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How to Defend Yourself in an IRS Audit

The IRS reviews your return to determine its accuracy, but as a taxpayer you have the burden of proof that your return is accurate; a tax audit can be a time-consuming and frustrating process. Here are some steps you can take to avoid an audit:

Document All Income and Deductions
You can verify income, profits and earnings with supporting documentation. Large tax deductions are audit red flags, so make sure all are well-documented. If you think that there is anything on your tax return that may cause the IRS to take second look, attach a copy of the invoice or paid bill in question. Check the Numbers-You are ultimately responsible for what is on your return so be sure to check that you or the preparer have entered the numbers correctly. I’ve seen $1,700 entered as $17,000 for farrier expense. The tax preparer reviewing the return didn’t know what a farrier was and so the expense didn’t look out of line to him. It definitely caught the attention of the IRS and an audit followed.

Use Common Sense
File your taxes on time and answer all of the questions asked. The cleaner the return, the less likely you are to attract the attention of the IRS.

Best Practices
Keep good records of your business activities: locations, times and dates, expenses, a description of what took place, along with accompanying receipts and cancelled checks. If you are audited, you have most of the work already done.

Report all your income
You are required to report all business income unless a special tax rule on tax-free treatment applies.

  • Report “invisible” income- If you barter for goods and services, you are taxed on the value of what you received in the trade.
     
  • Report cash-Tips and other cash payments are something that the IRS is focusing on. Based on your lifestyle and expenses, they can determine if you have been receiving additional income in the form of cash. This is particularly true in industries where payment in cash is common.

Keep the paperwork
Your records are the key to proving your right to deductions and credits. You may not be able to prevent a random audit but you will be able to survive it if paperwork is on your side.

Types of records
Receipts, invoices, and canceled checks for expenses paid, expense account worksheets, diaries and log books for travel and entertainment costs, including car usage.

Financial experts expect to see an increase in audits and assessments in the coming years because tax audits provide a revenue stream that the IRS currently is missing out on. The IRS estimates that it fails to collect about $345 billion in taxes each year. So it’s even more important now that you keep clean, accurate records and understand what factors can cause your return to be audited.

Over the next couple of weeks, we will talk about the types of actions that can raise a red flag with the IRS and prompt a tax audit.

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