Are you and your business ready for an audit?

Are you and your business ready for an audit?

While it remains to be seen exactly how the Internal Revenue Service will spend the $80 billion from the Inflation Reduction Act, it’s fair to assume that some portion will go to enforcement of tax laws, which includes increased audit activity.

There’s no crystal ball to know who’ll be selected, but we do know where the IRS’s Global High-Wealth Industry Group tends to focus its efforts and what you can do to be ready in the event you are audited.

Assets that may attract the IRS’s audit attention include:

  • Foreign or offshore bank accounts, trusts, business interests, overseas inheritance and associated reporting compliance
  • Partnerships and other pass-through entities, such as trusts, S corporations
  • C corporations
  • Private foundations
  • Giving practices

Regardless of whether you have or participate in any of these asset categories, some key proactive steps will leave you better prepared for an audit (and with a better understanding of your tax situation).

  • Develop a narrative summary. The purpose of this document, which may include an organizational chart, is to illustrate the foundational elements of your business, personal and charitable activity. The narrative documents the overall history of major recent transactions or changes and conveys clear explanation for items most likely to give IRS pause. Include photographs of major assets purchased or sold.  The narrative may also include a chronology and documentation of major real estate improvements, if applicable.

  • Compile a thorough accounting of key assets. Getting records of foreign assets can take time. For charitable vehicles, assemble careful record of any transactions that, absent these records and explanation, could be challenged as self-dealing.

The exercise of compiling the narrative and key assets may uncover for your tax preparer any areas where more clarification and documentation are needed. Consideration of privacy and privilege is important with this review.

  • Consider which of your business partners or family members might receive requests for information in the event of an audit. It may be mutually beneficial to coordinate tax preparation with these individuals within the limits of confidentiality provisions in business agreements.

  • Engage in a high-level pre-audit. This exercise helps identify gaps in records, anticipate any third-party summons and preemptively gather information and responses to potential questions or challenges.

  • Contemplate a preliminary audit plan and anticipate its potential scope. The first step of a Global High-Wealth Industry Group audit is to define its scope as well as initial expectations and timing. Identify ahead of time the types of records that may take extra time to compile or obtain so when the time comes to negotiate and navigate, you don’t overpromise.

  • Understand that the audit’s scope may expand and the IRS may request an extension of the statute of limitations, which is generally three years from filing. Granting the IRS additional time should be considered carefully and discussed with your tax preparer. Talking through these possibilities with your tax advisor when you’re not being audited can help you more readily absorb the information and prepare you to make the right decision under pressure.

  • Retain legal documents like real estate closing statements indefinitely, or for at least as long as you own the asset. Because the statute of limitations is generally three years, taxpayers often only retain documents for five to seven years. The exceptions to this rule are legal documents like real estate closing statements, leases, loan refinancing documents and, as mentioned previously, documentation of major improvements. It is prudent to keep these indefinitely.

Just as vacations and car purchases go more smoothly with preparation and inquiry, so do audits. Getting your ducks in a row ahead of time and “pre-gaming” potential trouble spots can make all the difference, not just for you, but also for the understanding of the auditors assigned your case.

Legal Disclaimer:  The information provided herein does not, and is not intended to, constitute tax, legal or accounting advice; instead, all information is for general informational purposes only. Information contained herein is subject to change and may not constitute the most up-to-date information. It is recommended that you contact your attorney to obtain advice with respect to any particular legal matter, and you should not act or refrain from acting on the basis of information contained herein without first seeking advice from your attorney. Only your individual attorney can provide assurances that the information contained herein – and your interpretation of it – is applicable or appropriate to your particular situation. All liability with respect to actions taken or not taken based on the contents hereof are hereby expressly disclaimed. The content herein is provided "as is;" no representations are made that the content is error-free.

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