Recently I made the visit to the downtown office of the IRS to assist a taxpayer through a very extensive audit. The process of dealing with the IRS can cause stress and sleepless nights for the taxpayer. The reason the IRS causes such fear is that they can be a real bully. My client can attest that the auditor will ask pointed questions and make you feel frazzled and on edge. IRS auditors are trained to find errors in your tax return and they will dig hard to find things that they determine to be non-deductible. Statistically less than 2% of taxpayers are subjected to a full IRS audit but it is still worth the effort to be prepared for the worst case.
Here are some tips for you should you ever receive the dreaded letter:
Don’t try to handle the audit yourself. You may feel that you are saving some money by trying to handle the audit yourself, but you could get hit with a much higher tax deficiency (in other words you will owe much more to the IRS) than if you had the assistance of a professional who knows the tax laws.
Keep good records. The auditor will disallow your deductions if you don’t have good substantiation. Keep cancelled checks, invoices, bank statements, receipts for meals and travel documenting business purpose, mileage logs, etc. In this case, the IRS is not going paperless anytime soon! Their systems are so antiquated that you can’t even send documents by email. You will need paper proof. Or you will need the ability to drag your computer with you to the audit.
Keep check copies or use your debit/credit card. The IRS will want to see that your payments cleared the bank and the best way to show that is with a cancelled check, bank statement or credit card statement. The advantage to using your debit card or auto payment through your bank account is that your bank statement will show the payee right on the statement. If you use a lot of checks you will need copies of those checks. Most banks don’t send check copies any more. You might want to check with your bank to see how best to store that information. Most banks can send “copies” of the checks 10 to a page with your statement. That is a good option.
Keep written contracts with those that you pay, especially your independent contractors. You will need to prove that your relationship has a “business purpose” and that you pay for a service or product.
Stay away from audit “red flags” if possible. Make sure your expenses are in line with your income. Large travel and entertainment expenses are a favorite trigger for audits. Auto expenses and auto depreciation can also be a trigger. Be sure to document on your credit card statement the “business purpose” of your meals and travel expenses.
As the saying goes, if you are prepared you have no need to fear. Simple practices now will save you a lot of headache if you ever become part of that 2% audited group. You might sleep better too!