How to Prepare For an Audit

Four years ago, Robert E. Leach returned from vacationing in North Carolina to find a letter in his mailbox from the Internal Revenue Service. The missive stated his 2005 taxes were being audited. “I’m forthright when I do my taxes.  I was shocked when I received the letter.  I never thought I would be audited,” says 41-year-old Leach, a partner in The Advisory Circle, a marketing and accounting firm in Atlanta. “My tax preparer and I went through the letter and my taxes and determined the audit was for the value of a car donated to charity.” Leach found the car’s value listed at $4,800 on Kelley Blue Book’s website. The IRS disagreed, quoting $2,400. Leach made an adjusted tax payment of $400.

Here’s how to handle this unpleasant surprise–along with pointers on avoiding an audit in the future.
Contact your tax preparer.  “Determine if you’ll represent yourself or be represented by a certified public accountant, enrolled agent, or tax attorney. Have your representative contact the examiner to schedule the appointment and acknowledge receipt of the information document request,” says Spiceada A. Davis, CPA and owner of Atlanta-based eXFinancial Inc.

Understand the triggers. Some triggers are earned income credit (a high dollar refund would cause the IRS to question whether children claimed are actually dependents), home offices (in cases of high deductions in comparison to earnings, home depreciation, or withholding), tax shelter losses, unreported income on 1099 forms, and inaccurate W2 forms. “If the IRS thinks you made a minor mistake, they’ll send a paper or correspondence audit. The triggers of a paper audit can be large charitable deductions, large itemized deductions, and mileage logs.  Letters from your church [or other charitable organizations] on letterhead and proof of the itemized deductions and mileage should satisfy their request,” says Terry J. Ellis, president of Alliance Tax & Financial Services Inc. “The triggers of an in-person audit would be investments such as stock loss and repeated late filing of quarterly reports for a business.”

Maintain accurate records. Keep tax returns for three years and receipts for everything you intend to report. Be sure there are no mathematical errors. This will help avoid an audit and prepare for future audits. “Review your tax return. Many don’t and are amazed, when the return is audited, the items that are reported,” says Koreen Jervis, enrolled agent and owner of Korje’ Tax Professionals Inc. in New York.

Beware of costs. Only an enrolled agent, CPA, or tax attorney is qualified to represent you before the IRS. The IRS doesn’t charge for representing you, but your tax professional will. “It’s usually an hourly rate that varies by company based on the complexity of the return,” says Jervis. “Most firms offer audit insurance so there’s no additional costs for audits.”

Know your rights and the rules. The IRS website has a section dedicated to explaining taxpayer rights. Click “individuals” and then “taxpayer rights.” Also read IRS publication Your Rights as a Taxpayer.