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Why Farmers Are Audited by the IRS
Over the years, I have heard a lot of misinformation about what happens during an IRS audit. First of all, the scenario you see on television rarely happens, with one agent and one taxpayer sitting down arguing over the legitimacy of business expenses.
Most of the audits are letter audits in which you receive a letter requesting backup for one or two numbers on your tax return. Why would you get that letter? The most likely reason is that the numbers you reported on your tax return don’t agree with corresponding numbers the IRS has received from other parties. Organizations such as your bank, your grain elevator, or the USDA send 1099 forms to the IRS every year. If your numbers don’t match theirs, that’s a problem.
The other prompt for a simple letter audit could be that a number you reported falls outside of the normal range. For example, you net $25,000 in farm income and contribute $50,000 to a charity. Don’t be surprised if you get a letter asking you to back up your charitable contributions with evidence. If you can, there’s no problem. Most of the letter audits are easily resolved, and there is no need for any kind of meeting with the IRS – just a letter response to the letter audit.
Sometimes, you get a letter calling for a full-blown in-person audit. Why does this happen? In my experience, it tends to happen when people take large losses or have any kind of unusual large numbers on their tax return. (By large, I mean six figures.) It also happens when people try some fly-by-night “special tax-saving strategy.” For instance, I once saved a retired professional athlete from investing in a gold mine to supposedly save millions in taxes. That deal was going to mean nothing but trouble for him. Believe the old adage about anything seeming too good to be true.
The third reason you might get a full-blown audit is that your ex-wife or ex-employee has decided to bring you down by sending a letter to the IRS about unreported income and fake expenses. Hopefully, none of you have those types of skeletons in your closet.
During the in-person audit, you will probably have your CPA do most of the listening and talking. The IRS will be focused on a few big numbers, and they are seeking evidence. While they’re at it, they’ll just go ahead and look at all of the numbers on the tax return. And, maybe they will look at two or three years if something seems wrong on a recurring basis.
One fact that surprises some people is that the IRS can subpoena your bank records before they even sit down with you and your CPA. A few minutes into the meeting the agent might say, “Well, I have a record of all of your deposits into your bank account. I just need you to explain where they came from.” The IRS has a lot of trouble with unreported income – more trouble than with phony expenses. However, there are a lot of made-up business miles out there.
If you have good answers for everything and evidence to back up your revenue and expenses, there is nothing to fear. Sometimes agents are inexperienced or overworked, and getting to the right answers requires multiple meetings, phone calls, and document submissions over time. Don’t get too stressed if the process takes months or even a year. Eventually, the agent will issue a final letter stating that the audit is closed and you owe nothing (or perhaps something, as the case may be.)