Keep Copies of Your Records

Source: http://www.seniorliving.org

This is, of course, a pre-emptive move. Keep records of all of your transactions, 1099s, W-2s, paycheck stubs, and, of course, a copy of your actual tax return. Record all correspondence with the IRS after you receive it. When dealing with the professionals over the phone, make sure to take down their ID numbers, names, the time at which you spoke to them, and specific points they may have related to you.

Do The Calculations and Talk to a Professional

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Human error is always inevitable when the IRS sends calculations. In 1998, the IRS sent apologies to 20,000 taxpayers for mistakes in handling their accounts. Math mistakes rarely lead to a full audit. In this situation, it’s best to send the IRS a printout of your calculations, along with any important or relevant documentation. Make sure you make your response as clear and concise as you can. You can also request additional information if the letter itself is unclear to you. If you’re confused or unsure, however, seek out a qualified tax professional to help you sort through the letter’s requests.

Know The Common Types of Letters

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Taxpayers are typically selected in the following ways:

1. Random selection based on statistical data

2. Document matching–match 1099s with W-2s with what individuals actually report. It deals with unreported income from another source–sometimes, it’s a company you may not be familiar with, or income reported on an earlier return.

3. Questioning accuracy of taxpayers’ returns. Correction notices are when the IRS says they’ve found an error on your return and corrected it for you. They usually ask you to remit a certain amount of more money. In this case, sign and date the notice and include your payment.

The only notice that permits the IRS to do anything is the CP 90–Final Notice of Intent to Levy and Notice of Your Right to a Hearing. After the final notice, it must wait 30 days before taking action. During the 30-day window, you can file a request for a meeting with an IRS appeals officer, or CDP.

Dispute When You Can

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The Government Accounting Office says that 48% of IRS notices are “incorrect, unresponsive, or incomplete.” If the bill is for a low amount–under $600–you should certainly dispute it. It might be wrong, after all. Don’t forget about your state returns, too–if you respond to any federal letters, you may have to change the information on those tax returns, as well.

Be Calm–and Respond on Time

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Again, don’t automatically panic if you get a letter. (More than one million letters are sent each year because people failed to sign their returns). If you do end up owing quite a bit, the IRS will usually work with you on a payment plan. And sometimes, after letters are sent, the IRS will actually owe you more money. Just make sure you respond on time–usually, within 60 days–or the IRS may put a lien on your property, serve a penalty, or take other unpleasant action.

But are tax audit visits really that frightening in real life? Not so. In fact, only 1% of all taxpayers even experience an audit. Of those, about 20% ever result in a face-to-face encounter with the IRS. Most inquires, fortunately, are resolved through correspondence. Take a look below at our guide to tax audits.

Audits Explained

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Though audits have increased slightly in recent years, chances of being audited are still low. In 2008, the IRS audited about 1.4 million tax returns out of a total of 140 million.

Most audits are conducted via mail. Last year, 78% dealt with the IRS via correspondence, while 22% came in for an in-person exam. CNN reports that correspondence audits are cheaper for the IRS–and, according to Georgetown professor Thomas Cooke, people tend to take action as soon as they get a letter (perhaps hoping to delay any personal visits.) However, don’t assume the IRS is correct. Research the issue the IRS is challenging. In many cases, the IRS may be unable to match information reported to them versus what you reported. Fortunately, it may be something as simple as providing additional information or an explanation to meet their requirements.

Correspondence audits usually require you to provide information (or evidence) about very specific claims made on your tax report–or a check for unpaid taxes. On the other hand, an “office audit” is slightly more involved and more intimidating–you’ll have to go into an IRS office. A  third option, a”field audit”,  is typically a fuller examination, and is conducted at the home or business office where you work.

The IRS will let you know which documents are needed beforehand. If your documents supports the original return, you shouldn’t have a problem–the audit is “no change.” If the auditor finds a discrepancy (and you agree), you can sign the documents and pay any taxes owed. You can choose to disagree with the auditor’s findings, in which case you can appeal the decision later. As a general rule, it is best not to offer the IRS agent any information beyond what is specifically needed. Otherwise, you could generate additional questions from the IRS.

You Might Get Audited If…

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You Claim Losses. If you own a business, you’ll need to first prove your business is legitimate (i.e., your intention is to earn a profit) and not a hobby. Claiming anywhere from a $5000 to a $10,000 loss is usually a red flag; if you get audited, you’ll need to provide statements related to loans, business bank accounts, business licenses, and income.

Claiming rental losses can also be a red flag for the IRS, since you can usually deduct only a limited amount of losses–and still must meet certain conditions. If “passive” loss allowance is higher than $25,000, expect a notice from the IRS.

You Claim Uncommon Deductions. If your deductions are unusually large, or are somehow related to home office expenses, your chances of getting audited are much higher than average. This is because some taxpayers have historically attempted to deduct non-business expenses (like home telephone service, living room or bedroom space, etc.) for tax purposes. Same goes for extravagant business deductions related to meals or entertainment.

Charitable Contributions. Claim a large charitable deduction and you’re likely to be on the IRS hot list. That’s because, in the past, documentation requirements for charitable contributions has been less stringent than it is today.

You Have a Cash Business. The IRS knows that businesses that deal much in cash transactions–like taxi driving, hair salons, etc. -can easily conceal income.  The IRS has actually fashioned a new guide to cash-intensive businesses for agents, so be meticulous with your documentation and reporting.

If you have evidence of your claims for all taxes, you should be fine.