The dreaded tax audit. Every year you file away receipts, you fill out the forms and you file them on time. Then you hope, more than anything else, that this year the tax auditors will pass you by and leave you in peace. But if, by some ill-fated chance, a tax audit is sprung on you, it is possible to get through this painful time in one piece… even if things do not go exactly to plan.
What is Involved in a Tax Audit?
The IRS audit more and more people every year, but generally audit target high income tax payers. If your tax returns show big charitable deductions, lots of business transactions, lots of itemized deductions and home business expenses, this may draw attention to your business from the IRS and increase the risk of being audited – but there are a number of other factors that can lead to an audit.
If you have been chosen for an audit, you must be prepared. First of all you should go through every letter of your tax return so you know it inside out and make sure that you gather together all the records that support whichever items were questioned by the IRS. If you are confident that you are in the right, presenting your records should be the end of it; however, it may not always be this simple.
Before the examination by the IRS, you should decide what kind of settlement you would be looking for if the IRS is right, as this may be an option open to you. If things go this far however, it would be advisable to have a taxation attorney to help you deal appropriately with the situation. Taxation attorneys are knowledgeable when it comes to these situations and will have dealt with this before, just make sure you have a good one!
Why Should you Hold onto Records and past Tax Returns?
To survive a tax audit it is vitally important to collect and organize your records throughout the year. This will not only have saved you time and effort when preparing your tax return, but will also allow you to defend yourself much more effectively, should the IRS find something wrong.
More specifically, it is important to keep your online bank records (if your bank does not already do this automatically), keep you check stubs as a receipt for the checks, track your cost basis for property and investments, keep your bills filed and keep track of deductable items when they happen.
You should make sure that your past tax returns are kept safe and organized, as the IRS may need to check your past tax returns from as long as six years ago. For past tax returns you should hang onto any records that help you identify sources of income, keep track of expenses, determine the value of property, prepare the past tax returns or support claims made on those returns. Usually three years after filing a tax return, the chance of a tax audit passes, however, if the IRS suspects that you may have underreported your income by 25% or more in a tax return, they have six years to check into your tax life.
Generally, people are advised to hold onto past tax returns and any related documents for up to 10 years for this reason. Furthermore, if you have a pension plan, own your home or invest in the stock market, you should keep these records indefinitely (or for at least three years after you dispose of the asset).
What Happens if Money is Owed once the Tax Audit is Complete?
If you have underpaid on your tax return, you could incur either of three penalties. The 20 per cent (basic) penalty applies to problems with property value, understating liability and making a mistake on your returns, among other things. The 75 per cent penalty will apply if the IRS suspects you have made fraudulent claims and basically deal with the serious tax offences that you cannot go to prison for. The third penalty and the most serious, is prison. Prison would be applicable where tax evasion or other tax crimes have been committed and are sometimes also accompanied by an enormous fine.
So, while tax audits can be scary, if you have done nothing wrong you have nothing to worry about. Just make sure that you are prepared and get advice from your taxation attorney if you need it.