An Internal Revenue Service audit is when the IRS reviews an individual’s or a company’s financial records and accounts to make sure that information is being properly reported and to verify the taxes being reported. Even though an IRS audit does not necessarily mean that an error has been made, no one wants to be audited by the IRS. An IRS audit can be cumbersome, laborious, and time consuming.
In any event, you can still significantly reduce the likelihood of an IRS audit if you take the time and expense to prepare your tax returns.
Retain Records for an IRS Audit
If the IRS, however, does conduct an audit, the IRS will notify you by mail or telephone and will provide you with a request for specific documents. In general, you should keep your documents for a period not less than three years after your tax return was filed. Not only does the law require you to keep your records used in the preparation of your tax return, but these documents are necessary to help defend an IRS audit.
If you do not have the documents to support your tax return, then the IRS can use this lack of evidence against you. A recent decision from the United States Tax Court, which was affirmed with the United States Court of Appeals, highlights the importance of retaining your records in order to defend against an IRS audit.
IRS Uses Lack of Backup Documentation Against Taxpayer
In Hoang v. Commissioner of IRS-a case that underscores the importance of record retention-taxpayer Mr. Hoang filed his 2006 tax return three years after it was due. His 2006 return showed an adjusted gross income of $22,921.19 and $13,221 in taxable income. The section for taxes paid and owed was left blank.
The IRS was skeptical of his tax return because various brokerage firms indicated Mr. Hoang received almost $15 million in proceeds from securities sales in 2006. Given the discrepancy between this and Mr. Hoang’s tax return, the IRS issued a notice of deficiency for more than $5 million in income taxes for 2006, as well as other penalties. The IRS assumed the entire $15 million was capital gains because there was no information about the cost basis for the securities.
Mr. Hoang, who represented himself, failed to provide any backup documentation for how much he paid for the securities. He claimed all of the documents were discarded. What is more, he failed to respond to various other discovery requests from the IRS.
The Tax Court found that Mr. Hoang had almost $15 million in capital gains during the 2006 tax year and had to pay more than $5 million in taxes on the gains. The Court of Appeals affirmed the Tax Court’s decision because Mr. Hoang “had many opportunities to show why this requested admission was incorrect.” And given the failure to provide a cost basis for the securities, the IRS correctly determined the entire amount was capital gains.
Contact a California Tax Attorney
This case is important for two reasons: first, it highlights the importance of having an attorney assist a taxpayer in an IRS audit. Mr. Hoang, who represented himself, could have helped his case if he responded to the discovery requests. Second, it is important that taxpayers retain their records for an IRS audit. Mr. Hoang’s lack of documentation resulted in a tax bill of more than $5 million.
If you have questions regarding an IRS tax audit or other tax-related matters, our experienced tax audit attorneys can help you. We have several office locations throughout Southern California. Contact us today for a free case consultation.
