Preparing for an IRS Audit

Old accountants say, "You win an IRS audit before you ever meet the auditor." And it is true. Your preparation work for the audit determines the tone of the audit and the outcome in most cases.

Gathering your information in advance and adding receipts together shows you where you stand. Weaknesses in your records are now clear to you, but not to the auditor. You can guide to a limited extent where the auditor looks.

Addressing lost documents up front can work to your advantage. If the auditor discovers something while working through your papers, you can have serious problems.

Never throw a stack of paper at the IRS auditor. Have everything gathered together in paper clipped piles. This way you only provide the information you want or the IRS requested. Why give the IRS extra information to use against you.

Read more about preparing for an audit here: The IRS Tax Audit Process: Preparing for the Audit




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Abatement of IRS Penalties and Interest

Taxes are bad enough. Personal matters in life can get you behind in your taxes and it is nigh impossible to catch up. The IRS has a program to get your life back without pages and pages of forms to fill out. Today I am going to talk about abatement of IRS penalties and interest.

• Abatement of IRS Penalties: It is easier to get the IRS to abate a penalty than interest. File Form 843 to request abatement. Keep your explanation short and to the point. The biggest drawback is that you need to pay the IRS in full for the tax period you are requesting abatement. If you owe on several years of taxes, file for abatement as soon as each year is paid.
• Abatement of IRS Interest: The IRS allows for abatement of interest for two reasons only: the IRS gave you bad written advice or the IRS delayed an audit unnecessarily causing more interest to accrue.

Learn more about the IRS abatement program here: The IRS Audit Manual: IRS Penalty and Interest Abatement


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IRS Audit Procedures

An IRS audit is not an accusation; it is an opportunity to verify your numbers. I make it sound so nice, don't I?

Most people do not understand how the IRS approaches a tax return for audit. The average taxpayer thinks the IRS auditor is looking for cheating and it is one thing the auditor will look for. However, the auditor is looking to verify the numbers on your tax return more than anything else. She will add up all your receipts and compare it to your deductions plus compare income to bank deposits and W-2s and 1099s the IRS has on file.

The IRS auditor will also verify that you applied tax law correctly on your return. A gift to your buddy is not a charitable tax deduction and will be disallowed if claimed. Each area of the tax return will face the similar scrutiny.

An audit is nothing to fear. It is more annoyance than anything. You can learn more by reading this article: IRS Audit Manual: IRS Audit Procedures



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How the IRS Selects Audits

There no fool-proof way to avoid an IRS audit, but you can reduce the risk if you follow a few simple rules.

1. Errors: The number one reason the IRS audits a tax return is errors on the return. There are two errors you must avoid: math and matching.
2. Math Errors: Math errors are going the way of the dinosaur due to the heavy use of computer software to prepare tax returns.
3. Matching Errors: Matching errors are on the rise, however. A matching error is where the IRS has different information than you reported on the tax return. Missed interest and dividend income top the list. Missed sales of stocks and mutual funds run a close second. In my office I saw a tax return audited due to missed mortgage interest. The IRS assumed if the taxpayer was so sloppy as to miss deductions, there could be unreported income to.

Income over $100,000 and a sole proprietor business also increases your chances of getting selected for audit. Reducing errors is an easy way to lower audit risk; income is a different story. I'll keep the higher income and take my chances.

If you have a small business, consider organizing as a partnership or S corporation. This can cut your audit risk by over 75%.


To learn more about the IRS audit selection process, click here: IRS Tax Audits: The Selection Process



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