Thursday 17 November 2011

How to get through an IRS audit?

A majority of us manage to get through the tax season with only the refund check from the IRS. A few not-so-lucky ones end up getting audited – nothing is more alarming for taxpayers than a letter from the IRS asking for more information on their tax returns, asking for proof of income or deductions. In some cases, a meeting with an IRS agent is required, and most taxpayers just press the ‘panic’ button then.

What are the odds of you getting picked for a tax audit? Factors such as your earnings, your profession, the type of return filed, nature of transactions reported are a few specific triggers contributing to an audit. Here are a few reasons why the IRS will want to audit you:

  • Huge business expenses (Travel & Entertainment for instance)
  • High deductions for employee business expenses
  • Large deductions under charity
  • Erroneous representation while reporting on your tax forms
  • Covering up of cash receipts
  • Complex business / investment dealings
  • Prior history of tax issues / audits
  • Informants
  • Your relationship to a taxpayer who is under audit

What do you need to do incase you are singled out for a tax audit?

Have a long hard look at your return, understand all its contents, and then collate the records of items in question.

To stay afloat on tax matters, here are tips best cultivated into a year-long habit:

1. Collect and organize your records through at least three years – it will make tax return preparation easier, and will greatly reduce the probability of errors.

2. Maintain and sort out all your purchase receipts through the year.

3. Retain your checkbook stubs.

4. Organize all bills, and keep track of all reportable and deductible items on your tax return.

5. If you have invested in real estate, keep all documentation such as cost basis, settlement / sale statements handy.

  1. First and foremost, do not ignore the IRS letter – respond to it at the earliest, requesting for reasonable time to get back after collecting the necessary paperwork.
  2. Most times, the letter from the IRS simply requests for more information / clarity on an item on your return – say, it wants you to send in receipts for the entertainment expenses you deducted. Then, just mailing across the required receipts will suffice, there is no need for bringing in a professional, say your lawyer or your accountant.
  3. In case you are unable to locate the information asked for and a meeting with an IRS agent has been scheduled, you are best equipped with professional help at hand. Bringing in an expert to represent you does not necessarily mean you are guilty, rather, it will be mutually beneficial as the agent will prefer to deal with the organized and detached ways of an accountant than an emotionally charged individual.
  4. On most instances, the IRS will have very explicit questions for you to answer with necessary document back-up. So, the best approach would be to hand over all necessary forms / receipts as required, and use the opportunity to convince the agent that there is no case of understating income earned. The IRS has kind of decided on your case, and you need to satisfactorily explain why the decision to audit is off beam. Do not volunteer to share additional records / overshare – you will only be subjecting yourself to a fresh audit then. It will only go on to cost you. If the agent happens to question you on an off-the-record item, refuse in a firm but polite manner to answer until a formal request on the specific information is filed. Do not give the agent additional or lesser information than that is requested for.

  1. At the end of the meeting, the examiner will present a reassessment in case of underpayment of taxes. Then, you can either pay the additional tax or fight it out in a tax court in case you feel it is unjustified. However, bear in mind that the IRS will usually conduct a tax audit only if it is confident of invalid deductions / expenses thus resulting in a tax bill. 

Whether your tax return was self-prepared, or by a paid preparer, you are finally responsible for its contents as you sign on the dotted line. Hence, review the items on the tax return to your complete satisfaction and check out any unclear items with the preparer thoroughly before signing it.

Around 2% of filed tax returns are picked for IRS audits. In case yours is one, do not panic, de-stress and bear in mind that an organized tax portfolio and a clear, uncluttered communication protocol will get you through the audit with ease.

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