IRS audit

When I was young, my father got audited by the IRS. I can’t remember the details — I was young, and my father died long ago — but I do remember how he fumed and fussed for weeks as he tried to gather the paperwork and make his case to the auditor. The IRS audit experience made an impression on me. I vowed that when I got older, I wouldn’t be as messy and disorganized as he’d been, and that I’d always do a good job of documenting my taxes.

For the most part, I’ve stuck to that. I’ve tried to save every scrap of paper related to my personal finances and, especially, my business finances. I’ve always tried to be meticulous about respecting the wall between business and personal accounts. And since I started this blog eight years ago, I’ve tried to pay attention to the red flags that lead to IRS audits (which is one reason I’ve never attempted to deduct a home office expense, even though there are times — like now — when I could).

Related >>  Ten Red Flags That Lead to IRS audits

My decades of being a pack rat paid off recently. In early April, I got a letter from the IRS. The government wanted to audit my 2011 taxes, and they were particularly interested in my Schedule C (“Profit or Loss from Business”).

“No worries,” I thought. “That’s why I saved those documents all these years!” Turns out my archiving techniques left something to be desired.

The documentation

Because 2011 was the last full year we were married, my first step was to contact Kris. “Do we have anything to worry about?” she asked.

“I don’t think so,” I said. “We never did anything wrong. At least not intentionally. We might have made some mistakes somewhere, but I doubt there’s anything major. You just pull together your paperwork, and I’ll pull together mine.”

Kris had gathered all of her info within a week, but I was completely consumed with preparing the Get Rich Slowly course. It wasn’t until the end of April that I began to gather my statements and receipts and the other information the IRS had requested.

I found most of the paperwork stuffed in a shoebox (literally!) in the back of my storage unit. Because there was zero organization, I spent an entire Saturday afternoon stacking statements and receipts in chronological order. “I guess that’s my first lesson,” I thought. “I ought to be more systematic about how I archive my financial records.”

After sorting the physical documents, I went online to retrieve digital statements. I was frustrated to find that many banks and credit card companies don’t allow users to access digital documents after a year or two. After a certain time elapses, you have to file a request to have the documents mailed to you — and that can take days or weeks. (It took over a month to receive one statement I requested!)

I was able to gather almost everything I needed. I hoped that the auditor wouldn’t worry about the few small gaps.

Note: Ultimately, I did have to fill in the gaps. I requested duplicate statements directly from the banks. But the real godsend during this process were Quicken and Quickbooks. During 2011, I kept complete business and personal records. The auditor was able to use these to track the flow of money from account to account.

The interview

On a drizzly morning in early May, I drove to my accountant’s office for the audit interview. “You don’t seem too stressed,” Sabino said.

“You know, I’m not,” I said. “I haven’t done anything wrong, at least not that I know of. So, this seems like more of an adventure than anything. Maybe I can write about it for the blog!”

Sabino looked through my paperwork. “You won’t need these,” he said, setting aside some extra financial statements I’d printed. “As a rule, you only want to provide the info that the IRS requests. You may think you’re being helpful, but every extra piece of information gives them another chance to expand the audit.”

“What do you mean?” I asked.

“Well, the IRS won’t go digging for dirt on other years. But if you accidentally give them reason to suspect there might be something to find in 2010 or 2012, then they can expand the audit beyond 2011. So, we never give them more than what they ask for.”

“Okay,” I said.

“That same thing is true during the interview. You can be friendly, and you should answer the questions fully and truthfully. But don’t be chatty. Don’t volunteer stuff. Even a casual conversation can give the auditor reason to expand the examination.”

We gathered the paperwork and headed to the meeting room. The auditor already had stacks of documents regarding our case.

“Wow!” I said. “You’re not messing around.”

The auditor laughed. “You know the government,” she said. “We love our paperwork!”

She started the interview by reading questions from a pre-prepared script. “Have you reported all of your income?” “Do you keep business and personal accounts separate?” And so on.

Eventually the questions moved off-script as the auditor tried to get a handle on my business. “You make money blogging? How does that work?” “This conference in Denver was with other bloggers? Did that lead to more business?”

After 20 or 30 minutes, we were finished. “I think I have all I need,” the auditor said. “I’ll get this wrapped up and then let you know my decision.”

Related >> How to Audit Your Own Investments

The outcome

I expected a decision on my audit within just a day or two, but that didn’t happen. Instead, the auditor continued to request information and clarification. Why did my checking accounts showed more money deposited than my W2s? What was this World Domination Summit thing?

As the weeks passed, we discovered I had made a few errors. I paid for certain business expenses out of my personal account, a mistake that actually hurts me. Plus, I’d made a personal loan but hadn’t been recording the interest income on my taxes. But it seemed to me that the mistakes against me were balanced by the errors in my favor.

The auditor must have agreed because today I finally received word: The audit will come back “no change,” meaning I won’t owe anything extra (other than the $1,500 I paid my accountant to coach me through the process!). The auditor did ask my account to scold me, though: “Please remind John that he needs to document the business purpose for an expense and make sure that the expense makes sense for his blogging business.” That’s a change I’ve already made to the way I track my expenses!

Here are some of the key things I learned during this process:

  • Don’t file a tax return during an audit. If you do, the audit could expand to include the new information. In my case, I received notice of the audit in early April, just before filing my 2013 return. My accountant immediately applied for an extension.
  • Get organized. As soon as you receive the audit notice, gather the requested information. Don’t wait. Even if you’re organized, this will take time. If you’re like me, you’ll discover some pieces are missing. It can take weeks to receive duplicate statements from your bank or broker, so start right away.
  • Get help. Hire a tax professional to represent you. He’ll have a much better understanding of tax law and the audit process, and can coach you on what to say and do.
  • Be courteous. You may hate the IRS and resent the audit process, but don’t take it out on the auditor. She’s just doing her job. Be polite and professional. Imagine that you’re at a job interview and act accordingly.
  • Change your habits. It’s easier to be organized now than to create it from scratch under duress. After my audit, I adopted a new, embarrassingly simple step: I labeled a file folder “2014 Taxes” and I’ve been placing all the year’s financial documents here. I even print electronic documents too, since I learned the hard way that many financial institutions only keep statements online for a few months.

I’m glad that my audit story has a happy ending. Many don’t. What about you?

Have you ever been audited?(Or do you know somebody who has?) What was the experience like? How difficult was it for you to pull together the requested documentation? Any advice you’d give others so that they can better cope with an audit in the future? (Or to avoid one altogether?)