5 Tips on How to Be Prepared for the IRS Audit

Tax forms in a file for IRS Audit
pic credit: Unsplash

A lot of people ask me what happens during an IRS audit. How does it go? So my goal in this article is to teach you how to be prepared for an audit. And I’m not talking about when you actually get the audit, I want you to be prepared in advance because most of the time these audits aren’t happening during the current year or right after the year ends.

They may be two years down the road, and by then it’s going to be a lot more work to try and get prepared for an audit. So you want to be doing it all the time in your business. Now I will point out that audit rates are fairly low right now. However, they are still happening. And just because you think you may not be the one, well, you may just be the lucky one. So I advise you to stay prepared with these five easy tips.

Types of Audits

It’s important to know that there are two main types of audits. One would be correspondence on it. And what this means is that the IRS is sending you something in the mail and they’re requesting a list of specific items for you to send back in. They will review. Hopefully it goes well and that may close it depending on what they’re looking for or what you’ve sent them.

They may send out more, but those are typically an easier audit. The bad news is if there’s anything complicated going on or anything is disorganized, you don’t really have the opportunity to explain it in person to someone. So you really have to make sure when you send it back that there’s a good road map for them to follow so that they can easily identify everything and hopefully close it out.

The other type of audit would be an in-person audit, and this is where the IRS agent is actually coming to your business site potentially, or you’re going to our IRS office. And they’re asking you typically they’re interviewing you in advance and requesting information and it’s a bit more detailed. So the downside of that is it’s more involved than an audit by mail.

The upside is you get to actually work with someone and hopefully explain and answer any questions better. Now let’s get into the five tips that are most important to be prepared for an audit. And I don’t do this all the time. Not when you’re pulled for audit.

1. Keep a Separate Bank Account For Your Business

man putting two debit cards in his upper pocket
pic credit: Unsplash

The first one is to keep a separate bank account for your business. Okay. I see this one all the time with people you use. Maybe a business accountant, but you run some personal expenses through it, or maybe you run some business expenses through a personal account. It’s a mess. It creates a lot of room for air, and it shows the IRS that you’re not really treating the business as a business.

So you’re already starting off on a bad foot. Plus, it’s much easier to organize your records and prove to the IRS your deductions because you have it all in one place. Now you will need more support is will go over but that’s the baseline is you start with having your bank statements, and credit card statements available outlining all the activity through the year in one place. It’s easy. It’s organized. So that is tip number one.

2. Support For All Deposits

checking balance in mobile
pic credit: Unsplash

Tip number two is support. Keep support for all of your deposits. The default from the IRS perspective is any deposit in a bank account is income unless it’s proven otherwise. There are many other types of deposits that may not actually be income.

For example, if you have to put money into the business, if you’re taking money from your personal account, putting it into the business to fund the business expenses. If you don’t have support and show the IRS that that deposit came from your personal account and not from, say, a customer or something else, then the IRS won’t treat it as income. So make sure you have that support available.

Another type of deposit that would not be considered income would be deposited from debt. So if you take out a loan and you use it in the business, or if it’s real estate and you refine hands and cash out and deposit it in the bank account for the real estate, then you need to be able to show where that deposit came from. So it’s not treated as income.

So always make sure you have that support for every deposit and you should really keep support for the deposits of income too. But the real concern here is the IRS saying you had more income than you actually did.

3. Support For Deductions

women reading her bill deduction
pic credit: Unsplash

The third tip is the other side. You need to support every deduction because if there’s no support, the IRS may disallow them. Now, a good baseline at a minimum, as I said, is having bank statements showing these expenses. But really what you want is receipts for every transaction.

And because that’s what the IRS is going to look at, they want to know not just that the money went out the door, but this is actually a business expense. So having an invoice with the detail. So if it’s a rental property and says you had the AC repaired, well, you would have an invoice with the property address.

And what happened that way, if the IRS questions that expense, like, for example, they may ask, well, how do we know that that wasn’t just a repair on your personal residence? How do we know that was for this actual rental property? Well, you’d have an invoice with that rental address supporting it, so it’s much easier to claim those deductions.

Now, you should also recognize that there are some expenses that the IRS requires even more support for than the typical expense. One of these expenses is auto deductions. The IRS wants to know, one, how much that expenses. Two, you have to keep track of the business mileage and total mileage of the vehicle throughout the year. Three, you have to have the date of the business for you have to have the business purpose of the business use.

So, for example, did you go visit a client’s office? Did you go pick up materials for something? You know, what was the reason you had that mileage and you’re calling it a business expense? Also, and this is very important. They should be contemporaneous. What does this mean? Basically, you don’t wait until the IRS comes in and questions the deduction to come up with the log and where you went.

You keep this as the year goes on. So it’s already there. You already have a log. That way it’s much harder to question, well, hey, you’re just doing this off of memory. Well, now this I did every time I had a business use, I wrote down all these things. I kept track of all the expenses, the dates, and it’s detailed. It’s much easier to support.

Plus, the IRS requires you to do that in order to allow the deduction of a second expense that the IRS requires more support for its travel expenses. They want to know the date of the departure and how many days. They want to know the destination. And of course, they want to know the business purpose and what the benefit that you expect to derive from that travel.

What keeps that in mind whenever you have those types of expenses that you need more support and then you shouldn’t be trying to come up with it after the fact when you actually get pulled for audit.

4. Have a Good CPA

Typewriter having page return Tax Return
pic credit: Unsplash

My fourth point is to have a good CPA. This is like anything else in your life. If you actually get pulled for audit one by having a good CPA in advance, they’re going to tell you all of this and they’ll be able to provide more information so that you’re already prepared and then if you are actually pulled for an audit, it’s much better to have the CPA handle it because the CPA is going to have a better idea of what the IRS is looking for on requests or interviews.

And so they will be able to target it better not under share or overshare. It will be a little more. Hopefully, they won’t overshare or under-share. Not that there’s anything to hide, but you want to make it seamless, as simple as possible. You don’t want to open a bunch of can of worms to go through. You want to close it as quickly as possible with the least amount of expense.

And a CPA can help you do this. So you want to check if they’ve got experience with this because that can be really important when the time comes.

5. Keep Good Records

pile of files in a record room
pic credit: Unsplash

Lastly, the fifth bullet point, and really this one is just a recap of everything because it’s so important. It keeps good records all the time. So many times I end up with potential clients or clients and things are just all over the place and it’s hard to pull together if you can’t find them easily. The IRS can’t find it easily.

And you know what? The IRS is going to spend time trying to help you get that deduction or clarify that something is an income. They’re just going to say you don’t get the deduction or that it’s income. So you have the responsibility of making sure that you have the right records and that everything is in place.

Also Read:

10 Tips for Saving More and Spending Less

How to Beat Every Level of Financial Independence

7 Critical Asset Protection Strategies for Investors

5 P2P real estate lending platforms to earn upto 15% per year

Top 5 TSP Investing Strategies

Why Stocks Always GO DOWN Right After You Buy

Why do you need a business checking account for your small business?

Do you know if your home is an asset or a liability?

Leave a Reply

Your email address will not be published.