Identifying opportunities during an IRS examination

Tax penalties are burdensome, often compounding a taxpayer’s original liability with stress, cost, and long-term financial damage. While many practitioners are familiar with abating penalties after they’ve been assessed, the most innovative strategy is to prevent them altogether. 

Often viewed as a reactive and defensive process, the examination stage is ripe with opportunities to prevent penalties before they’re proposed. This blog explores how you, as a tax professional, can use examinations as a proactive tool to position your client for the best possible outcome.

From defense to prevention

Too often, tax professionals treat the audit process like a courtroom: gather facts, brace for penalties, and wait for the judgment. But examinations are negotiations. From day one, you can influence how the IRS views your client’s situation and whether penalties are even warranted.

To do this, you must: 

• Engage with the examiner professionally and cooperatively
• Assume penalties will be imposed and prepare accordingly
• Use every interaction to build a narrative of good faith and reasonable compliance

The key is to think like the examiner. Ask yourself: What does the IRS need to see to justify not asserting penalties? By anticipating the examiner’s perspective, you can tailor your approach to address their concerns and demonstrate your client’s compliance.

Build credibility early and consistently

IRS examiners are people too. Their decisions are influenced by how they perceive the taxpayer and their representative. Credibility is currency during an audit, and it begins with your tone, transparency, and preparedness.

Tips to build credibility

Be timely: respond to all IRS document requests promptly. Delays can raise suspicion and suggest noncompliance.

Be organized: submit responses in clearly labeled folders with indexes, making it easy for the examiner to find what they need. 

Be clear: highlight the relevant facts and avoid making the IRS search for answers. 

When you make the examiner’s job easier, you foster goodwill and increase the likelihood that your client’s case will be viewed favorably. Consistent professionalism and transparency can go a long way in persuading the IRS to exercise discretion when it comes to penalties. 

Document the reasonable cause from the start

A common mistake is waiting until penalties are proposed before presenting a reasonable cause argument. Instead, build your reasonable cause defense into your audit responses from the very beginning. For example, if your client failed to file due to a family medical emergency, don’t wait until the appeals phase to share this information. Instead, provide relevant medical records, a timeline that aligns with the tax issues, and a summary of facts with your initial documentation. 

Best practice to follow:

• Include supporting documents exhibits, tabbed and indexed for easy reference.
• Use a cover letter with each submission to reiterate your narrative and highlight how the documentation supports reasonable cause.

By embedding your reasonable cause argument into your audit responses, you lay the groundwork for penalty prevention and make it easier to defend your client if the case proceeds to Appeals. 

Engage with the examiner before the 30-day letter

Once the IRS issues a 30-day letter proposing penalties, it becomes much harder to reverse them. Before that point, examiners have more discretion. If you’ve built rapport and credibility, you may be able to negotiate penalties down or away entirely without going to Appeals. 

Approach this conversation professionally and respectfully:

“We understand penalties are part of the process but, given the facts we've provided, including the documentation, we’d ask that you consider not asserting penalties under the reasonable cause standard.”

Show that the taxpayer acted in good faith

Whether you’re arguing for First Time Abate (FTA), reasonable cause, or reliance on a professional, the IRS wants to see that the taxpayer made a good-faith effort to comply.

Key indicators of good faith:

• Attempting to file or pay on time
• Correcting the issues as soon as it was identified
• Maintaining a clean compliance history

Presenting these facts early in the examination process strengthens your case and demonstrates to the IRS that your client is not a habitual noncomplier. Waiting until after penalties are assessed to present these arguments can weaken your credibility and reduce your chances of success. 

Turn audit weaknesses into compliance strengths

An audit may reveal past mistakes, but it also provides an opportunity to demonstrate your client’s commitment to future compliance. For example: 

• If prior-year returns were filed late, ensure current-year returns are filed on time and show this improvement to the examiner.
• If the taxpayer previously lacked documentation, help them implement better recordkeeping practices and provide evidence of these changes. 
• If the taxpayer was unaware of specific filing requirements, have them complete corrective training or engage a new preparer. 

By showing that your client is taking proactive steps to correct past issues, you signal to the IRS that future noncompliance is unlikely. This can be a persuasive factor in the examiner’s decision to forgo penalties. 

A word on preparer penalties

If you are representing yourself as a preparer, or assisting another preparer under review, your conduct during the examination is critical. A referral to the IRS Office of Professional Responsibility (OPR) can have serious consequences, including suspension or disbarment. Avoid these pitfalls. 

• Do not argue your way into an OPR referral and always remain professional and respectful.
• Do not assume minor penalties are insignificant; challenge inappropriate penalties early. 
• Do not represent yourself without legal guidance if you are under review for willful or reckless conduct under §6694(b).

If you are facing a preparer penalty, consult with an attorney immediately to protect your professional standing.

Prevention is the best form of penalty relief

The most effective way to abate a penalty is to prevent it from being assessed in the first place. IRS examinations offer a unique opportunity for proactive penalty prevention if you know how to engage strategically. Establish credibility from day one, embed reasonable cause into your audit responses, engage examiners before penalties are proposed, and prepare for appeals constantly, even if you never need it.

As a tax professional, your value extends beyond technical expertise. Your ability to navigate the IRS examination process strategically, advocate for your client, and deliver better outcomes is what sets you apart. Your clients depend on you not just to react to problems, but to lead them through the process and prevent issues before they arise. By mastering penalty prevention during IRS examinations, you protect your clients’ interests and elevate your practice to the next level.