Who's afraid of the IRS? Almost everyone. The key to surviving a tax audit -- and even coming out on top -- is not to panic, but to prepare.
If you go it alone, before meeting the auditor, you should thoroughly review the tax returns being audited. Be ready to explain how you, or your tax return preparer, came up with the figures. If you can't, then contact your tax preparer or another tax pro.
Find all records that substantiate your tax return. As discussed, the IRS has a right to look at any records used to prepare your tax return. Organize your records for the auditor in a logical fashion. Your pre-audit organization of receipts, checks and other items will refresh your recollection for the audit meeting.
Neatness counts. Forget about dumping a pile of receipts before an auditor and telling him or her to go at it. Messy records mean more digging, and more digging, to the IRS, means more gold for them. Conversely, auditors frequently reward good recordkeepers by giving these folks the benefit of the doubt if any problems arise. Neatness builds your credibility with the auditor. Tidiness and order appeal to an accountant's mentality, and most auditors are accountants.
Pinpoint problems backing up income sources or expense deductions . You'll need to legally show your right to take tax deductions or other tax benefits claimed on your return. Research tax law, if necessary.
Audit success means documenting your expenses. Proof should be in writing, though auditors are allowed to accept oral explanations. A list of items the auditor wants to see usually accompanies your audit notice.
At a minimum, the IRS will expect you to produce the following documents:
Since charges and statements don't always show the business nature of the expense, you can't rely on them as your only records.
Additionally, you must keep special records for certain equipment, called "listed property," that is often used for both business and personal purposes. (IRC § 280F.) Cell phones, computers kept at home but used for business, and vehicles used for both business and pleasure are designated as listed property.
Purely business equipment is not in this category. For example, mechanic's tools, a lathe, or a carpet loom are purely business tools, and no records of usage are required. But when assets are put to both business and personal use, the auditor can demand records of usage. For example, if you use a computer for business email and to play solitaire, keep track of the business portion. One way is to make notes in a note pad next to the computer.
If you haven't kept usage records of listed property, reconstruct them by memory or reference to projects that you worked on during the year.
A good way to document T & E expenses is with an appointment book or log, noting each time you incur a business expense, and the reason. Most folks aren't disciplined enough to write down every expense as it is incurred. It is okay to put together a log or diary after you have received an audit notice. But be up-front about it -- don't insult the auditor's intelligence by trying to pass off wet-inked paper as an old record. Remember, it's key to develop and maintain credibility with the auditor.
Copyright 2003 Nolo