`Dear Taxpayer: We selected your federal income tax return for the year shown below to examine the items listed at the end of this letter. We have scheduled the appointment for you at the time and place shown below.”
Those words, taken from an actual letter sent by the Internal Revenue Service, are enough to strike terror in the hearts of even the most law-abiding taxpayer.
That’s because, no matter how honest you are when filing your return, you’ll have to prove that honesty with such documents as checks, logs and receipts if you’re audited by the IRS.
“In audit situations, people run into problems not because they haven’t incurred deductions, but because they don’t have the documents to back those deductions up,” says Everett Roberts, who is owner of Comprehensive Accounting Services in Wood Dale, director of the Illinois Society of Enrolled Agents and president of the society’s northwest chapter.
(Enrolled agents have passed a four-part test on taxation, have been reviewed by the IRS, and are authorized to represent taxpayers during audits and appeals at any level of the IRS. Many also prepare taxes.)
“Taxpayers have more problems today because the IRS is matching more and more things electronically now, which puts a greater burden on taxpayers in terms of the accuracy of their own records,” Everett says. “And returns are more complicated today because there are so many more financial investment options available than there were 20 years ago.”
According to Mike McGrail, public affairs specialist for the Chicago District Office of the IRS, the specific documents needed to ensure a smooth audit vary from taxpayer to taxpayer. But he says that if people follow some general guidelines and are able to substantiate everything on their returns, they’ll “be able to face any type of audit under the sun.”
Keep copies of “your entire tax return for a minimum of three years, because the IRS has three years from the due date of the return to go back and audit a return,” McGrail advises, noting that an “entire return” includes all W-2 and 1099 forms that verify income and all bank statements documenting interest dividends.
However, Linda Cliffel, a Chicago attorney and certified public accountant who specializes in tax issues, notes an exception to the three-year statute of limitations: She says taxpayers can be audited for up to six years if they have for any reason understated their income by 25 percent, and for any amount of time if they’ve failed to file a tax return.
And McGrail adds that “fraudulent or frivolous returns”-those filed with made-up W-2 forms, for example-have no statute of limitations.
“We’ve stopped untold dozens of schemes,” McGrail says of fraudulently filed returns.
While circumstances vary, McGrail stresses that individuals who itemize deductions on their personal returns and those who are self-employed and file Schedule C must have records to back up any deductions they claim.
Those records, he says, should include canceled checks (if you don’t routinely receive canceled checks, the IRS will accept bank statements or copies of the checks from your financial institution); receipts to back up purchases (canceled checks are evidence only of payment, not deductibility, so you need an invoice or a receipt to back up the check); mileage and phone logs; doctor bills; medical insurance statements; a copy of the county assessor’s bill for property taxes; mortgage records that show interest payments on your home loan; and canceled checks and/or receipts verifying any charitable contributions claimed.
(Effective in 1994, receipts from the charity/charities will be required for donations of money or property totaling $250 or more; previously, the amount was $500, according to McGrail.)
Cliffel also advises taxpayers to keep records of and receipts from home improvement projects, because money spent on home improvements can reduce the amount of capital gains on the sale of a home. And she adds deposit slips and monthly bank statements-which can help validate income-to the list of documents taxpayers should keep on file. Those documents, she says, can be especially important for self-employed individuals who face a somewhat higher risk of being audited than employees who receive W-2 forms.
“The IRS can ask for deposit slips and bank statements from anybody. But they’re especially concerned about understatement of income from self-employed people,” Cliffel says.
In addition to the documents already listed, Roberts says taxpayers should hang on to “any document related to the purchase of your house” as well as to documents detailing the purchase of such investments as stocks or mutual funds.
“Sometime down the road, you’ll dispose of those assets and will have to document what you paid for them,” he says.
So what happens if that dreaded letter arrives and you know you don’t have all the documents being requested?
Be honest with the auditors
“Don’t play games with our auditors. If you don’t have the documentation, just say it. We’re reasonable and will give you time to get what documents you can,” says McGrail. “And don’t lie in an audit or submit fraudulent documents. It’s illegal and you can be convicted and end up doing time for doctoring receipts, documents and canceled checks.”
He also emphasizes that responsibility for the accuracy of the return always falls on the taxpayer-even if a tax preparation professional has made an error. “Your accountant bears no responsibility. You are liable, says McGrail.
Adds Cliffel: “You ultimately are responsible, so you need to review what’s done on your return and ask questions if you don’t understand something.”
And if you think you’ll get away with skipping the audit altogether, you’d better think again.
“When you get that letter, you don’t want to ignore it. We’ll disallow the deductions in question, and you’ll get a bill,” concludes McGrail. “Remember, we’re not going to go away. We’ll be here forever and ever!”
