ALWAYS, ALWAYS, ALWAYS, Keep your tax documents neatly organized!
I recently had the “pleasure” of being audited by the IRS. It is unnerving to open up any letter from the Internal Revenue Service and this one was no exception. I had visions of being hauled away to some federal prison with a roommate named “bubba”. Alright, enough of my visions. The reality of my audit was that it was not a big deal at all.
My 2004 Tax Return, which I filed jointly with my wife, was flagged by the IRS Auditors for an “Examination by Mail”. Essentially this is an audit done through the mail. Audits can be done in person with an IRS agent by request. The IRS uses several different means when selecting individual files for auditing.
The process of selecting an income tax return for examination is usually identified from computer programs or information that indicates a return has incorrect amounts. The programs used may be based on information returns, such as Forms 1099 or W-2, on studies of past examinations, or on certain issues identified by other special projects.
The red flag with my return was that I incorrectly reported company stock that I had sold through an Employee Stock Purchase Program. When I sold the stock the IRS received a 1099 from my broker indicating that I had sold the shares, but the 1099 didn’t identify the price that I had paid for the shares. The IRS recomputed our taxes for the full amount of the transaction instead of just the capital gain. The issue was quickly resolved by providing the IRS with statements from my broker indicating the price that I had paid for the stock.
After hearing so many negative things about the horrors of audits, I was pleasantly surprised with how nice the IRS Representatives where when asking them questions over the phone. Perhaps they do realize that people make honest mistakes. Audits are only scary if you didn’t properly organize your tax related documents and then stored them away for safe keeping. More on organizing your documents later.
