For whatever reason, we seem to see clients get audited in waves.
Months will roll by and other than those annoying “audit letters” (which are technically known as “correspondence examinations”) nobody hears anything from the Internal Revenue Service or the equivalent state revenue agencies.
Then all of sudden, boom! The IRS or some state revenue agency (usually a big state in fiscal trouble) gets aggressive and starts sniffing around for money.
If you get into a situation like this, even if you’ve correctly filed your tax returns and haven’t broken any laws, you’re in trouble.
Tax auditors (and in particular state revenue agents auditing nonresidents) seem to assume the worst, give you no benefit of the doubt, and often basically bully the poor, stressed out taxpayer.
Fortunately, and this is good news, you do have three super-powerful weapons you can use to do battle with the tax auditors.
Tool #1: A Decent Accounting System You’re Correctly Using
A first, quick tool to cover: Your accounting system.
Here’s the deal. If you’ve been using something like QuickBooks or Quicken and so can easily produce good, detailed reports that list transactions and explain amounts you’ve reported on a tax return? You’re in great shape!
You are not in this situation going to have to worry about explaining your numbers. Your accounting system will do that.
Further, because your accounting system will explain any number on the tax return (if sometimes after a bit of manipulation), you’re going to look like the sort of well-organized, dependable, no-nonsense taxpayer who’s neither unintentionally hiding stuff or may be unintentionally forgetting stuff.
Note: IRS examiners (and probably many state auditors as well) quickly assess the reliability of a taxpayers accounting records… and then adjust their audit procedures accordingly.
Tool #2: Organized Files of Supporting Documents
Okay, so here’s another weapon you can use with powerful effect if you’re audited: good, organized files that supply complete records of all your supporting documentation: receipts, contracts, logs, invoices, and so on.
In other words, you want to be able to easily locate and provide the supporting bits of paper and other evidence when the auditor asks.
If you don’t have this information, you’re basically toast in many situations.
Now technically, you can construct alternative evidence. But it’s best to use that approach for the documents you’ve somehow lost. You don’t want to be the taxpayer who’s got no or little supporting documentation and needs to scurry around trying to find other people’s copies of the documents you should have saved.
Note: The statute of limitations (three years since the date of filing a tax return that relies on a document) means that you probably need to keep any receipt that’s connected in any way to a return you’ve filed in the last four years.
Tool #3: An Outside Accountant Who Knows Everything About Your Return
A final tool or “weapon” you want: You’ll both be less likely to get into trouble and more likely to easily escape trouble if you have the help of accountant who knows all about your tax return and can interface with the auditor.
Sorry to tell you this… But clients (often in an attempt to be helpful) tell auditors all sorts of irrelevant, counter-productive, and damaging-to-their-case bits of information if they talk to an auditor.
Your accountant, if he or she knows the whole story, won’t do that.
Further, your accountant hopefully will know more tax law than the auditor auditing your return.
And in that case, your accountant will (rather like a big brother or big sister) be able to protect you from any of the bureaucratic bullying that (unfortunately) can too easily occur.