When the IRS comes knocking- either in person or via a correspondence audit-  you should be prepared to answer their questions- fully, completely, and truthfully.

You also should be prepared should they desire to expand the audit- especially, if they find something wrong.   What do I mean?  They may move forward to the current date (if they are initially questioning a tax submission from three years ago)- or move back three years.  This is all within the “normal” statute of limitations.

But, as a general rule of thumb, this phenomenon is why we always tell our clients that each year should have its own data file.  Because the IRS can (and does) demand a copy of the accounting records in the traditional audit.  If you QuickBooks file covers 25 years- then the IRS is free to examine anything in that file.  Likewise if you use Quicken and provide that data.

But, if you use an esoteric program (like the one we recommend for certain professionals), the IRS usually lacks the ability to read the data- and, more importantly, to employ the program.  So, there, they would demand general ledgers for the year(s) in question, profit and losses, etc.   (Yes, this is one way to limit tax audit creep.)

As one of our clients has found, if the IRS feels (and can almost justify that to be the case), the IRS has the right to examine SIX years of tax returns.  Oh, the IRS may also ask you to “voluntarily” extend the statute for a year or two.  While most advisors would tell you to agree, we tend to consider these requests on  a case-by-case basis.

Let’s start with simple reasons.  Your bank.   What?   Yes, most banks no longer have complete bank records going back more than five years or so.  So, if you don’t have full, complete, and accessible bank statements, you can be in a heap of trouble if the audit period gets extended.  Because you have no proof you are telling the truth and that the IRS guess is dead wrong.

And, given the fact that aggressive tax planning (something some of our clients rely upon our services to provide) and its difference from  tax evasion is treading a thin line.   In such cases, the IRS certainly will opt to six year and not three year audits in these cases.

Top that consideration off with failure to file.  (You know I write about ostrich behavior a lot.   Why would you NOT file a tax return?????) Or, if you filed a false tax return.  (My same question comes to mind.)  Besides the fact that you are now subject to incarceration (in a federal prison) and fines, the law [o.k., the tax code- Section 6351(2)] stipulates that the statute is for six years of examinations- starting from the date that the tax return was first filed.  (Obviously, if you haven’t filed for a few years, you’ve got a decade or more of liability to be audited.)  Some courts have even ruled that the time (the statutory time) clock doesn’t even start to run until the last time you attempted to evade taxes.

I’ve had at least one client (one, who I thankfully fired) who waited five years to file taxes- which we prepared in full.  And, it turns out, the information the client provided us was less than pristine- and they didn’t pay the full tax bill to boot.  Six years after we fired them, the IRS Criminal Investigative Division came knocking on our door.  To ask us to justify what we did.  (Yes, our time and task records tend to provide a complete historical background.)  We were absolved of complicity. They were not.

So, keep those financial records handy for SEVEN (7) years.   And, use a separate data file for each calendar year.  To cover your ass(ets)  should the IRS come calling.

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