The best way to avoid being audited is to follow the rules. File a return every year and be complete and honest. However, the IRS uses statistical sampling to identify auditees and you might just find yourself in their spotlight no matter how thorough you might be. If this is you, prepare yourself and manage expectations. An IRS audit might not be as bad as you think.
Getting an A+ on the audit is all about keeping accurate logs and correct reporting.
Not a tax expert? No problem. Hire a professional to do your taxes, especially if you are incorporated. Taxes are complex and your time is probably better spent managing your business.
Do not ever lie to, or hide the truth from your preparer. For example, if they ask you to disclose a foreign bank account, do it. More and more international banking centers are complying with the US’s requests to disclose account information.
Computers have greatly increased the ability for the IRS to collect data and query to determine whose returns are not telling the entire story. For example, the 1099 INT that your bank mails to you is also reported to the IRS. If you fail to report your 1099 INT, be sure that the IRS is already aware through simple database querying. When your name makes it to their exceptions report, you could greatly increase your chances of being audited.
Statistical Sampling – How the IRS Finds You
Every year the IRS publishes the Data Book, which is an extremely large, complex document telling us what the IRS is looking for. The 2010 Data Book reveled how the following groups were audited:
- 1% of individuals with income of less than $200,000
- 8% of individuals with income greater than $1,000,000
- 8% of corporations earning more than $1,000,000
- 2.5% of corporations earning under $100,000
- 98% of corporation earning 20 B or more
- Key triggers: missing schedules, excessive deductions, complex return
Key takeaway: if your corporation earns more than $1,000,000 you are a target. If you as an individual earn more than $1,000,000, you are a target. If you are a whale, 20 B or more, you are not just a target, but you have a full time IRS presence at your organization.
Sometimes just being a high profile, high net worth individual can trigger the IRS to scrutinize your return. Everybody should remember Richard Hatch of Survivor fame who served jail time for failing to report his million dollar prize. The IRS is known to target individuals whose incomes make headlines such as prize winners, executives, and star athletes and entertainers.
You’ve been selected, now what?
Proper record keeping will be your savior. If you are disorganized, you will want to apply for a delay so that you can organize your paperwork. Basically, what you will be doing is supplying support for every number recorded on the return. For example, you will need support for all revenues and expenses. If you deducted $12,000 in expenses you had better be able to supply documentation that totals $12,000. For any amount other than $12,000, the auditor will reverse your deduction. Expenses are where most people fail to keep accurate records.
Proper expense logs make an audit less of a burden, you will have readily accessible information to support the documentation. Otherwise, maintaining organized records is always a good business decision. A good log should include account number information. Docstoc has great logs for travel, mileage, and other expenses.
Special events like the sale of property and equipment, or grants and donations should command extra scrutiny on your part. Seek professional help if you need further advice on how to treat such transactions.
In many cases you can reconstruct missing information, but this requires time. The IRS will usually presume that the deducted expense should be reversed so long as there is no supporting documentation. Not having to reconstruct missing documentation is a great advantage in an audit because calling banks and vendors can take valuable time.
Where will the audit take place?
In a correspondence audit you will send in your support via fax, mail, or email. Most audits occur in this manner. If you are selected for a field office audit you will present your documentation at an IRS office or an IRS agent will visit your premises.
Should you hire an attorney or CPA?
In most cases yes. If you had a professional preparation or used a service like Turbo Tax, they might have certain guarantees and will assist you through the audit process. Turbo Tax’s website even claims that Turbo Tax will pay the penalty and interest, but read the fine print, this is only if you supplied accurate information.
An experienced professional will assist you in preparing supporting documentation. They will determine what to send and how to present it. Additionally, if the IRS does not request specific support, do not volunteer. A professional will have a much better sense of how to handle the IRS requests.