With the advent of 87,000 additional IRS agents, we best plan for more audits. And pay no attention to Biden's claim that it will be focused on the wealthy. As said before, the billionaire class already have audits so the growth and money is in the middle class and in particular those earning under $200K and mostly those under $75K per year.
OK, so now that we are resigned o the truth of the matter, how do we defend?
The first and last line of defense in most audits will be the proof presented as to the validity and correctness off the return as filed. The ultimate win is no change to the return and in some instances even a refund. I had that happen when audited 9 times ( 3 entities for 3 years each ). When done, it was a net winner resulting in a $4,000 refund. Of course, that doesn't come close to paying for the time to defend. There is no facility in the IRC for reimbursing time. I consider that very unfair because there is no penalty for frivolous and ineffective audits. The IRS can be wrong 100% of the time and never get a hand slap.
Documentation
Key to winning audits is the documentation that can be provided in support of positions taken. A tax position should have a basis in the law but there are some situations that are not black and white but rather gray. In previous times, taking a gray position or gray deduction was sensible because the likelihood of an audit was so low. With increasing audit rates that may be changing. Being able to prove your position or deduction is the imperative.
So what constitutes proof. For a simple deduction, a receipt or canceled check will prove that money was spent. Whether that expenditure meets the destructibility requirement as a routine and necessary expense or one that is delineated like medical expenses on Sch A etc.
To prove mileage deductions you'll need a contemporaneous record of the driving miles and purpose. You might fast talk it to an agreed expense but don't count on it. The IRS warns about this up front so take them at their word and keep a written record of your miles driven for business and charity or Investment.
Investment losses will have related documents supplied by your broker and will serve as good documentation.
House purchase expenses will be documented on the closing statements and supported further by canceled checks etc. Interest and property taxes will be on your 1098. Keep on mind that the IRS receives copies too so report exactly as shown to match. All income from W-2s and 1099s will also be supplied to the IRS and these are not normally in dispute unless an error was deducted and not corrected prior to the audit. Though there are some reasons a taxpayer might lie by increasing income on their return, it is not common nor are you going to get called out on it. The IRS is glad to have you pay more tax. This type of maneuver happens when someone wants to increase their potential for a bigger mortgage or auto loan etc.
Audits can present specific items of challenge. These can vary greatly but there is usually some way to document them. Examples might include repairs, miscellaneous expenses, supplies, and items that were expensed rather than depreciated...that one gets a bit tricky because of the "listed" properties and a few other fine points so when preparing a good tax preparer will know the rules and advise of proofs to keep in case of audit.
The idea here is to document or be prepared to document everything as if you will be audited. This will in the bulk of cases prevent any nasty surprises and outcomes. Good documentation is but one and an important one of the many ways to win an audit. Others involve law and tax court decision which might include letters. You can learn much more and even search the database concerning official Letters of Determination at https://www.irs.gov/charities-non-profits/eo-operational-requirements-obtaining-copies-of-exemption-determination-letter-from-irs#:~:text=You%20can%20download%20copies%20of,Exempt%20Organization%20Search%20(TEOS).&text=It%20may%20take%2060%20days,letter%20using%20Form%204506%2DB..
If you are a client and I prepare your returns, we will have a very good handle on documentation. If not a client, make sure to have a discussion with your preparer so you can keep track of documentation year round and be ready if and when the notice of audit arrives.
Good luck keeping your taxation low and proving you deserve it.
Best,
Donn Marier
DM-Your Own CFO