Expatriate Tax Audits
In the past, IRS rarely audited US Citizens who filed tax returns from abroad. This may, however, soon change due to a recently authorized increase in funding and staff in the IRS international tax department [www.ombwatch.org/node/10201 and www.journalofaccountancy.com/Web/20103170.htm].
We have been recently provided with the document used by the IRS to conduct audits of Form 2555, which is filed to claim the Foreign Earned Income Exclusion (FEIE). This audit is normally conducted by post and the IRS makes its decision based on the answers and supporting documents supplied by the taxpayer.
The following form is used by the IRS to audit expatriates claiming the FEIE. Download and examine it to determine if you have adequate support for your Form 2555 in case you become subject to an income tax audit by the IRS in the future.
If you find yourself subject to an IRS audit for any reason, let us know - we can help. We have helped many taxpayers (including expatriates) before the IRS on audits involving numerous issues in the Tax Code and have an excellent track record of success for our clients.
Audits are a Fact of Life
So you’ve been targeted for an audit by the IRS…The most important thing for you to remember is: It’s not worth losing any sleep over! The IRS simply wants to conduct verification on the items you’ve claimed. As you may remember, IRS did not request any supporting documents with your Tax Return (that’s why we mostly rely on our own Questionnaire when preparing your return). The purpose of the audit is to verify that the information supplied is correct.
Most audits performed are done so without any changes being made to your original tax return; as most of the people who file are able to backup every item listed. The most important step you can take once you are notified of an audit is to begin compiling all of your paperwork on which you relied to file your taxes in the first place. Also, don’t forget to stay calm and abstain from becoming defensive. If you need professional assistance, do not wait!
Why Am I Being Audited?
When you first receive notification of an audit, your first question is most likely, “Why am I being audited?!” Before we get into the possibilities of ‘why,’ let’s first examine the list of ‘why nots.’ It’s NOT because you forgot to pay a parking ticket before moving overseas or anything to do with any of the decisions you’ve made not related to your taxes. It all likelihood, you could have been just a random return which was chosen to conduct an audit for no reason other than to conduct an audit. Some more concrete reasons may include any of the following:
- Calculation errors
- Incomplete return (lacking required schedules)
- Failing to report all income from 1099 or W-2 Forms
- Setting off one of the many ‘secret alarms’ which vary each year. The most common alarms for the IRS may include abnormally high charitable donations; excessive credits or exclusions; excessive travel, meals, and entertainment; and more.
Even though it may be an interesting guessing game, odds are you will not figure out exactly why you are being audited. The more important investment of your energies, however, should be what to do next to make this as stress free as possible.
What to Expect?
Once your tax return has been selected for an audit, you will receive correspondence by mail at the address listed on your most current US tax return. If your current address is in an overseas location, the IRS will conduct the audit via total mail correspondence. More times than not, the IRS generally only targets 1 year and chooses one form to audit. For example, if you submitted a schedule A among other forms, the IRS may only be interested in auditing the items listed on your Schedule A. If you have no special additional forms you may find that your entire 1040 is examined.
Upon receiving your notice, you are going to want to ask yourself honestly, “Can I handle this on my own?” If you filed your tax return yourself and you have a complete understanding of each item on your return you should be able to make it through an audit without any trouble. If, however, you hired a professional to prepare your taxes and you’re confused about the claims within them, you will most likely want to hire an expert to help you with compilation of documentation and communicate with the IRS through your audit.
Whether you seek advice from a professional or you decide to communicate with the IRS yourself, here are a few important tips to consider:
- Organize all your documentation well. Organize each section of your return you will need by category rather than by date.
- Don’t forget that the IRS representative is sworn to the US government. Yes, they are people just like you; but they do not need information which could put them in a tough position with their sworn duties.
- Be respectful to and honest with the auditor. Try not to get defensive, and remain calm.
- Only provide information which is being requested – nothing more.
The entire process of an audit could very well take months, and audits conducted by correspondence have a tendency to take much longer. Al finale, you will sent a notice in the mail regarding the final outcome of your audit. If lady luck is in your favor, you will be notified of a refund which is due to you. If you are moderately lucky there will be no changes made to your return at all. If luck is not on your side at all, you will be notified of a balance due to the IRS. If you disagree with the decision you will be able to appeal, but we will touch more on that later.
If you are informed of a balance due and you do not wish to appeal, the best thing you can do is to pay the balance as soon as possible and be done with the entire thing. If you are unable to pay the balance and are interested in setting up a payment plan with the IRS, contact a representative immediately. Failure to communicate with the IRS could result in hefty penalties and interest which is applied daily.
What Sort Of Documentation Will I Need?
When compiling documentation to share with your assigned auditor, you will be selecting documents which prove the claims you’ve made on your US tax return. For example, sticking with the previous instance of a Schedule A being audited, you would compile your medical and dental receipts, all receipts you saved to prove your local tax deduction, mortgage interest , charitable donation receipts, and all job related receipts which were not reimbursed by your employer. If – for whatever reason – you do not have all the receipts, you can back up your claims with bank or credit card statements.
Can They Review Other Tax Years?
Yes. Remember one of the tips above during all of your conversations with the auditor: Only provide answers to that which is asked – nothing more. If an auditor find something suspicious in a return, they have the right (and generally enact the right) to investigate further – even if it has nothing to do with their original agenda. This rule does not only apply to the current tax year or even taxpayer; the only limit to the lengths a full investigation can go is that of tax returns which are 3 years or older.
What Happens if I Disagree With the Results?
If the audit has unfavorable results, and you disagree with the outcome you have an opportunity to fight it. Before enlisting any of your options, you should conduct your own research by reading over the IRS publications and documents in order to make sure you have a leg to stand on with proof of your claims. Cite the IRS code directly and support it with the documentation you have. You generally have 30-60 days to appeal the decision of the IRS. You may be able to resolve the issue within 30 days without having to file a formal appeal. Many clients find they are able to get an IRS supervisor or director to see things their way. IRS directors are human beings, and they are able to view things logically. They know that both the IRS and citizens make mistakes, and they are as open to your being right as they are to your being wrong. They want to settle if at all possible before your case reaches the level of formal appeal.
If you are unable to reason with a supervisor you can submit a formal appeal. Before doing this, it is highly recommended that you seek the advice of a tax professional or tax attorney to help you better fight your case.
It is possible for an audit to be free of stress. Planning ahead and being prepared are 2 very key components to a stress-free audit. When you file your taxes, assume you will be audited and keep all of your documentation in a safe place. Keep this documentation for at least 3 years, and remember to enlist the help of a tax professional when you need guidance.