Monday, March 15, 2010

Being Prepared for an IRS Audit

With the U.S. deficit growing each year, I expect that the frequency of IRS audits will increase to ensure that tax liability is being properly calculated and paid. While the overall chances of being audited are less than 1%, returns with inconsistencies, certain deductions, or specific credits may have a higher chance of being audited. Here are the things I do to be ready for an audit.
  • Keep receipts and invoices. I get and keep receipts for every charitable donations. I write down business mileage contemporaneously in a logbook kept in my truck. For my small business, I have invoices and deposits records to show revenue and receipts for expenses. For stock transactions, I use the brokerage gain/loss statements.

    I keep the records for three years after the filing date, which is the typical time in which an audit occurs.

  • Write down the rationale for my tax interpretations. Some parts of the tax return require little interpretation. For example, wages usually are taken from my W-2. However, many other elements require calculations or interpretation to determine the amount to include on the tax return. For example, the effect of IRA recharacterizations on contributions or distributions need interpretation and additional calculations to get the appropriate value to include on the tax return.

  • Only show related information. I am only required to show information related to the audit topic. Thus, for an audit of charitable contribution receipts, I would only bring the receipts, and nothing else. Bringing all my documentation could open up my return to further audit, since I have given the IRS implicit permission to inspect everything.
  • Since I don't hire a tax preparer, these are the things that I would do. Of course, if I did use a tax preparer, I would immediately contact him to help me prepare for an audit.

    Finally, an audit is not always bad news. I recall reading that 30% of audits results in an additional refund for the taxpayer, showing that the IRS isn't always correct :-)

    For more on Strategies and Plans, check back every Monday for a new segment.

    This is not financial or tax advice. Please consult a professional advisor.

    Copyright © 2010 Achievement Catalyst, LLC

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