It’s an amazing thing how many Americans live in fear of an IRS audit. We battle foes at home and abroad with tremendous bravery and dedication. We go to war to defend ideals and freedom. We are even willing to give our lives to right the injustices of dictators half way around the world. Yet a single letter from the IRS can often reduce us to a quivering, fearful, bundle of nerves!
There is good reason for this as the IRS has tremendous power and wields a very big stick. The unfortunate taxpayer who ends up in their radar, rightly or wrongly, can have a serious battle ahead in getting untangled from their grip.
There are many things you can do to help reduce the likelihood of an IRS audit. Obvious things come to mind like making sure you have no mathematical errors in your return and following the instructions exactly! Making sure that all income you received is included in your return and not taking ridiculous size deductions that draw attention to your return.
While it’s impossible to make a 100% guarantee that you won’t be audited, these steps will greatly reduce the likelihood of your return being individually selected for an audit. To a lesser extent, these steps may reduce the chance of a random audit too. Random audits are much more difficult to prevent, though, because they’re based on things that you don’t have a lot of control over.
That brings us to the point of this article. If you are selected for an audit, what can you do to limit the damages? Damages come in the form of increased taxes as well as increased professional fees required to deal with the audit. The two taken together can be very expensive!
In my 25 years of CPA practice I have come across one secret that is both childishly simple, yet incredibly effective in limiting these damages. That secret is:
Credibility is to an audit what exercise and good nutrition are to a car accident victim. These things might help a little to prevent the accident, but where they really shine is in reducing the damages.
A strong, healthy person will come out of a car accident in better shape than a weak and sickly one. In the same way, a credible person will come out of an audit in better shape than one who’s credibility has been compromised.
It is my professional opinion that credibility is the single most important element in any audit situation. Here’s why.
It’s basic human nature to want to do the minimum amount of work for the maximum gain in any given situation. This is also called return on investment. So when an auditor sits down with you to look at your records, their first order of business is to plan their attack (oh sorry, I meant audit). They want to recover as much money as they can for the least amount of effort.
By first establishing your credibility they can determine what steps they can skip and how much they can trust what you say. They also can make more assumptions of consistency. If you did something right once, you probably did it right all the time.
The difference between an audit where credibility has been established compared to when it’s been compromised can be astounding!
Let’s say the auditor asks you for your mileage log. First of all, the credible person actually has one! The auditor sees they have it, flips through, looks at a few pages, and gives it back. No adjustment!
Where credibility is suspect the auditor looks at every page and checks for completeness on every entry. Then they check to see if it’s written with the same pen all the way through. Does the writing differ sometimes, or does it look like all the entries were written at the same time?
The auditor may actually add it up and make sure everything makes sense intuitively. They may ask you questions designed to catch you in a lie or ask you to prove many of the entries. They may even look at the copyright date of the log itself to see if you just bought it and filled it in the night before.
Now multiply that simple difference by all the areas an auditor could possibly look at! Even if they don’t find anything wrong, you (or your tax advisor) could end up wasting a lot of time!
(Speaking of your tax advisor, NEVER represent yourself in an IRS audit unless you prepared the return yourself. Even then I wouldn’t recommend it. IRS agents are trained to make you incriminate yourself even if you’ve done nothing wrong. Even if you know the tax law, you probably don’t know your rights well enough to know what you are required to say or not say. Hire a CPA and make sure you don’t come to the audit meeting!)
What’s of much greater concern is this. The more they look, the more likely they are to actually find a mistake. Everyone makes mistakes. The name of the game though is to keep them to a minimum and then hope no damage is done by them.
In the event mistakes are found the credible person is much more likely to have them overlooked. In fact, I have seen auditors actually find a mistake but let the credible person get away with it. The non-credible person will not enjoy this luxury. They will be nickel and dimed for every little thing the auditor can find.
The credible person will almost always enjoy an assumption of innocence until proven guilty. The non-credible person will find himself constantly trying to prove his own innocence while the auditor assumes guilt.
Finally, there is an element of confidence a taxpayer and a tax advisor enjoy when credibility is established. It can actually be used as a stick against the auditor. I have had initial meetings with auditors where I have put them on notice that if they play hardball, I will make them get a subpoena for every single thing they want to see.
I would never consider saying this without absolute certainty of credibility. The auditor generally does not really need a subpoena for everything. This is more a verbal picture which says I will be as uncooperative as legally possible and make them work for everything they want to see.
The fact is, the only reason I have ever fired a client is because I felt they lost credibility because they lied to me or suggested doing something they knew was absolutely illegal! That’s how important this issue is to me!
Credibility is not something you can suddenly acquire when it’s needed. It is something you build over time. So it’s important to keep it in mind at all times. Here are some actionable steps you can take to establish your credibility as well as maintain it.
- Follow the law to the best of your ability. It’s okay to use the law to your maximum advantage, but try never to break it.
- Pay attention to the details. If the regulations say you should have a mileage log for example, get one and use it. Make sure you include every detail required.
- Watch those personal expenses. One of the most frequent things tax preparers see is personal expense mixed in with business. If you buy a candy bar at the office supply store, either pay for it separately, or make sure you don’t deduct it with the rest of the receipt.
- Keep orderly records. Don’t just throw everything in a shoebox. Even sorting them into separate envelopes for each type of expense will help. If you look like you have no idea what you’re doing, it can reflect as much on credibility as intentional misconduct.
- Don’t make jokes about illegal deductions or hiding your income to your tax preparer or an auditor. This may sound like obvious advice but it’s amazing how many people make this mistake. They go to great lengths to be credible and then ruin it at the last moment with foolish speech. The more you joke about this stuff, the more people will start to wonder if you really mean it.
If you keep these simple precepts in mind, they will do a great deal to establish and maintain your credibility.
I hope I have helped you to see how important credibility is as well as what you can do to keep yours intact.
Now it’s your turn!
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