Navigating an IRS audit involves understanding and complying with specific document requests, particularly concerning expense verification. In this second installment of our common questions series, John Milikowsky, founder of Milikowsky Tax Law, delves into what records are essential during an audit and the consequences of non-compliance.

Documenting Expenses for the IRS

When facing an IRS audit, the importance of providing comprehensive records cannot be overstated. If an audit letter specifies expenses such as mileage, travel, and cost of goods sold, it is crucial to substantiate these with appropriate documentation. This might include invoices, receipts, and accounting records. Failure to provide these documents can lead to the IRS disallowing claimed expenses, resulting in a significantly higher tax obligation.

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Handling Unreported Income

The IRS also has the authority to investigate and adjust reported income. For instance, if discrepancies between reported income and bank deposits are discovered, it is the taxpayer’s responsibility to prove why these should not be treated as taxable income. This often requires detailed financial records and corresponding justifications for any anomalies.

Strategic Negotiations with the IRS

It is sometimes possible to negotiate with the IRS to focus on major expense items during the audit, potentially simplifying the process and building credibility with the IRS agent. However, even with negotiated focus areas, the need for third-party records remains paramount to verify the legitimacy of expenses, ensuring they are recognized as business rather than personal expenses.

Understanding and preparing for the documentation requirements of an IRS audit can significantly ease the process and potentially reduce the financial impact. By providing thorough and accurate records, taxpayers can better manage the audit experience and uphold their expense claims effectively.

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