Not All Audits Are Created Equal
It was last Friday that I was walking back from the mailbox and flipping through the mail that I saw one of the most dreaded envelopes you could imagine. It had the IRS logo and information in the return address spot. I knew that any letter from the IRS at this time of year has probably anything but good news in it.
As I open it, I’m expecting the worst. This was the first year I’ve ever hired an accountant and claimed the home office deduction. I thought for sure that I’ve triggered some sort of red flag and I’m going to get the financial equivalent of a rectal exam. But my fears were calmed as i started to read the letter. Yes, there was an error with my return, and yes, I did owe the IRS more money, but it was really not a big deal. It was still enough to tie your stomach in knots as you open a letter like that. Luckily, my problem was minor and it could be resolved easily.
It was actually a simple mistake on my part, but they obviously were quick to catch it. When I set up my estimated quarterly tax payments last year, I had the intention of setting it up so that I paid the same amount each quarter and a nice round number. I use EFTPS for electronic payment, but I also just record the amount and date of each payment in a payment log that I then hand over to the accountant.
So, when it came time to do my taxes, all they need is how much I paid in total in estimated taxes for the year, so I gave them the number I had. Well, what I didn’t realize was that for some reason I paid $500 less for that estimated quarterly payment. I still don’t the reason behind that or why I recorded the amount paid incorrectly, but clearly this showed up on my tax return when they compared the amount I paid via EFTPS to what I said I paid.
The IRS was kind enough to send me a copy of the EFTPS transactions and it sure enough indicated that I paid $500 less on that first payment. So, they simply ask that I pay the $500 plus interest and penalty. Well, thankfully that only worked out to a couple dollars. They even provided a self-addressed envelope, so rectifying the situation is as simple as writing a check. Crisis averted, although an important lesson was learned — always double check your records and don’t make any assumptions.
The Correspondence Audit
This is the type of audit I experienced, and it’s the most common type. In fact, many people receive these each year without even realizing it’s what most audits consist of. The correspondence audit is simply a letter sent to you by the IRS that identifies a possible error, information regarding the error, and instructions on how to remedy the problem.
In some cases this may result in actually receiving a larger refund, but more often than it means you’ll owe some additional money unless you can prove otherwise. This correspondence also includes information for how to challenge the IRS’s claim and what information you might need if you want to fight it.
Either way, these audits are relatively painless unless you’ve done something major such as failing to report something significant. As long as you take care of the problem in a timely fashion, you’re not likely to encounter any further correspondence from the IRS.
The In-Office Audit
This is one of the audit types that people usually think about and fear. In these situations, you actually have to gather information and take it to an IRS office to prove that your return is accurate. The auditor will schedule a date and time to meet and suggest what documentation you should bring so that you can substantiate your claim.
It’s obvious to see how this can be something to fear. If you haven’t kept good records or have lost receipts or other important documentation, you obviously know that it can be difficult to prove your claim. Depending on what the IRS asks for, it could be as simple as showing a few expenses to trying to verify that something like your home office actually qualifies for the home office deduction.
Of course, if you have good records and aren’t trying to pull a fast one, even these audits are relatively painless. The IRS may see something differently than you do, but this is your chance to prove it and hopefully fix the issue before additional penalties are enforced. This is where having a tax attorney or accountant can be beneficial.
The Field Audit
The final type of audit isn’t typically going to happen to an individual. The field audit is one where the IRS sends an agent into the field to meet with a taxpayer on-site. These audits are most commonly done on businesses or self-employed individuals making a lot of money. These audits are also sometimes the most feared.
If you do happen to be subject to a field audit, it’s imperative to have legal counsel. There may be significant sums of money at stake and tax laws can be complicated, so having someone on your side that specializes in tax law can potentially save you or even your business.
The Importance Keeping Good Records
As you can see, fearing the IRS and an audit probably isn’t as big of a deal as you may think. Everyone has stories about a friend who had their home ransacked by the IRS trying to turn up receipts from 5 years ago, but in most cases this just isn’t true. For the average taxpayer an audit is simply going to be triggered by inconsistencies in their computer and can be fixed by mailing in proof of something or an extra payment.
Unless you’re claiming a lot of extraordinary deductions or own a business, chances are an IRS audit will be little more than correspondence. Even if it’s as simple as that, without keeping detailed records you could find yourself in a situation where you are actually correct, but can’t prove it. If you can’t prove it, the IRS wins.
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About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.