“You are being audited …” Words that can strike fear into the hearts of the bravest, most stable and level-headed adults. A federal tax audit is a fearful thing to most of us – and with reason. Instinctively, we know an audit will take time, create frustration, and cost us money. It will make even the most intelligent and honest of us feel inadequate, dumber than a doorknob, and criminal, as well.
Why? Because we know we don’t really understand all the rules and regulations of filing our income tax. We know that common sense and intelligence are no guarantee of doing the darn things to the satisfaction of the IRS department. And, we’ve heard all the horror stories about others’ audit experiences.
So, is it as bad as all that? Well, it CAN be bad, but there are things you can do to make the audit a less painful experience. It will, no doubt, still be a fearful and unpleasant thing, but not so bad as you think.
Once you have been notified of the impending audit (no, I didn’t say impending doom), you will have to make an effort to keep a sense of humor about it. Because even if takes some effort, you may as well look at it with a sense of humor. Maintaining a sense of humor will help keep you sane through the ordeal – – – well, process.
OK. You have received your audit notice and we will assume you aren’t laughing. What should you do?
First, you will want to decide if this is something you want to face on your own. We advise that you let your accountant or tax preparer in on the audit. In fact, it is best if you let him take care of all the direct communication with the auditor. He is in a better position to be objective about the whole thing (he isn’t numb with fear). And it is important to be objective and unemotional with the auditor. Your tax preparer knows what the auditor wants to hear and will be able to discuss any problems and answer the questions more intelligently than you could (he isn’t speechless with terror). If your tax preparer wants to make time to consider the tax implications of certain information, he can stall for time with a simple, “I’ll have to check that with my client.” Besides he is more likely to understand the jargon and what the auditor wants.
You will have to gather up all your receipts and other documents and make sure they are in order. Be sure they are orderly and understandable. Your tax preparer will likely have to find things for the auditor. It is also a good idea to go through the records and recalculate. Check the mathematics. Check transfers of figures from one record to another. Check your deductions, in particular. If you find you made a gross error when your reported, let your tax preparer know. He will take care of letting the auditor know.
But give him only your receipts for each item that is being checked – with totals. Don’t volunteer anything that hasn’t been requested! You do not have to give him cancelled checks, expense logs, or other backup material. If the auditor decides he needs those, he can get them at a later visit. Remember the adage: “less talk, less mistake.”
If you decide you want to handle this thing on your own, the same thing goes for what you say. Give him only the minimum – answer with just a yes or no. Don’t say anything you don’t have to. Don’t volunteer anything or defend your answers unless directly questioned about your reasoning. But if you go alone, you had better be prepared to defend your every entry on your return. If you have accurate and complete records, the audit will be easier – it will be much easier to defend your entries. Your tax preparer will want those records to be accurate and complete, too, if you have wisely chosen to have him represent you at the audit.
A great deal depends upon what shape your records are in. An audit often takes place long after you filed – it can be years after – so if your records aren’t clear it will be pretty difficult to defend your entries.
An audit can consist of one short visit or several visits over an extended length of time. It depends upon the thoroughness of the auditor you have been blessed with and the complexity of the return you filed. The auditor will probably operate in a less specific manner than you would like – you’ll probably have to suffer a time of suspense, because the auditor does not have to give you any specific results right away. But you will be notified of those, too, sooner or later.
And what will be the result? That will depend on how accurately your return was completed, how well you handled the audit interviews, and your auditor’s opinions about what are allowable deductions (and, of course, whether he and his wife are getting along). And that is why we become so frustrated – some of these matters we have absolutely no control over.
But whatever the result, be prepared to pay. It will, no doubt, cost you money. Sometimes they decide that you did a good job of deciding what to put on the form, so you don’t owe them any money. Sometimes they will disallow a deduction or change a depreciation schedule or something so you do owe them some money. Whatever the auditor decides, you will more than likely end up owing your tax preparer for his services. But cheer up! You probably won’t end up in jail – unless, of course, you have been deliberately defrauding the government. But even then, a check can usually buy forgiveness.
So an audit isn’t the end of the world. But it is tense and frustrating and most of us would like to avoid it.
What are your chances of being audited and how can you reduce them?
Well, every year more than two million “invitations” are sent out to reluctant guest (not many of these invitations are declined, by the way). Most of the time, you are chosen for an audit by a computer program. The computer scans returns looking for items that may indicate an error. Large deductions in comparison to your income is one. Some are randomly selected by the computer that have no questionable items.
Some types of deductions that auditors examine closely are those that you are not likely to have adequate documentation for. If you have had losses due to vandalism, accidents, floods, fires, storms, and the like, you may be picked for an audit.
Since child care is often paid in cash. If you have a large claim for child-care expenses, be sure to document it carefully. Get receipts.
Charitable contributions are carefully checked. For your protection, always ask for receipts to back your claims.
Also, handle auto and entertainment deductions carefully.
If your return has been examined in one of the two previous years for the same items they are questioning this year and that audit resulted in no extra payment, you can call the IRS. The audit will likely be suspended.
Once the computer kicks out your return for audit, will you automatically be audited? No. Your return is reviewed by IRS employees, and they make the final decision on whether or not to audit your return.
You can stop the process right there. In fact, many returns that have been kicked out are never audited. Some people never even know that their return was chosen by the IRS computer for an audit!
So, what can you do to stop the IRS from auditing you? Prepare your return correctly. If it is apparent that there is no error on it, the IRS employee who reviews it will overturn the computer’s decision and you will not be audited. If you have unusual or unusually large deductions, include proof of the deductions with your return- receipts from charities, receipts for other deductions – so that the reviewing agent will know that you have not made an error and to convince him that there is no need for examining any further. (When you include receipts or proof with your return, always be sure to keep a copy for your records.) He will overturn the audit – and you will probably never know that the IRS computer picked your number!
- How to Avoid Tax Audit: Red Flags for Entrepreneurs
- How to Avoid a Tax Audit of Your Business
- Good Record Keeping for Your Small Business
- Non-Traditional Tax Deductions: Successes and Failures
- Home Business Tax Deductions: What to Watch Out For
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