I'm Bob Brooks and you are watching prudent money. One of the most traumatic financial experiences imaginable for most Americans is the idea of an IRS audit. Yet there really is no reason to fear you just have to understand the game and how the process works. Well today IRS expert Dan Pilla is my special guest on proven money to talk about how to win a tax audit. Now this of course, is from his latest book, how to win your tax audit, an Insider's Guide to successfully negotiating with the IRS. The Associated Press once wrote about Dan Pilla, he said, Dan Pilla probably knows more about the IRS and the Commissioner of the IRS.

His work is the final word on IRS issues. Dan, my friend, always a pleasure to get to have these conversations. It's my pleasure to be here, Bob, thanks for having me. You know, I want to point out that the title of the book is not how to deal with an audit or how to get through an audit. It is about winning. audit, which is something that many people, I don't think they think it's possible.

No, you're exactly right. This is all about winning the audit. Listen, the vast majority of people that go through a tax audit, end up owing money to the IRS, the IRS has statistics indicate that about 88% of every person that goes through a tax audit will end up owing the agency money. But here's the thing that's fascinating, when when you appeal the audit decision, again, the IRS has own statistics indicate that you're going to win your audit between 60 to 90% of the time, so that what that tells me, Bob, is that the vast majority of tax audit decisions are wrong. And people need to know how to challenge those decisions in order to prevail in their case. And to take it a step farther.

If you go into your audit. Knowing what your responsibilities are and knowing what the challenges are and how to meet those challenges. You're not going to want any money to begin with. You know, Dan, we've done interviews probably well over a decade there's been one consistent theme when it comes to dealing with the IRS. You don't have to feared the IRS. You just have to learn how to play the game and how that system works.

Yeah, that's exactly right. We know what we're talking about when we're talking about tax a lot. It's five. The tax auditors systematically use tactics of bluffing intimidation, misinformation and disinformation. And in many cases, they just outright lie to taxpayers concerning what their rights are, when you understand how that game is played, what they're going to do and how they're going to do it. Then you have the upper hand in my book, how to win your tax audit.

I've got a chapter in there that's entitled 13, IRS bluffs and intimidations, and how to counter them. So I show you exactly what the agency is going to do and exactly how to counter it in a given situation. I also show you Bob, step by step how the IRS will attack a given tax return. There's two very generally speaking, there's two strategies they can use. They can come at your deductions and of course, most people think in terms of the IRS disallowing deductions, whether they're, you know, charitable contributions, mortgage interest, business expenses, whatever it happens to be. They can approach that tax which Turn on a tax return from that standpoint, and they can approach a tax return from the standpoint of the income reported on the return, the IRS may look at a return and say, well gee, Mr. Smith, Mrs. Jones, we don't think that you reported enough income on your tax return, we really think that you had income that you haven't reported, we think you're lying about your income.

So very broadly, very generally, those are the two strokes that the IRS can take in terms of attacking a return, I show you very specifically exactly how they approach each strategy. And then I show you the taxpayer exactly how to defend against either of those strategies. We know Dan, let's let's start with the basics. Everyone wants to avoid the red flags that could trigger that audit. Now, those are those deductions that are considered maybe a little bit controversial, yet they are literally I mean, they're legit deductions. So they don't claim them for fear of triggering that red flag.

You know, Home Office expenses as a deduction that offers up a good example, give us the inside knowledge. How does the IRS select people for audits Well, yeah, you're exactly right. A lot of people will leave deductions on the table because they think if they don't claim the deduction, that somehow they're insulating themselves from an audit. And that's not true at all. By not claiming the deduction, the only thing you've guaranteed yourself is that you're going to pay taxes, you don't know because the legitimate deduction cuts your tax liability. The way that the way a tax return is selected for audit by primarily, there's a number of ways they do it.

But the most common way, the one way that literally two thirds of all returns are selected is through a sophisticated computer program that the IRS calls that this program is called the discriminant income function system. And what that program does is it compares every line of your tax return with national and regional statistical averages for a person in your same income category professional, if any line of your return is out of sync with those averages, the differences scored is called the diff score. And the higher the score, the more likely you are to be audited. And so what that means is when you come away from that analysis with a high Before with the IRS is saying is that your claim is far enough away from the national average to be questionable. Now, the simple fact that your tax return is questionable Bob doesn't mean that it's wrong.

For example, if you're if you're tithing, if you if you tithe 10% of your income your church, then you are giving your income at a rate of about three times the national average. So, so that doesn't mean you're not giving your income. And it doesn't mean you're not entitled to the deduction, it simply means that you're above the average. And so when you when you go into your audit, if you understand that your responsibility is to prove that your tax returns correct, and you know how to go about proving that your tax return is correct. You don't have anything to worry about in an audit, you shouldn't leave deductions on the table because that only increases your tax liability. You shouldn't worry about an audit because you got the documents to prove that your tax return is correct.

The IRS is not going to get into your pockets. Now in the book, you Refer to correspondence audits. I think the most people assume all audits are face to face. Talk about the difference between the two types of audits. Yeah, people think of an audit typically as a face to face challenge with the IRS or face to face encounter and certainly there are a great deal of face to face encounters no question about it millions, you know, per year and the book how to win your tax audit focuses on face to face audits for sure. But but a great number.

In fact, millions of audits every year done through the correspondence process, where the IRS sends you a letter it says dear taxpayer, your return has been selected for audit or channel you know, we're questioning this particular item, send us your documentation on that particular item. And so the IRS, it also this happens through the correspondence process. And frankly, I recommend that people to the fullest extent possible deal with the IRS through the correspondence process, because when you're writing letters to the IRS and providing documentation through the mail to the IRS is pretty hard Bob to help Have somebody misunderstand what you say what you say is in writing. At the same time, it's pretty hard for the IRS to use tactics of bluffing intimidation, when they're communicating in writing. It's the verbal encounters the face to face encounters, where the IRS can use this bluff and intimidation and, you know, try to mislead and taxpayers and try to get them to do things that people might not otherwise do.

Like, for example, signing forms. They've got no business signing, you know, at a particular juncture along the way. So, so yes, the correspondence process is critical. In my opinion, it's an important step toward insulating yourself from the potential for IRS abuse through the bluff and intimidation structure they use. You know, Dan, I think most people assume that the IRS has control and power over your entire past. However you right that that is not true that there is a statute of limitations.

In an audit situation. How far can the IRS go back? Yeah, that's a good question. There's statute of limitations in every aspect of dealing with The IRS Bob from from criminal cases, there's only so long they can charge you with a crime. civil cases there's only so long they can audit tax return collection cases, there's only so long they can collect the tax once it's assessed. So the statute of limitations everywhere.

And I talked about the assessment statute limitations at length in the book, how to win your tax audit. The collection material is talked about in my book, how to how to the the the book, how to get tax amnesty, it's talked about there. And so when we're talking about an audit, I recommend that people keep their records for six years from the date you file your tax return. So so for example, your 2010 tax return was filed sometime in 2011, either April or October, depending on if you're an extension. So you come forward six years. From there, you get to let's say October 2017, would be six years out.

That's when your 2010 tax return is essentially beyond the risk of an audit. Now here's how the statue of limitations works. The IRS says three years from the date the return is filed in which to audit that return. And it goes from the filing date not the tax year date. So 2015 is filed in 2016. Three years forward is 2019.

So they've got three years from the date the return is filed. Unless there's unusual circumstances bobbins certain unusual circumstances, the IRS can go back six years to audit your return. And that's why I recommend you keep your records for six years. Now you file copy of your tax return, you know, you always have a file copy of your tax return that you mail into the IRS, you must keep a copy of your tax return. If you're not doing it viewers that start right now, you should need to be keeping copies of your tax returns. I recommend that you keep your file copy of your tax return indefinitely because the IRS can go back five years, 10 years 15 years to make an assessment.

If you didn't file a tax return the statute of limitations on assessment is based on the filing of the return right so if you didn't file they can go back, you know, theoretically 10 years. Theoretically and definitely you can go back if you haven't filed so keep your tax return to prove that you filed your return. And if you file electronically, of course, you've got the filing confirmation, you need to keep that I still recommend that you file your returns through certified mail with return receipt requested. So a hardcopy was sent into the IRS. Sometimes that's not possible when you're filing your returns through through a preparer services, you know, they're required to file returns electronically. So the important thing is just keep your filing documents intact, prove that you file that return.

You know, Dan, I'm just thinking about all this information that people don't know how important it is, you know, and when you get into an audit situation, is it possible to represent yourself or should you always get help? Well, it's certainly possible to represent yourself by book how to win your tax audit is based on the premise that you can represent yourself but the key of course is to have some guidance and know what you're doing. You know, you just can't go in there blind Bob for sure. You can't go in there by the seat of your pants. You got to know what the audit is all about. You got to To know what the IRS is questioning, you got to understand what's on your tax return.

People sometimes don't even know what's on their own tax returns, they used to prepare to put the return together, you got to know most importantly, how to prove your return is correct. If you understand these things, you got it, you've got an excellent chance of winning your audit without professional representation. However, Bob, if you don't know these things, you cannot fly blind, you need to get counsel. Here's the other time you need to get counsel for sure. Anytime the F word comes up, during the course of your audit, you need to stop the audit in its tracks at that point and get counsel. The F word of course is the fraud word.

If the IRS starts using fraud in any way, shape, or form in connection with your examination, you need to stop the audit and get counsel. Now in terms of stopping the audit, this the the law is perfectly clear and I talked about it in the book. The law is perfectly clear that when you say to an IRS person, I want representation. I want to get counsel they absolutely must terminate the examination at that point in time, stop the interview, they cannot force you to continue with the interview, they have to give you a reasonable opportunity to get counsel and then proceed through the audit process at that point, with the advice of counsel. You know, one of the claims that you make in the book is that the IRS adds Phantom income to almost every tax return that is audited. I mean, how do you protect yourself from that type of situation?

Well, you know, this is what it goes back to what I talked about earlier, the two general ways the IRS attacks in return, they can look at your deductions, or they can look at the income and more and more about the IRS is using this income attack on the tax returns as a means of raising the audit revenue, the IRS will look at your return and say, Well, you know, you reported $50,000 of income here but we really think your lifestyle is a 70 or $75,000 a year lifestyle. So you must have had 20 to $25,000 of income that you didn't report on your tax return and the IRS will will assert this. This is particularly Probably or I should say, particularly prevalent Bob, in the case of small business people now with wage earners, the IRS is less likely to get away with this, although they try it.

But with self employed people, the IRS can do it all the time because they can take the position that well, you just didn't report the income on your tax return, you just didn't deposit the money to your bank. You know, if you're self employed, you're not necessarily getting 1099. And so you know, it's quote unquote easy for you to hide your income. But I show you the book exactly what the law is with respect to the IRS has responsibilities Bob, when they challenge your income. Here's one of the best kept secrets in the country when it comes to dealing with the IRS. I said earlier that the burden of proof is on the taxpayer.

When you're dealing with the IRS, it's your responsibility to prove that your tax return is correct. When the IRS challenges your income. And they assert that you had income on their tax return that was not reported. Guess what the burden of proof is on them. They have to prove with some clear solid evidence, Bob that you had income that was not reported on their tax returns the mere suspicion or belief that you had this income, the mere suggestion on their part that you couldn't have lived on $50,000 You must have had more, you know, this must have had is not a standard of proof under the United States tax laws, it's not alright, they have a burden to prove with a foundation of substantive evidence that you had income that you didn't report on your tax return. The law is very clear, I lay it out in the book, I show you step by step how to assert that law to the IRS if they're challenging your income.

And then I show you how to present a foundation of evidence to satisfy an examiner Or more accurately and appeals officer that your income Declaration was correct to start. Well, Dan, walk us through the process. You're getting audited, you know that everything is correct. What are some keys to defending your tax return? Well, the first key is to understand what the IRS is looking at. You know, sometimes they'll send you a letter that says we're looking at your charitable contributions, and we're looking at your mortgage interest deduction?

Well, those are two simple examples. In other cases that so now you read the letter, you know exactly what they're looking for. But the next question is, well, what if they're not clear in the letter as to what they're looking for? What if it just says, you know, we've set an appointment for you bringing your quote unquote, books and records? that's mostly what these letters Say bye. They say, bring in your books and records.

Well, what are you looking for? What are the questions in the return? I insist that you respond to an IRS auditor with what I call the ground rules letter. And in the book, I show you how to set the ground rules of the audit. So you know what you're dealing with, we strike the deal off so we understand what the terms of the you know, the game are going to be so to speak. And when the first thing that you're entitled to know is what they are looking for, what is the question about the tax return?

Is there a specific question about income? Is there a question about specific deductions so that you can organize your documents properly before you go into an office? You know, Dan, another common theme that runs Throughout all your books is the reassurance that you've got rights as a taxpayer. In fact, the tax code does a fair job in protecting taxpayers. Unfortunately, people don't know their rights touch on some of the rights that you have as a taxpayer, you know, in an audit situation. Yeah, exactly.

In fact, I got a whole chapter that delineates very specifically taxpayer rights Bob, and you know, I alluded to one just a minute ago the right to stop the examination and get counsel. That's an absolute right. You've got an absolute right to know what the issues are that are in question. You've got an absolute right to play a role Bob in determining where and when the audit takes place. It is very common for the IRS to send you a letter that says we want you in our office next Wednesday at nine o'clock Well, I can't be in the office next Wednesday at nine o'clock. Often people will call their examiner's they will utilize, can I get more time?

No, you can and the auditors will often say well, no, you can't get more time. You need to be here when I say to be here, and that's simply not true. The regulations are very clear about your right to play a role in when and where the audit takes place. This is vitally critical. You have the right to, you have the right to present witnesses, Bob, to to establish, you know, whatever factual questions need to be established to prove that your deductions are correct. You know, for example, if you were, let's say your small business person and the IRS is challenging your home office deduction just as an example, well, one of the questions that you have to satisfy as a taxpayer is that the office in your home the space in your home, is used regularly and exclusively for business purposes.

And it's not used for personal purposes. You have the right to bring in witnesses, let's say a spouse who can testify that under no circumstances are these business spaces in the home use for personal purposes. That would be just one simple example. In the book, I go through about 12 or 13, taxpayers rights that are very definitive, clearly delineated in the law that you've got an absolute right to assert, and I showed exactly how to assert. You know, Dan, what most people don't know is that you do have the ability as an actor taxpayer to challenge an IRS decision talked about the process of how you would go about challenging a tax audit decision you didn't agree with? Yeah, this is this is a critical part of the process.

You know, as I said, when we started the interview up, about 88% of every person that goes through an audit ends up owing more money, but when you appeal it, the the statistics just reverse themselves, the IRS is wrong 60 to 90% of the time. So it's vital to understand how to challenge a tax audit decision. And you know, people are tentative about this. And they're hesitant because they think that that if they fight back somehow against this tax auditor, that the tax auditor is going to make matters worse for them that somehow he's going to put them in jail or levy their bank accounts or seize all their assets or file a tax lien. Listen by the tax auditors got no power whatsoever to do any of those things. He can't put you in jail.

He can't lien your assets. He can't seize your bank account. He can't even change your tax return without your consent. So if you're not completely in agreement with this adjustment that the auditor made. And you know, maybe the adjustments, correct? The IRS, you know, the IRS is not wrong every single time and taxpayers do make mistakes.

So it could be that the decision is right. But if you're not 100% sure that that audit decision is correct. You've got the right to file an appeal. And the way it works is when the IRS sends you an examination report, they also send a letter that tells you that this is the examination report, the audits finished as far as they're concerned, here's what the report is. They'll invite you to pay the tax, of course, but they'll tell you if you disagree. You've got 30 days to file what's called a protest letter.

In my book, I show you exactly how to write a protest letter. It's really very simple. You state in your letter, what you disagree with, what is it about the adjustment that you disagree with and why you disagree. There's a couple other, you know, spaces that need to be filled in. It's not quite that simple, but it's that's the essence of it. You submit that letter to the to the IRS in response to the examination report.

They haven't approved duty to send the case off to the appeals office and they will do it the case will go to appeals. And now you have an opportunity to sit down with an appeals officer present your case to a fresh face. present your case to a person who is trained properly to evaluate the law the facts to look at your evidence to understand what your claims are. And Bob, this person is the one with a written job description to negotiate settlements protectors. Well, in the book, he quotes senator Henry Bellman, where he said in a recent conversation with an official, the IRS I was amazed when he told me if taxpayers of this country ever discover that the IRS operates on 90% Bluff, the entire system will collapse. So what is the senator referring to with that statement by the IRS official what we're talking about the audit collection process Bob, he's talking about audit and collection.

The IRS uses tactics of bluffing intimidation, misinformation and disinformation. And in many cases, they outright lie to taxpayers concerning what their rights are in 1999 In fifth 1998, about 15 years ago, that's longer than 15 years ago, I testified before the Senate Finance Committee, that was that was conducting the IRS investigated the investigations, the Senate investigations into IRS abuse. I documented about 15 specific ways that tax auditors use these tactics of bluff intimidation, Bob, I've got my testimony, reproduced in the book, how to win your tax audit, I tweaked it out, obviously updated and so forth. But it's essentially the same testimony I gave to the Senate Finance Committee 16 years ago, 17 years ago, whatever it's been now it's getting longer every year. It seems like you're dating yourself a bit now. But But the point is, Bob that this continues, it goes on, and the IRS would not be able to get in the pockets of the American taxpayer if they didn't use these tactics.

That's what Henry Bellman was talking about. His quote came from 1969. my testimony was in 1999, here we are 2016 and it's still going on. While I was reading through that list of bullets in the book, and most taxpayers, of course, have no idea that this is even happening. And this speaks, of course, as we always talk about here the power of information and getting informed, talk about some of the more dangerous bluffs that really cause problems for for the taxpayer. Well, the single most important one, Bob, is this idea that the auditor is going to put you in jail, you know, that it is not uncommon for auditors to take the position that, you know, you've done something wrong and that and that, you know, somehow, somehow they can enforce collection through, you know, either either either wage levies or, you know, putting you in jail, which is just simply not true tax auditors do not have that power.

If they if they honestly believe Bob, that there was that there was criminal activity involved in your case, for one thing, you wouldn't even be being in most cases you wouldn't even be be interviewed by a tax on Earth, the case would be referred over for a criminal investigation. So the simple fact that you're going through an audit is is is proven wrong. cases not every case but most cases that they're not pursuing the criminal elements against you to begin with. Another common bluffing intimidation is that the IRS says, Well, if you don't accept this deal, we're going to add more penalties and interest to your bill. And that's simply a bluff as well, because the penalties we already talked about, you know, I talked about penalties in the book, at length that I explained that the penalties don't apply when you did not deliberately disregard IRS rules and regulations.

The IRS is not at liberty to simply add more penalties because you disagree with with the determination. The other thing is, is that the IRS auditor will tell you that you can't win your appeal. You know, you've got the right to appeal, Bob, that's true. But you know, we win these cases you can't win your case. And that's simply not true. We know what the statistics are 60 to 90% of the time, IRS audits are wrong.

And so when you appeal your case, you are going to win something if not all of the issues at stake. Well, you know, going through an audit can be stressful enough and in most cases Because that would think you would want to keep it a private matter and prevent the IRS from contacting people. You know, I mean, Dan, how do you handle that situation? Yeah, that's a good question. You know what, when you get the introductory letter from the IRS that says, Congratulations, you've been selected for audit. You know, one of the things they say there, Bob, is that they can contact third parties.

And I believe that the language of the letter says, we may contact third parties in connection with this examination when people read that and they panic and say, you know, Oh, my Oh, my goodness, is the IRS going to go talk to my talk to my neighbors? And are they going to talk to my employer and I don't want my employer to know I'm being audited. The main language is very important, doesn't doesn't say they will go contact third parties. They have the power to contact third parties. That's true, but they will only contact third parties, Bob, if you are not providing the information necessary to show the correctness of your tax return. So it's important to understand that you got an affirmative duty as a taxpayer proof to prove that that tax return is correct.

And so if the IRS is asking for, you know, information About this deduction or that deduction, or your bank records to show your income or whatever, you know, you've got a responsibility to provide that information in a timely manner. If you don't, then you run the risk that they're going to go to third parties to get it. Well, you also write about audit proofing your return, which is a topic for another interview here on the food and money channel. But talk about some mistakes that, you know, taxpayers make the can trigger an audit. Well, you know, that there could be any number of things, you know, the vast majority of audits are selected for tax returns are selected by there's not even a mistake on the return. So I mean, you can't obviously, we want to avoid mistakes, you want to make sure that you've got the the supporting schedules with your tax return that are required.

You know, if you're claiming itemized deductions, you got to have a schedule a, if you've got a self employment income, you got to have a schedule C. You know, if you're claiming a depreciation deduction, you got to have the depreciation forms with it. So you need the supporting schedules and your tax returns. For sure. That's a common mistake that people make they Don't sign their tax returns that gets the IRS as attention, obviously, but but the fact of the matter is, it's not mistakes so much that caused the audits. It's this discriminant income function computer program that does it. And that's got nothing to do with mistakes.

It's got to do with this with this evaluation of your claims in light of the national averages. And that means anybody can be selected for an audit, it does not mean that you made a mistake. Well, Dan, as always, great information. And thanks for coming on prudent money. If you want more information on Dan, and you want to check out some of his books that he's written, you can go to triple W dot Tax Help online.com Well, here's the bottom line. There are rules and procedures when it comes to dealing with the IRS.

Yes, you can win a tax audit, you just have to know how the game is played and how that process works. That is the power of information. investing time into knowledge and providing that information is our number one priority on the prudent money channel with approved money channel. I'm Bob Brooks, keep the faith and have a great rest of your day.