By John Alan Cohan, Attorney at Law
Many taxpayers fear being audited, for good reasons. An extended period of deductions for horse activities, livestock ranching or other farming ventures can easily trigger an audit. Even with the best of records, IRS auditors are inclined to deny these deductions if there are ongoing losses. Although these industries are crucial to the American economy, the IRS takes a skeptical view towards taxpayers who have a history of losses in these areas.
There are remedies available after an adverse audit decision. Most often, the remedy is to file an appeal with IRS Appeals. Information about this is set forth in IRS Publication 5, “Appeal Rights and Preparation of Protests for Unagreed Cases.”
Once the case is with IRS Appeals, your returns are re-evaluated by a different staff, and you will have the opportunity to present new evidence, oral clarification, witnesses and negotiate a settlement with the appeals officer. If you have a good case and a formal business plan that makes economic sense, you even stand a chance of getting the entire matter dismissed in your favor. About 86 percent of the cases in IRS Appeals end up being settled.
According to the IRS Appeals mission statement, their mission is “to resolve tax controversies without litigation on a basis which is fair and impartial to both the Government and the taxpayer, in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the Service.”
Section 6662 of the IRS Code imposes various penalties that are almost always assessed by the IRS auditor if the audit goes against you. These penalties include an accuracy-related penalty, a separate penalty for negligence and others. These can also be contested in IRS Appeals. The negligence penalty is based on the notion that your tax deductions were attributable to negligence or disregard for rules or regulations. As mentioned, these penalties are also at issue in IRS Appeals, so that you can provide evidence to show that you reasonably relied on advice given you by your accountant or attorney.
Filing an IRS Appeal keeps open the option of going to Tax Court if your case is not settled in Appeals.
Filing an IRS Appeal is also time sensitive. It must be done within 30 days of the date of the 30-day letter that informs you of the adverse audit decision.
Often, the Appeals officer will ask for additional information. The Appeals officer will evaluate how credible you and other witnesses are, how likely you will be able to prove the legal points of your case and how good your documentary evidence is.
If, for example, you have a formal business plan that makes sense and sets forth how you expect to make a profit, this will be important evidence in your favor. If you have evidence of significant sales or evidence of efforts to reduce costs, this also will be helpful to your case.
Tax planning in advance is always the best approach in operating an activity in the horse, livestock or farming industries, but there is still always the risk of an audit—especially if tax deductions are used to offset other sources of income. One of the worst things you can do is to try and get advice from one of the IRS “hotlines” in which you can pose questions to IRS agents.
The problem is, first, the information given over the phone is not binding on the IRS. Second, you will likely get different answers to the same question, depending on whom you speak with. Third, IRS agents may not be able to answer complex questions, and how you frame a question will be a factor in what answer you get. And fourth, you will have no documentary evidence to prove what the IRS agent told you.
John Alan Cohan is a lawyer who has served the horse, livestock and farming industries since l98l. He has clients in all 50 states. He can be reached at (3l0) 278-0203, by e-mail at [email protected] or at JohnAlanCohan.com.