There is no such thing as a ‘perfect’ tax return. This is due to differing interpretations of the tax laws, human error and/or computer error. 2% of all tax returns are chosen for random examination without any apparent errors.  Therefore, the question is not if you will be subjected to a tax audit but when it will happen. When it does, the issues become which taxing authority is examining you, how good are your records, how much is it going to cost you in additional taxes, and who can help you keep that number as low as possible?

The following discussion will help you answer the most personally-manageable of those which is “How good are my records?” because supporting your numbers is more than half the battle.

Most Common Errors that Trigger Audits:

• Filing paper returns:

We understand in this age of rampant ID theft not feeling safe putting all your data ‘out there’.  It’s scary.  BUT, tax software and IRS-approved E-filers have the necessary security in place to keep your information safe.  More importantly:

• • Most math errors will be automatically eliminated by the software.
  • There won’t be a fallable human being on the other end manually entering your information into the system, possibly making errors that change your return
  • Your return will not be at the mercy of the US Post Office which is being targeted by ID theft gangs.
  • Your return will be processed faster, more accurately, and you’ll get your refund sooner.

• Getting Careless With Your Forms:

Nowadays, the IRS is getting copies of your documents and their computer makes comparisons.  If they find a discrepancy, it will trigger an audit.  Double check that you received all your forms from all your banks, mortgages, investments and business.  Verify all your numbers three times to ensure that you have input 100% of your data correctly.  And KEEP COPIES of all your documents in paper and electronic format.

• Missing an RMD:

RMDs (Required Minimum Distributions) from your retirement accounts can trigger an audit plus a  25% penalty.  Take the distribution, pay the taxes.  If you don’t need the money, you can always re-contribute it (which makes it deductible) or put it to work in another type of investment that will not require RMDs. Strategize with a professional on the best options for you.

Bullet-Proofing Your Return:

Rule #1:          Your tax return data is YOUR responsibility

• Your Accountant is NOT responsible for your tax return.  Although reputable preparers will defend their work, and most will absorb any penalties due to their errors, they are not liable for any tax assessments due to errors and/or omissions.
• Your accountant MUST depend upon you for numbers and support.  Your accountant’s responsibility is limited to helping you determine what expenses are legitimate deductions, guiding you in proper tracking procedures, and making sure your taxes are prepared properly based on the information you have provided.  So give them EVERYTHING so they can do their job with full information and insight into your financial situation.
• When you sign your tax return, you attest to its accuracy.  You cannot avoid tax penalties and interest by solely claiming that you relied  on a professional preparer.

Rule #2           Why you need documentation

• Documentation is the single most important part of surviving an audit.  It is key to supporting your position & is required by Federal and State law.
• You have the burden of proof as far as the IRS is concerned. If you don’t have good records, you can be held liable for fraud which could mean jail time.
• Without it, your deductions may be disallowed

Rule #3           The cost is high if your deductions are disallowed

• Wage earners income tax start at 10% of their taxable income and increases from there.
• Business owners are taxed on the profits of their business at a minimum of 25.3% (10% income tax plus 15.3% Social Security tax) which goes up as the income increases.
• Both types of filers will incur penalties and interest on amounts due:
  • a standard 10% penalty for any payment past the due date of the return
  • PLUS: 0.5% per month penalty during until the tax is paid in full
  • PLUS an increase to 1% per month if the tax isn’t paid within 10 days of notice from the IRS
  • PLUS 20% of any underpayment due to negligence or lack of reasonable basis for the deduction
  • PLUS 75% of any underpayment attributable to fraud

Rule #4           Avoid Penalties by Meeting Record Requirements

You can avoid all of the problems by maintaining accurate, reliable records of all activities.

• Become a Pack Rat – scan and save each and every receipt and DO NOT prescreen the information.  Let your professional tell YOU what’s deductible not the other way around.
• Build a filing system separated into business and personal information by month and type of information. Then prepare a summary by expense type for your financial professional to save you money on the preparation costs.
  • Permanent Records should include your home and auto purchases plus the records of any other assets or other transactions you will need to keep for more than 1 year.
  • Temporary or Regular Records should include any records that pertain to only one year such as checks, invoices and receipts and forms 1099 or other official tax paperwork.
  • Daily Diary should keep track of mileage, appointments, etc.
• Use 3-part checks and keep one copy in a numerical file and the other copy with the receipt  If you use electronic checks or bill-pay, save an electronic copy of the check with the invoice/bill..
• Use a business credit card to reduce your need for paper record keeping.  The credit card activity reports detail purchases and create an audit trail for you.  Some even provide annual summaries by type of expense as well as copies of the charge slips and payments.

Rule #5           Retaining your Records

By LAW, you must keep your records in sufficiently adequate detail to establish your income and deductions beyond a reasonable doubt.  Such records must be available for inspection as long as the information is significant to the administration of any tax law related to your return.

• Three Year Rule  – All taxes must be assessed by IRS within three years from the date the return is filed or the date it is due, whichever is later.
• Six Year Rule –  If you omit an amount in excess of 25% of gross income, the 3-year limitation is automatically extended to 6 years.
• No Limitation – If you fail to file or file a fraudulent return, there is no statute of limitations.
• Extension by Agreement – The statute of limitations may be extended by a written agreement between you         and the IRS.  We recommend this be avoided if at all possible.

 We recommend keeping records for 7 to 10 years AFTER the date the return was filed, the activity occurred and/or the asset was traded, sold or disposed. Make certain you make electronic copies of heat-sensitive receipts as they will fade very quickly and become useless. Lastly, electronic copies of bank and credit card activity, statements and reports can be exceptionally helpful in any audit.