The IRS audit process typically starts with a letter from the IRS indicating that your tax return has been selected for audit. The letter will typically identify the tax form, tax year, and taxpayer (if it is not an individual income tax return) that is being audited. It will also provide the contact information for the IRS agent assigned to your audit. Last, it will typically ask you to contact the IRS agent to schedule the opening meeting. The letter may even include a list of items that the IRS agent would like to review at the opening meeting. If you have received this type of letter, here are a few of the things that you need to do to prepare for the coming audit:
1. Gather records that identify what items of income you received. This may include your tax returns, tax forms (such as Forms W-2, Forms 1099, Schedules K-1, etc.), and bank or other deposit account statements. Review the information and identify any large or unusual items of income. Be ready to explain these items if the IRS agent inquires about them.
2. Gather records that identify your expenses. You might start this process by reviewing your tax return and the expenses that were actually deducted on the return (or those that factored into a tax credit). You should locate records for the large or unusual expense deductions. This may include requesting bank, mortgage, brokerage, loan, and other statements – preferably statements for the entire year and/or cashed checks for unusual or unusually large expenses. You should also be ready to explain these items if the IRS agent inquires about them.
3. Focus on smaller items that have a number of entries or transactions, even if they are not individually or collectively the largest numbers on your tax return. IRS auditors love to review this type of items, as it gives them something to verify. Put another way, these items are auditable. The downside is that these items may require a significant amount of documentation to support. It may be advisable to get a head start on pulling these records or at least organizing the information so that the records can be located easily. This may include summarizing or sorting the records electronically or in folders. Pay particular attention to receipts for charitable gifts and business expenses.
4. Locate rental and other lease agreements and employment agreements, contracts, etc. both personal and business. The IRS agent will want to review some of this information to verify the income and expense items on your return. If these items do not come up, they can be used to bolster other positions (or even to pad the IRS file if there are other related issues where the records are not so plentiful).
5. Relax. Audits happen and taxpayers do survive. If you are prepared (and with a bit of luck), you may end up with no change to your tax return. Even if this is not the case, the IRS audit process can be an educational process whereby you improve your personal finance and/or business knowledge.