Tax Return Service

A Real World Example of an IRS Audit – and what happens when you don’t keep your documentation

I am in the process of helping a new client through an IRS audit for his 2012 federal income tax return and I thought this lesson learned would be helpful for every American taxpayer out there who takes the time to read this blog post.
Let’s be creative and call my client “James” to protect the innocent. James was flagged for an income tax audit because of high W-2 wages, and a schedule C that showed a significant loss for his first year as a business owner which is typical. He was transitioning from a job as an employee to a sole proprietorship so there was really nothing he could have done differently from an income tax return reporting perspective. Even though the numbers were legitimate, it was still a red flag with the IRS. So, the IRS requested copies of receipts for every single business expense reported on his schedule C.

James wasn’t able to recover some of the documentation he needed, but he wasn’t overly concerned. After all, surely he could rely on the following companies to maintain his records for him, thinking he could pull them up online or call for archived copies of statements any time he needed them:
• His bank (a large national bank)
• His cell phone company (can you hear me now?)
• His airlines company (the #1 airline in America)
• His internet company (a national internet service provider)
• His credit card company (what’s in your wallet?)

Guess what – he was wrong. NONE of the companies listed above could give him the complete set of records he needed for this audit: bank statements, credit card statements, flight records, phone bills or internet bills. It is not THEIR responsibility to maintain records for tax purposes. It is the TAXPAYER’S responsibility. Period.
Think about it – this audit is only for the year 2012 and as of December 2014 which was when he received his first notice from the IRS about the audit, these companies couldn’t go back any further than the fall of 2012!

All in all, he was unable to recover several thousand dollars’ worth of legitimate business expense receipts and could be facing a tax bill that will also include penalties and interest dating back over 2 years.

Don’t let this happen to you! Here is my advice:
1. Keep your documentation for 7 years!!! Is 7 years the magic number? Unfortunately, there is not a one-size-fits-all answer. It depends on the situation. So the safest option I can recommend would be to keep your records for 7 years.
2. Keep hard copies or online PDF versions that are backed up! I can’t emphasize enough the importance of maintaining a backup of your documentation if you store your records electronically.
3. Stay organized by keeping each year’s worth of receipts and business records all in one place so you don’t have to gather records from multiple sources if the IRS ever comes knocking at your door.
4. And finally, know where your records are at all times. Are they in your basement, or in the attic, or in your office filing cabinet? Do a check once a year (at tax time would be ideal) to insure you can account for the last 7 years’ worth of tax returns and more importantly, your supporting documentation.

If you would like to chat more about this riveting subject, feel free to contact us!

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