Tax Audit –Preparedness Is Key

Posted on 9/27/2018

Fall is upon us! Time to enjoy the cooler weather, changing leaves, and seasonal treats. And for snowbirds, like our good friend Tony, it’s time to prepare to head back home. We had a chance to catch up with Tony before the move and, unfortunately, he had some bad news to report - he’s being audited for last year’s tax return.

As a high earner, he was slightly more likely to have a target on his back, but it’s still a fairly uncommon situation – see statistics below. Now Tony is going to have to go through the process of proving the accuracy of his return. Let’s just hope he’s kept everything that he’ll need and that he has his information organized. What should you do if you find yourself in Tony’s shoes? We’ll provide you with the information you’ll need to understand why you may have been audited and what you’ll need to defend yourself.

_{Greenberg, Scott. “The IRS Audited 1.2 Million Households in 2015.” Tax Foundation, Tax Foundation, 16 Jan. 2017, taxfoundation.org/irs-audited-12-million-households-2015/.}

An income tax audit sounds intimidating. But should it? An audit is just the process by which the tax authority examines your tax return to confirm you’ve accurately represented your situation and paid the appropriate amount. An audit can be issued by the Internal Revenue Service (IRS) or by a state tax authority. There are several ways that you can be selected for an audit.

• Having documentation in your return that does not match with a 3rd party provider, such as your financial institution or your employer.

• Computer analysis, which is done on all returns, can give you high scores for the likelihood of a discrepancy in the filed return and/or the potential for unreported income.

• Randomly selected

Tony must have been randomly selected. He’d never do anything to make his tax return inaccurate, right Tony?!

So, what should Tony do first? If he used a tax professional or tax software for his return, he should see what kind of audit support is available to him. Many tax preparation businesses will offer you help in the event of an audit. Some, such as TurboTax, even include basic support in their price so it is free should you need it. If you do not have support available or require a higher level of support, you can hire a tax professional to help you through the audit process.

Tony’s next step? He should pull together all of the information related to his tax return for the year in question, this step is where most of the pain of an audit will come from. However, by proactively organizing your documentation at the end of each year, an audit will become a much easier and smoother process. So, hopefully, Tony has been keeping this information each year, has it organized, and just needs to open his file for the year in question. Luckily, relatively speaking since it is an audit, after all, he only needs to go back one year. But how far back should Tony keep records? It’s recommended to keep your tax documents for a minimum of 3 years, the standard statute for an audit to occur. Although, in certain circumstances where the tax agency believes you have misrepresented gross income by more than 25%, they can audit you within 6 years. If you ever missed a return or knowingly reported inaccurate information (tisk-tisk), you should keep your documentation for that year indefinitely. Since it’s so easy to scan, photograph, or download documents and with the availability of low or no cost storage, we recommend keeping digital copies of all documents for as long as possible. By using your phone/computer and a cloud storage system (such as Google Drive or iCloud), it is very easy to digitize all of this information and store it in a secure location with folders for each year and type of document. Okay, okay, that’s it for my pitch about using technology to make your life easier (TaxBird’s exact goal!). What to keep though?

• All income and financial documentation. W-2s from your employer. 1099s from investments, dividends, or self-employed income. Statements from your bank and brokerage firm. Any other documentation related to income or interest. Gains from gambling.

• Taxes already paid. Taxes paid to state and local taxes (SALT) should be saved, along with any taxes paid throughout the year, note these are now capped at $10,000.

• Deductible expenses. Any expenses related to your home, including 1098s, home improvement costs, and/or tax-deductible moving expenses. Medical or dental bills. Child care or dependent care. Alimony. Gambling or investment losses. Educational expenses including tuition, loans, fees, books, supplies, and equipment. And of course, charitable donations.

• Retirement contributions. Keep all records of contributions to all retirement accounts.

• Records of where money was earned. Detailed records of where the money was earned and where you live. TaxBird’s reports, which are delivered as a PDF and can be easily saved with your other files, can help show which days were spent in and out of states for state income tax records.

• Any other documents related to income or deductions that you have taken.

You can see that there is a lot that could be beneficial to have when defending yourself, and the more you have readily available and organized, the easier this will be. As long as you were honest and accurate, an audit is a fairly simple and straightforward process. The process can take place either by mail or through an in-person interview. They’ll review your records and work with you to reconfirm what you should have paid. It’s important to know that you have the following rights as a taxpayer during an audit (as stated by IRS.gov):

• A right to professional and courteous treatment by IRS employees.

• A right to privacy and confidentiality about tax matters.

• A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.

• A right to representation, by oneself or an authorized representative.

• A right to appeal disagreements, both within the IRS and before the courts.

The audit will be concluded in one of three scenarios. No change, an audit in which you have substantiated all of the items being reviewed and results in no changes. Agreed, an audit where the IRS proposed changes and you understand and agree with the changes. Disagreed, an audit where the IRS has proposed changes and you understand but disagree with the changes. If you disagree, there is further action you can take to try to reach a decision that both parties agree to.

I hope you find this information helpful. But I have far greater hope that you’ll never need it!

For more information about this topic, check out the IRS Audit page.

Questions, comments, or feedback for the author? Contact jared@ware2now.com.