Surviving a Tax Audit

Spring, 2009

Documents, receipts, support, and contemporaneous records; these are the tools to surviving a tax audit.  During the audit, you will be asked to utilize these tools to support the position that you have taken on your tax return and the auditor will be scrutinizing your position.  In other words, based on information received by the IRS from you and/or outside sources, the auditor will examine certain specified items on your tax return.  Not everything will be checked, but the auditor may open the scope of the audit to include other items on the return, if deemed necessary.

Of course, most know an audit is designed to insure the proper reporting of income and eligible expenses.  Many of the income items are provided to the IRS by third parties through information returns such as a Form W-2 or Form 1099.  As long as the income on your return matches the information reported to the IRS, there should be little question about the income reporting.  However, it is sometimes difficult to match income reported for business, farm, and rental property operations, making them a target for vigilant scrutiny.

The auditor is looking for unrecorded income so it is imperative to have a good system to document these sources of income.  One way would be to keep a daily or weekly log of deposits.  However, using professional accounting software, something like QuickBooks, would be more ideal.  Remember, the IRS is looking for where your money came from and whether it is taxable or not.  So, if you receive income that is not taxable, such as gifts, inheritance, and loans, make sure you keep a copy of the check or document that accompanies that income.

As for expenses, you are allowed to deduct many types of expenses on your tax return and some of these items are easily documented because the amounts are reported on a statement sent directly to you, such as mortgage interest, real estate taxes, and property taxes.  But, it is more often difficult to support out-of-pocket medical expenses, contributions, and miscellaneous itemized deductions.  These expenses need to be supported by receipts and proof of payment.   However, credit card statements are not proof of payment, the credit card receipt is the proof.

Since many taxpayers often expense personal items that should not be deducted because they are not “ordinary and necessary” business expenses, returns containing business, farm, or rental expenses are audited more frequently.  Therefore, it is important to know the rules and to have the proper documentation.  Besides needing to be “ordinary and necessary”, they too must be supported by receipts and proof of payment.  Of course, certain expenses receive more scrutiny than others and the areas auditors tend to focus on are meals and entertainment, travel, and car and truck expenses because maintaining these records are more time consuming and more often abused.

For example, meals and entertainment are deductible only if the expense occurred for the purpose of the business, if there is sufficient documentation, and only 50% of the expense is deductible.  Many taxpayers expense 100% and often include personal meals.  Be aware, if the expense is over $75, you must have a receipt, otherwise a contemporaneous record, which is documentation prepared at the time the expense occurred, is acceptable.  The receipt or record must show where the expense took place, the date, the amount, who was involved, and the purpose.

For car and truck expenses, they can be handled one of two ways, mileage method or actual expenses.  If using the mileage method, contemporaneous records, complete with beginning and ending odometer readings for the year, should support the mileage.  These records must show, the date, miles traveled, and the business purpose.  Actual receipts should support parking and toll expenses.  Unless the vehicle is 100% business, you also need to keep contemporaneous mileage for the actual expenses method.

If you would like assistance with your record keeping requirements or if you would like for us to represent you in an audit, please call.