Hans Kasper, MS-CPA, PS

Individual and Business Income Tax Preparation
and IRS Audit Prevention Procedures

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The trick is to stop thinking of it as 'your' money.
~IRS auditor

The hardest thing in the world to understand is income tax.
Albert Einstein

Intaxication:  Euphoria at getting a refund from the IRS, which lasts until you realize it was your money to start with. 
~From a Washington Post word contest

As an ex-IRS agent, I know that there is a proper path to take when preparing an income tax return.  While an audit may not be totally preventable, a properly prepared tax return can avoid unnecessary audits by taking the steps to eliminate audit potential through the implementation of properly designed deterrents.

First, there is proper individual income tax planning.  One day to two half days per year should be adequate.

Second, there is the proper preparation of the return which lies in the correct presentation of the data.  To understand why this is important, you should know how a return is pulled for an audit by the IRS and what goes through the head of an IRS agent.

  • The IRS computer looks at your tax return and gives it a score--called a Diff Score.  This score is assigned based on prior audit results of other taxpayers' returns and on the likelihood that it will generate additional tax dollars should it be audited.  Like any business, the IRS wants to make sure that they get the biggest bang for their buck--or, should I say, your buck.  You see, through your tax dollars, you are paying them to audit you.

  • Next, should your Diff Score be a very desirable score, which means that if your return were to be audited that it would generate more tax dollars, then it is shipped off to the District office closest to you.

  • Once it arrives at the District office, some poor soul (this is one of the least desirable jobs in the IRS) has to review your tax return manually for its audit potential.

  • This poor soul is sitting in a room with no windows and someone rolls a cart in with 300 tax returns on it.  The supervisor says to this poor soul, "Hey you, review these 300 tax returns today and pull 30 for an audit and make it snappy."

  • So now, here sits this poor soul looking at your tax return.  I'll bet you that you can't guess what he is thinking?  He is thinking, "Boy, is that supervisor nasty.  Well, I guess I'll just have to take it out on these taxpayers."  And, then he looks down and sees your name.

  • He starts thumbing through the pages of your return.  "What's this?" he says. "$5,000--No one has an even dollar amount for an expense of this type!"  (This was the first mistake you made--not knowing that even dollar amounts are a red flag.)  "These people must be making up numbers," he says to himself.

  • He flips a few more pages and BINGO--another home run, a large amount ($20,132) where a small amount normally would reside.  "This surely looks crooked to me", he says.  (This was your second mistake--not knowing that large dollars amounts in the wrong places are a sure audit.

  • Now he flips to the last few pages of the tax return where explanations and supporting schedule normally appear.  "Oh no!" he says.  Foiled again!  A paragraph explaining the $5,000 deduction and a supporting schedule breaking down in detail the deduction for $20,132.

  • "Well," he says, "I guess this one looks all right, but I'll bet I can get the next one."

  • And so, you are passed over for an audit.

It is even helpful to include in the more difficult tax returns, court cases and legal citations to support your deduction.

Among the returns that could raise red flags are those that:

  • Show a lot of activity but little profit or loss.
  • Show profit or loss inconsistent with industry standards.
  • Take big travel and entertainment deductions.
  • Have large vehicle deductions.
  • Deal in cash more than credit.

HOWEVER, should you ever be called in for an audit, let me tell you another way that I am going to screw the wallet right out of your pocket.  What I am going to do is ask you for the supporting documentation for your deductions, and I am going to go for the details.

I'm going to ask you for cash register receipts, cancelled checks, bank statements, credit card receipts (no, credit card statements will not work), and charitable contribution receipts as examples.  If you have those documents, then you win, and if you don't, then I win, and nine times out of ten--I win.  I win because you should have known the old proverb, "No tickee, no washee."  I am going to disallow those deductions and make you pay more tax.  That is how I get my thrills.  I'm counting on you not to have kept those receipts and I will hate you if you do because then I will end up with a NO CHANGE audit, and that goes against my record.

The only way you can beat me is to keep good records and documentation.  This means that you have to know what good records and documents are and have retained those items.  Without them, your wallet is mine.

Congress gave the IRS a law and here is how it goes:  The taxpayer is required to prove expenses and the IRS is required to prove income.  The expenses have been covered above and now income will be covered.

Here is how the IRS proves incomeEvery deposit to your bank accounts less transfers between accounts is income unless you can prove otherwise.  Unless you can prove that the birthday gifts that you got and the large gift that you got from Aunt Jane are not income, then they are as far as the auditor is concerned, and the IRS has Congress to back them in this case. 

So what are you going to do?  On every deposit that you record in your check register, you are going to write who it came from.  That is all you have to do.  Also, get a gift letter from Aunt Jane as proof of the gift.  For those of you who don't even reconcile your bank accounts--well, YOU'RE MINE.

But wait, there's more!  I can take this to a whole new level.  I mean, "Let's step it up a notch."  The courts have given me even more power.  I can make you prepare for me a cost of living for the year under audit.  When I take that amount, subtract gifts that you have gotten and the bank transfers, and it is more than the amount of income that you have reported on your tax return--well, YOU'RE MINE AGAIN.  Only this time I am shipping the file up to the I.D. section (the investigation division for fraud).  If they pass on the fraud case, then I get my free will to assess you with any penalties that I have in my gift bag (some up to 25%).  You will gladly sign off and pay the tax and penalties since that is still less costly than hiring a criminal attorney to defend you.  If they keep the file and go after you, well, I just wouldn't want to be you.

So if you are going to cheat on your taxes, then you better never have another drink for the rest of your life.  You see, here is what happens.  You have a few too many drinks and you just might start running-off-at-the-mouth about how you are cheating on your taxes.  It may be your brother-in-law or someone else who hears you who can't stand your guts, and they have been waiting for this day.  Now they turn you in to get the reward (yes, they do pay rewards).  And, you are DEAD MEAT.  It happens every day.

For real IRS case stories click here.

Therefore, as you can see, proper preparation of your income tax return is the best first-line of defense in preventing an audit.  So, when I ask you for more documentation, more breakdowns of items, and more details, I am on your side.

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This page was last updated on 05/13/2010


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