As most of our clients know, a large majority of our practice surrounds tax planning and preparation. However, we are often asked to represent taxpayers that are undergoing IRS audits for various reasons (not our tax preparation clients I would stress!). Sometimes their tax software or tax professional made an error, but sometimes an audit can occur for myriad other reasons. We want to devote the next few blogs to discussing audit issues and ways we mitigate your audit risk when we prepare your returns.
Good record keeping is always the best defense to any audit. We have previously discussed the importance of keeping records so that your tax return can be properly prepared, and so that claimed items can be backed up in the event of an audit (despite a popular misconception that the IRS Reform Act of 1998 shifted “the burden of proof” on audits to the IRS, the law does not relieve any taxpayer of the obligation to keep proper records to substantiate deductions and tax basis). Here, we focus on common records that are needed in connection with taxes on your personal income.
You should keep records of expenses that can be claimed as itemized deductions. Thus, you should keep records of unreimbursed medical and dental expenses, including receipts showing the dates you paid them, and receipts for transportation primarily for, and essential to, medical care; payments of state income tax, including any Forms W-2 from employment and canceled checks of payments of state estimated tax and of any additional state tax paid with your return (which also should be retained); records and canceled checks showing interest payments on your home mortgage and payments of real estate and personal property taxes.
You also need records of charitable contributions. For cash contributions of any amount, keep a canceled check or a receipt from the charity showing the amount and date of the contribution. For a contribution of $250 or more, you need a written acknowledgment from the charity containing very specific information and you generally must get this before you file. Additional records are needed for contributions of property other than cash. If you perform services for a charity, keep records showing your out-of-pocket expenses. If you give clothing or household goods, you need proof that they are of “good or better” condition or they are not deductible at all.
You must keep records of stocks, mutual funds, bonds and other similar investment property. Retain information on how and when any such assets were acquired, including additional shares purchased by reinvesting dividends. For these items and other types of assets, you must keep track of your basis, which is used to measure your tax gain or loss when you sell an item. Basis is ordinarily your cost but is different for property acquired by gift or inheritance or in a divorce. It is especially important to keep records of the basis in your home, which you may not sell for several years. Records of sales also need to be kept, along with commissions and other selling charges. Good record keeping is particularly important with the trading of cryptocurrencies. This may be a hotbed of audit scrutiny in coming years, so it will be important to justify and support the basis for sales of cryptocurrencies.
As always feel free to contact us if you ever have a question about what records to keep.