Are you audit ready? Audits of high-income taxpayers are on the rise, according to Secretary of the Treasury Janet Yellen. Specifically, funding from the Inflation Reduction Act has enabled the IRS to target taxpayers earning more than $400,000 per year, and the results have been encouraging thus far – over $1 billion in taxes owed has been recovered.

What does this mean for you? If you earn more than $400,000 per year, your chances of being audited have likely gone up. However, a tax audit does not have to set off alarm bells and there are steps you can take to get audit ready. Here are a few tips:

Income Reporting

 

1. 1. The IRS already has access to most of the income information that it expects to see on your tax return. That is why it is important to trace each item of income from source documents – W-2s, 1099s, capital gains, and K-1s –to the appropriate lines of your tax return.

 

• • Keep your prior year tax return handy when gathering your current year tax documents. Compare the current year information to what you reported last year and investigate variances in income sources and amounts.

 

• • Set up an online account with the IRS and download a Wage and Income Transcript. These transcripts provide a listing of what has been reported to the IRS on your behalf and can be helpful in ensuring that you have complete information to file your return.

Deductible Expenses

 

1. 1. While most income items are reported to the IRS by third parties, the same cannot be said for deductible expenses. That is why it is important to maintain accurate records for all deduction items presented on your return. The records can take the form of receipts, bank statements, and credit card statements. Be aware, however, that certain deductions require a higher level of documentation. For example, charitable contributions generally require a contemporaneous statement from the charitable organization that affirms the date, payment amount, and deductible amount of the contribution.

 

• • Also, be skeptical of tax deductions that appear to be too good to be true. For example, the IRS has begun cracking down on syndicated conservation easements, a tax-savings strategy that offers a taxpayer-investor a charitable contribution deduction far greater than the investment amount. Make sure that you understand the risks of “manufactured” deductions and credits as you are ultimately responsible for the items presented on your tax return.

 

• • Lastly, do not take a position on your income tax return that you cannot defend upon audit. This advice is especially true for business owners where the line between a deductible business expense and a nondeductible personal expense can sometimes be unclear. Business expenses must be ordinary, necessary, and reasonable to be deductible. Do these terms seem vague? Yes, but they each have specific meanings in the world of tax and have been battle-tested in audits and courtrooms for decades.

If you receive a letter from a taxing agency challenging items on your return or notifying you of an audit, consider seeking representation from an experienced tax advisor. You can be audit ready. The DIY approach can cost you far more than engaging the services of a professional.