3/4/2013 6:15 PM ET|
How to prepare for an IRS audit
Only about 1% of taxpayers get audited, but here is a record-keeping strategy to ensure you are ready for that possibility.
The kind of audit we really fear -- a line-by-line examination of our tax returns by a gimlet-eyed Internal Revenue Service agent -- is actually the kind we're least likely to face.
"Only about 1% of all taxpayers are audited," said Bob Meighan, lead certified public accountant for the American Tax & Financial Center at TurboTax, "and approximately 80% of those represent a correspondence audit."
Correspondence audits are conducted entirely by mail and focus on a few, limited issues. Office and field audits are the big baddies that involve greater scrutiny.
But whatever the type of audit, you'll be better off if you've kept good records, tax experts say. Here are the documents you should be sure to keep:
Whatever's not readily available from a third party. You typically can get several years' worth of bank and brokerage statements online, so you don't necessarily have to keep paper copies or download every monthly statement. (Check with your financial institutions to avoid any surprise charges.) On the other hand, it probably won't be so easy or even possible to get copies of utility bills or receipts later if you need them for tax purposes.
Credit card statements might be accessible online for only a few months, so those should be downloaded and retained if you need them for tax purposes. If your card issuer provides an annual summary, you can keep that instead of the monthly statements, said Sherrill Trovato, immediate past president of the National Association of Enrolled Agents. All this assumes you need the statements for tax purposes; if you don't, credit card statements can be discarded after a year.
Charitable donations. If you itemize your deductions and claim charitable contributions, you'll need documents to back up those claims. "The IRS likes to look at charitable deductions, in the belief that people tend to overstate them," Meighan said. The rules are stricter than they used to be:
- Now every monetary gift (including donations by cash, check and credit card) requires written proof. That can be a bank record, payroll deduction record or a written communication from the charity that includes the date and amount of the contribution.
- If the contribution is greater than $250, you'll need a written acknowledgment from the charity showing the amount of the cash and a description of any property contributed. The letter also has to say whether you were provided any goods or services in exchange for your contribution. If so, the letter has to provide a description and estimate the value.
- Noncash contributions, such as clothing or household items, must be in good used condition or better to be deductible. Meighan recommends taking photos of any goods you donate to charity and keep those as proof along with your letter or receipt. Almost everyone has a camera in their phone, he noted, and a photo can document not only the goods but their condition.
Business expenses. The IRS believes people often fudge the line between business and personal expenses, said CCH principal tax analyst Mark Luscombe, so good record-keeping is a must if you have a Schedule C or other business. Expenses for meals, entertainment and travel tend to draw special scrutiny, so make sure your records reflect where you were, who you were with and the business purpose of the purchase, Meighan said.
Medical expenses. Medical and dental care costs you paid for yourself, your spouse and your dependents can be deductible if they exceed 7.5% of your adjusted gross income. TurboTax has a partial list of eligible expenses, and you can find a complete list in IRS Publication 502 (.pdf file). Once again, you'll need to keep proof of what you paid, to whom and for what. You can include the cost of your transportation to and from medical care, along with tolls and parking fees, but you'll want to keep proof of the fares, tolls and fees you paid. If you used a personal car, you'll want receipts for out-of-pocket costs for gas and oil, or a diary that tracks your mileage if you plan to take the standard mileage rate.
Cost basis in investments. If you sell stock or real estate, you may have to pay capital gains tax on your profit. Your "cost basis," or the amount you invested, is subtracted from your sales price to determine that profit. Brokerages are now required to track the cost basis of investments purchased in 2011 and later, but your brokerage may not be able to track your basis for older investments or investments you transfer in from another source, so you'll want to keep your own records of purchases and sales.
As for real estate: Typically no one is tracking your cost basis, which includes not just the purchase price but also improvements made over time, so you'll need to keep good records to reduce your potentially taxable profit. All profit on the sale of raw land or commercial or rental property is potentially taxable. When you sell your primary residence, the first $250,000 of profit ($500,000 for a couple) is excluded, but after that, the profit is subject to capital gains taxes.
How long must you keep all this stuff? Most tax experts recommend keeping your tax returns indefinitely, but you normally can shred supporting documentation after seven years.
Your risk of audit drops dramatically three years after filing. That's when the statute of limitations for most audits expires, Luscombe said. For 2012 tax returns, which are due April 15, the statute of limitations would expire in 2016.
The IRS has six years to look at returns if it suspects you've underreported your income by 25% or more, he added. That would extend the statute of limitations for 2012 returns to 2019. So keep records longer if you have a cash-based business, accept tips, get a big cash gift or other windfall or have a lifestyle that might be hard to explain based on your taxable income.
The exception to the seven-year rule relates to investments, including real estate. Keep those records for as long as you own the investment, plus seven years. There's no statute of limitations if the IRS suspects fraud or if you fail to file a return.
By the way, the IRS accepts electronic records, so you don't necessarily have to keep physical paper. You can scan it instead -- just make sure you have a good backup system in place. Another option is to keep both paper and scans, and shred the paper when the relevant statute of limitation has expired.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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Just do away with the IRS and go to a flat tax. That along should balance the budget by not paying so many IRS people that knows no more about the ten thousand rules they have anyway.
A straight 5% from everyone's pay check, including big business with no write-offs at all along with No more spending increases by the Fed. Cut off all foreign aid and the dollar will be worth a dollar again.
Warning for the inexperience!!..If you go to one of these tax preparers who gets you more $$$ than others get you by inflating your deductions, Run for the hills!!..What will happen is one day the IRS will catch someone...then they look at who prepared the taxes and then the open up the books for everyone who is under the tax preparer. This happen to me when i was very young....they went after all of us and we were all making under $45,000.00 and we are talking deductions here, not hiding income. Then the tax preparer who coached all of us young dummies says “That is what they told me their deductions were”. ..at the end of the day it was our responsibility but I see this go on and on all of the time with these “tax preparers” who promise to get you a bigger return...If you do this, just have the $$$ in the bank just incase they come for it.
Stop doing a disservice to people again! People have short attention spans nowadays, so you should of left out the 3yr statue of limitations advice and stuck to keep your records indefinitely.
Don't be fooled. You CANNOT prepare for the lying, corrupt, thieving, dishonest, criminal bastards at the IRS. I've been audited 14 times -- beat them twice in tax court, and have lived with their UNENDING HARASSMENT EVER SINCE.
Their agents will lie to you, cheat, and do any thing possible to steal from ANY WORKING PERSON. At the same time the wealthy skate the audits with 34,000 of our most wealthy paying zero, zilch, - NOT A PENNY of income tax in 2010 (data for 2011 not yet available).
They will cite some obscure case they won in court as a precedent for WHY YOUR DEDUCTION isn't allowed, but they won't tell you about the other 15 more cases they lost in tax court that were much more on point to your situation.
Only way to prepare for the bastards is wear an explosive filled vest and take them out with you. Otherwise expect lies and damned lies from conniving bureaucratic ckskrs.
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