this year’s filing — say we are working on 2018 and your 2018 tax year is audited in three years, still within the statute of limitations — do you think you will remember anything in three years?”
“When you do rely on your memory, that may not be the best strategy when you deal with the audit defence, because the facts may suggest otherwise and there may be some evidence that the tax authorities have that may be contrary or not as helpful to the taxpayer’s case,” he says.
Instead, says Manasuev, his firm develops tax filing positions at the time of preparing and filing tax returns.
“We put quite a bit of effort and time into documenting and making sure that whatever tax position we take we can support.”
“In some cases, if the issue is uncertain, if there may be a possibility for a challenge by the tax authority and it is not black and white but potentially has different interpretations, then you would want to document your analysis and conclusions," says Manasuev.
Although this service requires taxpayers to pay more for advice and compliance services, Manasuev says it is often a worthwhile investment.
“In our experience, when you have a fully documented position and support at the time you prepare and file the client’s tax returns, when the IRS comes back and audits you, and you present your analysis, the IRS usually is satisfied, and there are no additional issues raised.”
The audit process itself, says Manasuev, starts with an IRS notice that advises the taxpayer that a particular tax year has been selected for an audit. The tax authority may audit narrow issues or review the entire tax year.
Some issues, he says, are automatically spotted while reviewing a return and may automatically generate an audit — for example, the return may have information that doesn’t fit with how it should have been completed, or some lines may be missing or miscalculated.
Audits may also depend on particular campaigns that the IRS is running at a certain point in time.
For example, he says, the IRS initiated large international compliance campaigns in 2017 aimed at businesses, which included several tax issues that were not previously in focus.
“Now the IRS puts those issues into focus, reviewing tax returns and tax positions taken by taxpayers as relating to those issues.” Some issues being looked at include transition tax under s. 965 brought in by recent tax reform and filing by Canadian and foreign corporations.
“There is a higher chance for taxpayers to be selected for an audit if their return contains one of those transactions or issues that are identified by those campaigns," says Manasuev.
“A lot of taxpayers have been hit with transition tax under s. 965 so you would expect that this would be a highly audited area,” he adds.
The most critical factor during the audit process, Manasuev says, is to think about the possibility of an audit when you are preparing and filing your tax return with the IRS.
“Second, documenting the tax filing position is crucial and setting support by applicable tax authorities and having developed the facts in the case contemporaneously with taking that tax position is also quintessential," he adds.
When the audit process is underway, Manasuev advises taxpayers to be respectful of the IRS agent.
“Ultimately, it is in the taxpayer’s best interest to work through the issues with the IRS agent and try to resolve the case as fast as possible by being transparent and providing all necessary information as long as it is required by law.
“Sometimes the information requests may be excessive, and it takes a qualified U.S. tax adviser to understand what needs to be provided as opposed to what is required to be provided, and then you can still provide that information, but you may still want to point out that it is not required and the taxpayer does it just in terms of full co-operation and in the spirit of openness,” he adds.
In addition, he says, “You don’t want to take inconsistent positions on both sides of the border because ultimately that can come to light, considering the exchange of information between the IRS and CRA and other tax authorities.”
It is also crucial to respond to the IRS examiner’s requests in a timely manner and provide any information and support to the positions taken as requested.
“There are a lot of procedural requirements that need to be followed, and it’s quintessential to respond to the IRS and the tax authority’s inquiries within the time that was given to you, and if there is no possibility to do so, you should reach out to the agent and request an extension. You shouldn’t just ignore the time deadline and file whatever response outside of that deadline without having been granted an extension by the respective tax authority.”
Taxpayers who have retained a qualified U.S. tax adviser to represent them before the IRS should advise the tax authority to deal with the representative — whether a U.S. tax attorney, Certified Public Accountant (CPA), or whoever is assigned on the power of attorney to represent the taxpayer.
Clients who rely on the advice of a qualified U.S. tax professional, he adds, are also protected from potential penalties as a result of reasonable cause defence. If the case is not resolved through the examination process and goes to an appeal, working with a U.S. tax attorney can also be helpful due to the procedural nature of an appeal.
The ideal outcome of an audit, says Manasuev, would be for a taxpayer to provide the requested information and documents, and for the IRS to consider this information to be satisfactory and sufficient and agree to close the case.
Ultimately, when the matter concludes, says Manasuev, taxpayers should be sure to get the closing letters.
This, he adds, ensures “that the audit has been concluded and so that, in the future, that year is not audited again, and they have evidence of the audit having been concluded.”