How To Audit-Proof Your Tax Return Forever!

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How To Audit-Proof Your Tax Return Forever!
(My Recent Close Encounter Of The IRS-Kind)

-- by Wayne M. Davies

Copyright 2003 Wayne M. Davies Inc.
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Congress recently passed legislation that is supposed to
result in a more "sensitive" Internal Revenue Service. You
know, not such a lean, mean, tax-collecting machine.

I DON'T THINK SO! Here's why.

A few months ago, one of my clients (let's call him Mr.
Jones) got one of those IRS "love letters" requesting more
information about his return, and the IRS wanted to meet
with Mr. Jones in person to discuss the situation (not a
good sign!)

Mr. Jones (a local small business owner) was required to
show up at the local IRS office with all his records. The
IRS was questioning the legitimacy of several business
deductions -- and so the IRS was doing what it is allowed by
law to do -- demand that the taxpayer prove that those
deductions were valid.

[By the way, most IRS audits are done these days by mail.
Humans are rarely involved in these so-called
"correspondence audits."

Those big IRS computers can check and cross-check all kinds
of information that should be reported on your tax return.
And if something doesn't show up on the return that is
easily tracked by the IRS computers, then the computer just
spits out a not-so-friendly "discrepancy notice", which you
can respond to via mail.]

Turns out that Mr. Jones lost the audit and ended up owing
the IRS a significant amount of money -- the additional tax,
plus penalty and interest for late payment of that tax.
Why did Mr. Jones' lose the audit? Mr. Jones made two
"classic" taxpayer mistakes:

MISTAKE #1: "NO RECEIPT, NO DEDUCTION"

Mr. Jones lost several deductions simply because he didn't
have the proper documentation to prove the deductions.

What do I mean by "documentation"?

Well, if the IRS requires you to substantiate a deduction on
your tax return, you must be able to provide written proof
that the deduction really happened. The easiest way to
prove a deduction is to hang on to:

a) The receipt or invoice, and

b) Proof of payment, which can be a canceled check, cash
receipt, or credit card statement.

Mr. Jones reported numerous deductions for which he simply
didn't have the documentation. No receipts, no canceled
checks, no nothing. Turns out that Mr. Jones was one of
those "cash guys". Do you know what I mean by a "cash guy"?
Maybe you know what kind of guy I'm talking about -- He
never wrote a check in his life, just carried a wad of cash
around in his pocket. He paid for everything with cash, and
never kept any of his receipts.

Every year he would just sit down with his wife and
"remember" how much he spent on different things. No way to
prove any of this, of course. He just had a "feel" for how
much cash he had spent, and he had run his business for so
many years that he just "knew" how much it cost to purchase
certain things.

Well, this is the kind of taxpayer that the IRS loves!
It really is true -- if you can't prove that you paid for
something (with receipts, invoices, canceled checks, etc.),
then you run the risk of losing that deduction in the event
of an audit.

One of the most common questions I am asked by clients is
this: "I know I paid for something, but I don't have a
receipt. Should I still report the deduction."

My response is usually this: "You only need a receipt if
you get audited!"

Think about that for a minute! At first, many clients don't
know if I am joking or not. Well, I do make that comment
with my tongue planted firmly in cheek, but there really is
a lot of truth to it. If you don't have the documentation
to prove a deduction, you can still report the deduction
(if you want), because you only have to prove the deduction
if you get audited.

But if you do get audited, knowing that there are
undocumented deductions on the return, be prepared to lose
the deduction!

And here's the second major mistake that Mr. Jones made:

MISTAKE #2: BOGUS DEDUCTIONS!

It turns out that Mr. Jones wasn't completely honest with me
about some of his deductions. He reported deductions that
simply were not real deductions. Here's one example:
Mr. Jones owned several rental houses. These rental houses,
of course, required maintenance and repair work. Many
times Mr. Jones would do the work himself rather than pay
someone else to do the work.

Well, Mr. Jones would estimate what he would have had to pay
someone else to do the work that he did himself, and then
he would report that amount as a deduction, even though he
didn't actually pay anybody to do the work!

In other words, Mr. Jones deducted the value of his time --
a big No-No!

This is an important point -- you can never legitimately
deduct the value of your time for work you did. You have to
actually pay someone else to do the labor.

Well, that's what happened to Mr. Jones. He made a couple
classic mistakes and paid the consequences.

I hope you benefited by learning what can happen in a real
audit. If you ever get a letter from the IRS that demands
additional information, you'll have nothing to worry about
if you do exactly the opposite of what Mr. Jones did. If
you can properly document your deductions and assuming you
have no bogus information, you'll pass the audit with flying
colors!