What does an IRS interview request entail when called in to verify expenses for a sole proprietor small business?

Question

I received an IRS audit for the following:

I had to call them within 10 days to confirm receiving the letter. And I've scheduled an appointment 2 weeks later.

They basically said I just need to come in with bank and credit card statements for the years in question and they will go over it. They also mentioned my filing red flagged due to my expense and income ratio was much greater than previous years.

My question is:

• Should I hire a tax person to represent me? Or go in myself? I'm just afraid of saying the wrong stuff.
• Yes, I have all my expenses organized as I mostly buy stuff from amazon and ebay related to my business, but obviously there could be items that are "questionable".
• What are some other things to be aware of?

There isn't much info and stories of others that has had a interview audit for "all expenses" relating to a business such as "cost of goods sold".

Answer 1

Should I hire a tax person to represent me? Or go in myself? I'm just afraid of saying the wrong stuff.

I can't tell you whether or not you should hire someone, but here are some things you should consider:

• Penalties/Interest: After an audit, if you owe additional tax you'll pay 0.5% per month up to 25% of owed amount in penalties and will also pay interest at 3-6%.

• Fraud vs Negligence: If you messed up pretty badly (without it being considered intentional), you may be considered negligent, which would result in an additional 20% penalty (based on additional tax owed). If they believe you deliberately evaded taxes you could face civil or criminal tax fraud charges. Civil tax fraud can result in an additional 75% penalty (instead of the 20% negligence penalty), while criminal tax fraud can result in very high fines and jail time.

• Cost of representation - Depending on your income/deduction levels the cost of an attorney could vastly exceed the additional tax/penalties that the audit resulted in. Of course, if facing criminal tax fraud charges I'd want an attorney. This doesn't mean representation has no value, just that the monetary benefit (if any) they can provide is most likely going to be less than it costs to hire them.

Most audits end with no change. Next most common are those where there is a change and the taxpayer owes penalty/interest, but they are not considered to have been negligent or to have committed tax fraud.

Personally, I wouldn't hire someone to represent me in an audit because I am pretty confident that all of my deductions are well-supported and appropriate and that any mistakes I have made wouldn't be considered fraud. I'm also familiar enough with the process that I'm not particularly anxious about audits. Many people find audits to be very stressful and aren't confident about their tax preparation, so paid representation can be very helpful to them.

If I were to hire someone I would most likely hire a tax attorney rather than a CPA/tax-preparer. Attorney-client privilege is a big deal.

Yes, I have all my expenses organized as I mostly buy stuff from amazon and ebay related to my business, but obviously there could be items that are "questionable".

This is the most concerning part of your question. If you just mean that you understand why the IRS would want you to provide supporting documentation or justify them, then this is less concerning. If they are questionable because you know it's 'creative' or not typically acceptable then that could be problematic.

What are some other things to be aware of?

Since this letter is not a summons, you do not have to appear, a representative can handle this 'examination' for you.

If you paid for tax-preparation you may have some sort of audit assistance available to you, that might be worth looking into.

Answer 2

Prove your business expenses and cost-of-goods-sold

Let's start with 2015. Start by looking at what you claimed. You need to produce documents to support the expenses and CoGS that you claimed on your taxes. They are looking to see

• that you really did lay out the money
• that it was an actual business expense or inventory purchase, and not a disallowed use. E.G. buying "inventory" that's really for personal use, claiming square footage of the house for a home-office that is actually mixed-use, whatever.

I hope you kept the physical documents. If you didn't, you may be able to collect them "online" from Amazon or (less likely) eBay. Amazon keeps purchase history in their system for a couple of years, eBay not so much. I recommend downloading them into "PDF" format and putting them in a computer folder of the tax year and the purpose of the receipts.

That way you can show the auditor the PDFs instead of having to go online (and the Internet will be lagged/down/forgot password when you try).

I have a scanner which lets me do the same with paper docs. And I have Acrobat Pro which lets me bundle up bunches of PDFs into a single PDF. In my phone call with the auditor I would offer to just email him the PDF bundles.

Really, documents are what they want to see. They don't care so much what you have to say. Of course, if you don't have documents and all you have is your talk... then (for you) it becomes a desperate search for the magic words, and (for the IRS) the comic relief of watching the taxpayer put his foot in his mouth. And they will troll you into saying the wrong things. So in that case I'd bring in your accountant and let him do the talking.

Answer 3

Just came back from my interview IRS audit. Here's my experience:

My appointment was at 10am. When you arrive you have to call the agent to come out to get you.

I went with my business partner just so I don't go alone as I'm not sure if I might say the wrong thing and also to backup our claims on certain expenses.

I spent a good 1-2 days to prepare for this "expense" audit. What I did was look at my tax return and under your schedule C for expenses, I found all the expenses that backed up those numbers. What they really are looking for is how did you come up with the expense numbers you have on your tax return. So for example, you have advertising for $5000 for the year. Show all the expenses in the year that adds up to $5000. We use expensify.com to track our expenses, so it was easy to filter each category to output the expense numbers which is what we used in our tax return anyway. You can also do this in a spreadsheet by compiling all the transactions from your statements and just picking out those transactions that pertain to that category. Just keep in mind what you pull out from your statements should add up to $5000 advertising. They will look at this spreadhsheet and pick out a random one and cross reference it to one of your statements. Below is an example of how it might look:

You should have a page full of transactions just for each category with the total added up that matches what you have on the tax return under expenses.

My agent went through each category and asked for my spreadsheet breakdown. He would look through the page and randomly pick out ones that looked "questionable" and ask us what did you buy here at "urban outfitters" as it doesn't seem like a business expense. Keep in mind every transaction can be "questionable" depending on the agent as it's all really subjective from this encounter. After questioning us about it, we gave our argument, or some times we just said yeah we need to get the actual receipt and see what we bought. As we did not bring any receipts, but only bank and credit card statements. It wouldn't make sense to bring all the receipts because it would be thousands of papers especially if you run a business that deals with inventory.

As the agent goes through each category of transactions, he doesn't go through all of it. In our case he at most looked at less than 5 transactions per category. We had 50-100 transactions per category. Bottom line, its partially luck and really up to the agent if he wants to be extremely detailed or just let things go if he sees something off.

What really helped I believe is being able to come off as genuine about the situation and your business. Also being able to make small talk and have a talkative personality is a BIG plus. End of the day, the agents are just regular people and they can easily screw you over if they wanted to as many of their decisions are really subjective if you cannot defend your reason for an expense. Basically, get on their good side. We really lucked out as they only checked 2016 and they only penalized us for 2% of that year and then used that same percentage for 2017 and didn't even bother looking at 2017 as they assumed it would have the same issues as 2016.

After stressing over this for a good 2 weeks, it really wasn't that bad assuming you have most of your paper work in order. If you don't, its just all based on what you say and if they will believe you or not.

Other notes:

• If you don't have all your paperwork, and they want you to prove an expense, they give you a few days to find it. If you cannot find it, it would just be considered as income and have to pay taxes on it. Not that big of a deal...
• Some agents might not be as detailed. So they might not look at everything fully and just accept your expenses. This is just based on luck.
• We looked into someone to represent us, but it cost $5000. Most people might not need to hire anyone unless you have some very shady stuff going on and cannot explain certain expenses at all.
• After you get your bill if you owe anything, you just wait 2 months to get the actual bill in the mail and pay online. And also you might get a State tax bill on that income aswell in about 6 months.
• Hope they do not outsource IRS audits to AI bots in the future, as they would have no mercy on your audit. The fact that you are able to talk to another human, brings in the element of "human errors", "subjectivity", and empathy.
• I had a hard time finding others in the same boat that actually gave me sane advice on what I'm dealing with. Yes, sure you can read stuff online, but they all say the same thing as in bring in your expenses and make sure its all documented. But lets face it as a small business owner, you do not have everything perfectly documented, what do you do in that scenario? No one mentions that you can literally "talk" your way out of things in these audits. Others looking for advice can msg me if you want.