If the taxpayer agrees with the proposed adjustments in the letter, he signs the agreement and pays the assessment. Alternatively, the taxpayer may dispute all or part of the adjustments. He has the right to pay only those adjustments with which he agrees and to request a review by an appeals officer within 30 days. When the case moves to the IRS Appeals Division, your representative will present information to support your position. He will generally use information not considered by the government in its final report. If you lose your appeal, your next recourse, unfortunately, is tax court.

Nemo Perera and Doug Rogers are executives with Risk Capital Partners, a risk-consulting firm with offices in Los Angeles and New York. Rogers formerly served as director of penalties and interest for the IRS.

Flying Solo: An Expensive Lesson

One of our clients confessed that he had been skimming funds off cash receipts that represented 30 percent of his gross profit. He initially entered the audit representing himself, having full confidence in his ability to handle the auditor’s questions and hoping to avoid having to tell anyone of his skimming activity. His confidence was short-lived. During the initial interview, the auditor asked for all supporting documents to substantiate the claimed cost of the goods he sold. The client produced his records, but an analysis of the data showed that the invoices for purchases, minus returns and allowances, resulted in a much greater cost of goods sold than was reported on the return. When the auditor began to follow up on this issue, the client’s world started to cave in and he finally sought help.

In the end, the client’s audit expanded to three years, and, when the questionable funds were included in his earnings, his net profit increased by 30 to 40 percent for each year in question. The net tax increase ranged from $150,000 to $250,000. The IRS also added a civil fraud penalty amounting to 75 percent of the tax adjustment for each year. By employing a professional from the outset, the taxpayer could well have lessened the final tax adjustment by identifying the under-reporting prior to sharing his records with the IRS. Then he could have provided corrections to the agent with an explanation of what was not reported, how he identified it and actions he took to eliminate future under-reporting. This may have led to the assessment of an accuracy-related penalty: 20 percent in lieu of 75 percent for civil fraud.

The advisor may also have won a smaller penalty by removing any bias that might have developed during the taxpayer’s initial interactions with the auditor, allowing a more objective and fair assessment of the actual tax due. While no professional will help an individual defraud the government, an advisor can help ensure that a questionable situation is resolved so that the amount of tax paid is assessed fairly and that punitive penalties are limited or avoided if the taxpayer demonstrates good-faith efforts to ameliorate the disputed transactions—rather than a belligerent attitude that may become evident if a taxpayer attempts to negotiate the matter himself. The IRS wields latitude in assessing punitive penalties. A professional can present a taxpayer’s case in an objective light that can often remove any rancor that may have grown between an auditor and a taxpayer.