Pursuant to the “Taxpayer Bill of Rights,” enacted by Congress as part of the Internal Revenue Code, the IRS is required to disclose to taxpayers their rights, and the obligations of the IRS during the audit, appeals, refund, and collection processes. In the event that the taxpayer is audited, an awareness of the audit process, and rights accorded to the taxpayer during it will best enable him or her to meet the challenge.

Assume that a hypothetical taxpayer converts a personal residence to a rental unit in 1993, sells the unit shortly thereafter, and claims a $15,000 loss on his 1993 return.

What are the chances of this taxpayer being audited?

Normally, losses on the sale of a personal residence are not allowable, but losses from the sale of a rental unit are. Since the residence was sold shortly after its conversion to a rental unit, the likelihood of an audit is increased substantially. Despite the common belief that audits are a random process, the phrase “audit-lottery” is misleading. Since audits are designed to produce additional revenue, the probability of an audit depends in substantial part on the amount of additional revenue which the IRS believes it might collect were the return to be audited.

When will the taxpayer’s 1993 return no longer be subject to the threat of an audit?

Generally, 3 years after it is file. However, if the IRS suspects fraud, the taxpayer’s return may be examined and subject to an audit forever. If the IRS asserts negligence, the statute of limitations is 6 years.

What are the procedural aspects of an audit?

Some audits are conducted by means of correspondence between the IRS and the taxpayer. These audits usually involve matters such as substantiating medical deductions claimed on a return. In other audits, the IRS asks the taxpayer to meet with an IRS auditor at the office of the District Director. Complex returns may require an IRS revenue agent to visit the taxpayer at his place of business in order to conduct a “field examination.”

Must the taxpayer cooperate with the IRS during an audit?

Yes; the taxpayer must furnish various records and books to substantiate deductions or transactions reported on the return. Privileged workpapers of the accountant, however, are seldom requested. Nonetheless, the taxpayer is accorded many important rights during the examination and appeals process. First, he has the right to suspend an interview with any IRS employee in order to consult with a tax professional. The taxpayer also has the right to be absent from any meeting with the IRS if so represented. If the taxpayer has relied on erroneous written advice furnished by the IRS, any penalty or addition to tax attributable to that erroneous advice must be abated.

Can the taxpayer “bargain” with a revenue agent conducting an audit?

Technically, no. Revenue agents have no formal settlement authority as such. However, factual disputes can be resolved, and areas of disagreement can be narrowed. Some factual differences may be amenable to solution by means of informal conferences with the revenue agent’s supervisor.

What occurs at the conclusion of an IRS audit?

If the IRS is satisfied with the accuracy and propriety of the taxpayer’s return, it will simply accept the return as filed. Alternatively, the Service may propose a “deficiency” and in so doing issue an examination report, along with a letter requesting that the taxpayer accept its findings by executing and returning to the IRS within 30 days a “consent to assessment and collection.” The taxpayer need not affirmatively respond to this “30-day letter.” However, during the 30-day period,  additional evidence may be submitted, or a conference with a senior examiner may be requested. The taxpayer may also request a conference with an appeals officer who, unlike the revenue agent, does have authority to settle issues of fact and law. Appeals officers will generally consider any offer made in good faith.

What happens if further conferences are unavailing, or if the taxpayer  disregards the 30-day letter?

He will be issued a “90-day letter.” Also known as a “notice of deficiency,” the issuance of this letter puts the taxpayer at the crossroads of his dispute with the IRS. Upon receipt of this letter, the taxpayer may either pay the tax or not pay it. If, during the 90-day period the taxpayer files a petition in Tax Court for a “redetermination” of the deficiency, the IRS is not permitted to assess any taxes until after the conclusion of a Tax Court proceeding. Therefore, the taxpayer has the right to fully contest the merits of the dispute before paying any additional taxes. However, if the taxpayer ultimately loses, he will be assessed the tax, plus interest which accrues during the dispute. Despite the interest penalty, the vast majority of taxpayers prefer to litigate in Tax Court rather than prepaying the asserted tax deficiency, and then bringing a refund suit in U.S. District Court or Claims Court.