Southwest Research and Outreach Center

University of Minnesota Extension ServicePreparing for an IRS Audit

By: Erlin Weness, Extension Educator, Farm Management

October, 2001

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We all hope that we never get audited by the Internal Revenue Service (IRS). However, the chances are good that you will be audited at least once during your lifetime. As with most things in life, if you are prepared for an event, it is easier to endure. Listed below are several practices that you can incorporate into your record keeping procedures to make any IRS audit easier and less stressful.

  1. Keep your receipts to justify all deductible expenses and capital purchases. Keep them filed according to your various expense ledger accounts.
  2. Keep your checks to verify all deductible bills paid. Write the purpose of the check in the memo portion of the check. Don’t write things on the check that can be confusing for the IRS auditor. Every memo should relate to a clear business or deductible personal expense. If you write "food", "life insurance", or "kid’s allowance" on the check, don’t expect it to be deductible.

  3. Don’t try to deduct capital items as current repairs. If any repair checks are for a large amount expect the auditor to make you prove that they are repairs rather than a capital purchase. It may be better to write numerous small checks than one big check, if you are paying for repairs.
  4. File and keep all W-2 Forms, 1099’s, K-1’s and other informational returns sent to you by financial institutions, employers and other businesses (like brokerage firms or value added partnerships or corporations) at year-end.
  5. Use proper terminology for all entries in your accounting program. Don’t type or write in such things as "gift", "labor" (if you aren’t planning on issuing a W-2) or "used tractor"(if you are entering it in repairs). Be careful how you describe things.
  6. Write checks for specific items. If you write one check for several items such as feed, fertilizer, repairs, it can be very confusing for an auditor. They like to see one check for every bill, not one check for several bills. This may be difficult to do, but will keep things simple if you are audited.
  7. Write checks for all charitable contributions. Cash donations may not fly very well. If you give property to charities, have proper documentation and a receipt from the recipient.
  8. If you buy capital items like machinery, list them as capital purchases and put them on your depreciation schedule. If listed as repairs, they will probably be ruled non-deductible and moved to your depreciation schedule. If this happens after your tax year has closed, you are no longer eligible to claim the Section 179 fast depreciation on the item. If you are purchasing machinery or equipment with a useful life of over one-year, it is considered a capital item.
  9. Make sure you have a current/ qualifying written employment agreement or rental agreement if you are employing or renting land from your spouse. The same goes for renting to or being employed by your corporation or if using the Sec 105 medical plan. These are current hot buttons for the IRS; they are concerned with proper documentation, reasonableness of compensation and rents and self-employment taxes due on rents. Make sure your documentation and practice are in tandem and relate directly to one another.
  10. Set up an organized filing system. Having an organized filing system for retrieval of important receipts can by a big help if you are audited. An audit is a demand for you to prove the legitimacy of your tax bill. If you can’t prove deductions, don’t expect to deduct it.
  11. Keep a journal of difficult or hard to understand transactions handled during the year. It is easy to forget your reasoning regarding accounting entries a year or two later. Write down unusual transactions to explain them while you understand them and include it with your documentation for the year. Commodity Credit Corporation and United States Department of Agriculture transactions particularly sometimes need explanations.
  12. Don’t take shortcuts when dealing with the IRS. If the proper thing is to write and exchange checks, do so instead of writing a “net” check. Document in writing any item pertaining to self or family deals. The IRS particularly scrutinizes family and controlled group transactions. If you adhere to these suggestions, the stress of being put on the spot by the IRS can be reduced.

     

Items that trigger IRS audits

All items reported on 1099 informational returns, W-2 wage and K-1 information forms should be identical to what you report on your tax return. If they don’t match, you can expect and audit or inquiry.

Avoid large numbers. If your repair bills, medical expenses, contributions or any other single item is very high compared to your total expenses, your chances for an audit increase. If any one item appears outside a normal range for comparable taxpayers, you return might be targeted for an audit.

Don’t use even round numbers.

Try to keep your tax return fairly consistent from year to year. Unusual fluctuations or activity can cause an audit.

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This page was created on 10/15/01 by Erlin Weness with assistance from M. Werner.