Tag Archive for: IRS audit letter

IRS Audit Letter

In the final part of our three-part series “how to respond to an IRS audit in 2022,” the IRS Audit Attorneys here at Milikowsky Tax Law focus on the actual response to Internal Revenue Service (IRS).

Watch the video below to learn more from Milikowsky Tax Law’s Founder and Managing Attorney, John Milikowsky, as he explains how to craft the right response.

The Initial IRS Audit Letter

When IRS sends the initial IRS audit letter, they send Letter 6323 initiating the audit. This initial letter gives small businesses 10 days to contact the assigned revenue agent. The reason for the quick turnaround time is to schedule an appointment with the assigned revenue agent to go through a litany of questions to determine the following:

  • What income do you have
  • What sources were they from
  • Whether you have cryptocurrency
  • What form of bank accounts did you use
  • And more

What Should You Do After Receiving IRS Letter 6323?

After receiving IRS Letter 6323, review your business’s tax return before meeting with a tax attorney. Partnering with a trusted tax attorney will help guide you to understand the scope of what this audit involves. Moreover, this tax attorney can help create your response to the initial letter within the 10-day timeframe.

What Happens If I Don’t Respond to IRS Letter 6323?

Failure to respond to IRS Letter 6323 in a timely manner will result in an Information Document Request (IDR). The IDR includes bank statements along with any other information relating to what is reported on a tax return—or includes whatever additional information IRS has in their database.

Businesses that fail to respond to IRS requests typically result in the following: The government agency will estimate the business’s income along with disallowing most, if not all business expenses and any other deductions. The business’s income is typically a higher amount than what is reported on the income tax return. Why? Because IRS doesn’t have the source information.

Anticipate IRS summoning your bank account because they don’t need a court order to do so. A revenue agent can send a signed document to your bank requesting all of your bank statements, canceled checks, and deposit items in order to estimate what income should be.

They don’t, however, have the ability to receive the source documents for your expenses. If it relates to your business or charitable contributions, the agency will not look into that—which means they will be disallowed.

More times than not, failure to reply to IRS Audit Letter 6323 does not benefit your business. After the audit review, if you do not respond to IRS Letter 6323, the government agency will calculate a much higher number for taxes due than what’s on your tax return. Because of this, it’s encouraged to respond to IRS in a timely manner.

Another negative consequence of failing to respond to IRS is it can increase the scope of the audit to other issues that IRS may not have been originally looking at, as well as additional years than originally intended.

What To Do If You Receive Audit Letter 6323?

If your business receives Audit Letter 6323 from IRS, contact a tax attorney and your CPA. They will help defend your business against the consequences of an IRS audit.

By partnering with a tax attorney and your CPA, you recruit a team of experts who:

  • Comb through your source documents
  • Understand each of your deposit items in your bank account
  • Ensure accurately reported income
  • And more

This way, you are prepared to fight back from IRS claims and come out unscathed on the other side.

An added benefit of partnering with an attorney is protection through attorney-client privilege. If your business misfiled taxes, accidentally or purposefully, you are protected by attorney-client privileges.

Communication with a CPA is not protected in the same way. A trusted CPA, especially if your case leads to any type of fraud or criminal investigation, could be summoned before a grand jury, along with the information requested from him or her.

From day one, speak with a San Diego tax attorney to make sure you have the best strategy implemented, and that your communications are protected.

For more information regarding IRS audits, read our article explaining five signs your business is prepared for an audit by IRS.

Bank Deposits

IRS Letter 6323 and Bank Deposit Analysis

In part two of our three-part series “how to respond to an IRS Audit in 2022” we discuss IRS letter 6323 and the bank deposit analysis. For every audit IRS opens, they conduct a bank deposit analysis to determine whether you correctly reported your income on your income tax return.

Watch John Milikowsky, Managing Attorney and founder of Milikowsy Tax Law explain more on IRS Letter 6323 and their bank deposit analysis below.

What is a Bank Deposit Analysis?

During a bank deposit analysis, IRS adds up all of the deposits from all of your bank accounts: both personal and business. Once gathered, they compare the amount they calculate to the amount you reported on your income tax return.

Keep in mind that there are, of course, non-taxable deposit items. Provide these source documents to IRS to ensure the numbers match. Such items include:

  • Transfers between bank accounts
  • Drawing money from a line of credit
  • Insurance proceeds (which are generally non-taxable, although they may be in certain citations)

If you don’t provide all of your bank statements to IRS- including both business and personal accounts- IRS will summon your bank directly to receive your statements and deposit items.

Learn more about IRS looking into your bank deposits here. 

The agency summons your statements because they need to confirm whether you’ve accurately reported income on your tax return.

The best practice to prepare for an audit in 2022 is to collect these items ahead of time, and then review the statements with your CPA and tax attorney. If during your review you determine that there’s a significant difference between income reported and actual income found after review, it will need to be explained.

The gap in reported pay versus actual pay sometimes occurs accidentally (or intentionally in the case of fraud) by miscalculating income because you left out some income. If this occurs, it can lead to a grey area where the support of an experienced tax attorney will help defend your business.  Any communication you have with your tax attorney is attorney/client privilege- which means it is protected information. IRS does not have access to it.

Review your deposit analysis ahead of time with your CPA or tax attorney to implement a strong strategy for your specific case. If there is an explanation for why the income wasn’t reported, make sure you clarify why it occurred before IRS  provides that information to you. If the agency finds the discrepancy first, it puts you at a disadvantage to then review source records and then come up with an explanation.

For more information, read our last part of the three-part series in “how to respond to an IRS audit in 2022” here.

Tax Calculation

IRS Letter 6323 and What to Do Before Contacting IRS

Small business owners should be prepared in case the Internal Revenue Service decides to audit your business. Watch part one of our three part series for advice on how to defend your business against a battle with IRS.  In this video, our founder and managing attorney, John Milikowsky explains five things to do before you respond to an IRS audit letter.

Identify the Taxpayer

Before diving into your audit letter, first identify who the taxpayer is on the top left corner of the letter. If the letter is addressed to you as an individual, IRS is primarily looking at your 1040 return.

This can include other companies you own or control where the income and/or losses are being reported on your individual return.

If the letter addresses your company’s name, then you can expect a broader audit. A broader audit can impact other shareholders and partners.

Identify the Revenue Agent

After identifying the taxpayer, review who the revenue agent is. The revenue agent can be located either inside of your city or outside of your city.

If the agent is located outside of your city, we recommend you question why.

Recently, we defended a client in a battle against IRS. The client is based in Los Angeles, but their revenue agent was based in Chicago, Illinois. This identified larger issues at play- IRS was potentially looking at not only this tax return but possibly other tax returns as well. In this case, they could be part of a broader, national audit.

Identify the Tax Year Being Audited

Confirm the tax years IRS is auditing. Ask yourself, “Is it a single-year audit?” or “is this audit for more than one tax year?”

Typically IRS will audit three years of tax returns. Initially, they may begin with a single-year audit.  Depending on the results of the audit, they’re may explore other years to identify a trend.

IRS can audit as far back as 6 years, if there’s gross understatement of income. If there is fraud involved, IRS can audit an unlimited number of years.

Typically, if IRS is looking at a 5-year block of time, they are looking at a potential fraud issue- which could lead to a criminal investigation. Before they can determine if a case involves fraudulent activity, IRS will review your returns in detail to identify any incriminating information.

Identify the Issue(s) that Triggered the Audit

Read the audit letter to identify what issue(s) are being identified for audit. This is not an expensive all-inclusive list, however, it is a starting point for IRS.

During an audit, IRS always reviews income on tax returns and evaluates if that information reported was accurate, not understated. How do they evaluate your income statement is accurate? IRS does so by conducting a bank deposit analysis: they collect all of your bank statements, both personal and business, to determine whether you reported the correct amount of income.

When assessing income, there are times income for an individual may be reported in a business account or vice versa. During the audit, IRS ensures they capture all of your transactional information, and that it’s accurately being reported. Anticipate IRS asking for:

  • Bank statements
  • Cancelled checks
  • Deposit images

IRS also looks at your expenses. When looking at your expenses, they are looking for source documents, such as, invoices. They are checking payments, to verify that you not only incurred the expense, but also that you paid for it.

The purpose of gathering this information is to verify the deposits are income and not non-taxable income such as insurance proceeds that would not normally be taxed. The only way IRS can reach that bottom line number is by reviewing the source documents.

Identify the Response Deadline

IRS will identify a deadline by which you must respond  to their letter by. Generally, the revenue agent will give you 10 days to respond to the initial letter- you are not yet providing the documents requested. This initial response serves the purpose of:

  • Contacting the the revenue agent
  • Scheduling an appointment to provide the requested records

During the first appointment, you will go through an interview with your assigned IRS agent. Your agent will walk through a whole litany of questions to understand:

  • The scope of what income looks like for you
  • Whether you received an inheritance for instance
  • Whether you received any large transfers
  • Whether you have any cryptocurrency
  • And more

Best practice is to contact a tax attorney to review the questions ahead of time. Credibility is one of your most valuable assets during an audit. When you first meet with IRS and communicate with them, their agents will judge whether you’re credible and whether the information you’re providing is forthcoming and truthful. If IRS deems you are not, they will launch a deeper dive.

For more information on IRS audits in 2022, read the second part of our series by clicking the link here.