Uh-oh. You just got a letter from the IRS
You’re flipping through your mail, and the return address on one letter makes your heart rate quicken — and not in a good way. It’s from the Internal Revenue Service, and they want to audit your return.
Don’t think it can’t happen to you. The IRS seems to have gotten back to work after a lull, and I’ve recently gotten several frantic calls from clients who have received audit notices.
Your mind races and your palms sweat. Did you do something wrong? Why are they coming after you? How are you going to be able to defend yourself against the U.S. government?
Let me offer the most straightforward piece of advice I can: Take a deep breath, exhale slowly and set the letter aside.
Do something else for a while. Finish some chores. Walk the dog. Once you’ve calmed down, you can focus on the letter.
Who made the mistake?
For starters, there’s a chance the IRS flubbed. Remember, it’s a massive government agency handling millions of tax returns. It’s understaffed, underfunded and staffers are overworked. They can — and do — make mistakes.
You or your tax preparer could also slip up. The agency sends out nearly 2 million notices about math errors on returns the prior year. Maybe yours is one of those.
An IRS reviewer may also have missed seeing your correct information in the spot they thought it should have been in, even if you included it elsewhere on your return.
They may not have applied a payment that you already made. Or they may have transposed some numbers or gotten a date wrong. Believe me, it happens.
Pull out your tax return and check for those clerical errors first. After that, thoroughly review the letter. What exactly are they asking for? What are they claiming is missing from your return?
Letters resulting from a 1099 audit often include a “notice of proposed adjustment.” The “adjustment,” of course, is the additional money the IRS says you owe them, including the penalty and interest that’s been assessed.
Selected for an audit?
An IRS letter may also state your tax return has been chosen for an additional investigation or audit, and it may give specific categories the agency wants to review from either a business or the taxpayer’s personal records.
This is where taxpayers’ hearts begin palpitations, and there’s a simple reason why: Most don’t have a clue about what’s actually in their return because they hire others to do it, and sign off without reading it. Given that professional tax experts sometimes miss details, it’s likely laypeople miss them as well.
Send your tax preparer a copy of the IRS letter and ask for an explanation. There’s an excellent chance they will have answers that will satisfy the IRS.
If you prepared your return yourself, look for the same issues a preparer would: perhaps a date was misread, information that is being requested was, in fact, included in the return, or the time period wasn’t clear.
The IRS is not in the business of chasing people for amounts that aren’t due. If they’re satisfied you’ve paid what you owe, they will move on.
If there are remaining issues, there’s a good chance these issues may be a consequence of tax items from a prior year that impacted the current year’s return. This means the IRS may be scrutinizing whether you incorrectly applied tax deductions or credits disallowed on previous returns to the current year.
These deductions and credits make more tax revenue if carry forwards can be disallowed, so of late the IRS has asked taxpayers to provide the original source information for the deduction or credit, even though the statute of limitations related to that particular item may have long since passed.
Hold on to important docs
To address these questions — now and in case of future audits — keep your receipts and records for six years at a minimum.
And this is crucial: The IRS does not accept credit card receipts in an audit. Even if you regularly use a company credit card to pay business expenses, the IRS requires the original vendor receipt. This is one of the most common errors I see among my clients.
I strongly recommend getting an app that allows you to take a picture of the original receipt using your phone and maintain a record of all the receipts on your credit card. At the end of the year, you can download a PDF report that is easily archived.
Keep contemporaneous records along with the receipts to indicate how each expense benefits the business in case you’re called on to justify it.
It’s entirely possible the dreaded audit letter can be resolved relatively painlessly. Just never forget the IRS is always trying to collect money. It is not trying to reduce your tax bill to the lowest amount legally possible. Mistakes they notify you of will almost always be in their favor.
When you have stellar records, you know you’ll be able to resolve what is often a small error. And your heart won’t race (as much) when you see that dreaded envelope in the mailbox.
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