Receiving that ominous letter in the mailbox from the IRS stating
that your tax return has been selected for audit, or an error has
been found in the return, sends icy cold shivers up your back.
Don’t panic! Here are some practical ways to avoid those dreaded
letters from the IRS.
File a return that is complete and accurate. It will dramatically reduce your chances
of facing the ‘audit lottery’ – the process the IRS submits tax returns to before
selecting them for audit.
Ensure your tax returns are not missing information you receive from third parties.
Sometimes in the rush to pull together information, you forget certain documents
such as 1099s, K-1s, or brokerage statements. One of the confusions with these
forms is that they are filed at different dates. For example, if you are a partner or
limited partner in an investment partnership, the filing deadline is March 15, which
means your K-1 won’t be mailed to you until this time. If you miss forms that add
income to your tax return, you can count on a letter from the IRS adjusting your
taxes.
Make sure all forms are provided to your CPA. If you have not received a form,
some financial institutions have 800 numbers or web access for you to obtain the
needed information. Your CPA needs the forms to file your tax return accurately
because there are many kinds of dividends – capital gains, life insurance, and stock
dividends, just to name a few. Not all are taxable or even taxed the same.
Act on IRS notices promptly. Missing forms are usually not the cause of a tax audit,
but receiving notices from the IRS because forms are missing can be costly. When an
IRS notice is received, your tax return must be reviewed. If the IRS is right, accept
the notice, but if they are wrong, disagree with the claim and correct the matter
quickly. IRS policy is to charge interest and penalties on amounts of taxes not
properly claimed. While the IRS is not always right, it does a great job of matching
income filings from third parties – banks, insurance companies, brokerage firms and
K-1s from partnerships.
Make sure your CPA receives copies of all notices or letters you receive from state or
federal taxing authorities. The notice may be minor and have no current tax effect,
but it could give you an additional deduction this year – even though the notice was
for a prior year.
Use the tax organizer to your advantage. Most tax preparing organizations give you a
tax organizer with your prior year data as a guideline to help you compile your
paperwork. The first part of the organizer is a series of questions on address changes,
children over 18 being full time students, IRA rollovers, and others. Many of these
do not apply and there is a tendency to overlook these questions. This can cost you
money because your tax preparer has to hunt through the information you provided
and may miss a tax deduction by not knowing you are still eligible to claim a
dependent or have extra deductions apart from your normal expenditures.
Effectively communicate with your CPA. When you drop off your taxes, leave a
written note of any questions or issues you have, even if you tell your CPA in person.
CPAs are busy and sometimes forget verbal instructions or don’t fully write out the
item discussed. If you have made a general calculation about your tax results, convey
it to your CPA. This information can be compared to your return once it is prepared.
Ask your CPA to review your return with you over the phone before it is processed
and mailed out. During this conversation, find out if all deductions were fully
claimed, how the return compared to prior years, and is there anything you
overlooked or should do that might make a difference. This process will help you and
your CPA file a complete and accurate tax return.
Review what you can do differently to pay less tax. Some suggestions may be
keeping more complete records, tracking your mutual fund basis to assure as you sell
these investments you report on your tax basis not your original cost, or consolidating
brokerage statements to help you track your investments and assure your tax return
reports information from all of these. The goal is to make your tax return easier to
prepare so you pay the least tax by getting every possible deduction.
Lastly, if you are successful, be cautious about investing in “tax motivated
investments,” formerly known as tax shelters. Every month, there are articles in
business newspapers and magazines about executives who made such investments
and are now suing the parties that got them involved. The people selling these “tax
dodges” neglect to tell you how heavily they are commissioned, that the IRS is on the
lookout for tax avoidance schemes, and that for years you will be involved in
correspondence, tax audits and possibly hiring expensive tax lawyers to defend you
from legal action. If you lose, not only do you lose the tax deduction and owe the
taxes, interest, and penalties, but odds are your investment will vanish too.
By taking an active role with your CPA in making sure your tax return is complete and
accurate you will have the satisfaction of knowing you are paying the least tax possible
and that you have reduced your chances of the audit lottery.
