Most American citizens do their taxes every year and then are done with them. They owe money, they break even or they are owed money by the Internal Revenue Service (IRS). However there are a certain number of individuals every year that are chosen to be audited. If your tax return has been picked then you may be feeling nervous and panic stricken. Here we take a look at how you can best prepare for an audit if you have been picked as one of this year’s candidates. We also look at the type of penalties that you may have to cope with if you have not paid enough taxes. We also touch on the likelihood that you will be chosen for an audit. Let us begin …

Keep Organized Records

The IRS provides taxpayers with ample opportunities to save money on their taxes. However in the end the responsibility for keeping accurate and organized records lies with each taxpayer. You need to be able to justify all of the deductions on your tax returns if you are picked for an audit. It is wise to collect, maintain and organize your financial records throughout the year. Having a sense of order will make it easier once it comes time to do your tax return. It also reduces the potential for errors. It is also a good practice to get into if the IRS decides to dispute your return for one reason or another.

To remain on top of everything related to your taxes you should develop good habits throughout the calendar year. To do this you should always save your checkbook stubs and keep at least three to four years’ worth of tax returns and records on hand. It also helps to categorize the receipts from all of your purchases from the previous year. Whatever you do make sure you do not throw the receipts away!

But it does not end there. It is also wise to track cost basics for any property you own as well as all of your investments that are taxable. You should jot down in a book or journal your deductible items as they take place. You should also use an organized filing system to save all of your bills in. It is a good idea to buy folders and label them as required. You can choose any system you want as long as it keeps the necessary documents organized.

Could You Be Chosen?

You may wonder what your odds are of being chosen for a tax audit. There is good news and bad news on this front. Over the past several years the number of audits that the IRS has conducted has been increasing. However the focus of the vast majority of these audits is taxpayers who are in the high income bracket. The focus is also on abusive tax shelters and corporations.

J.K. Lasser, the premier publisher of consumer tax guides since 1939 reported in the tax guide it published in 2006 that the number of audits in the nation had gone up as much as 37 percent since the year 2001. Of those being audited more than one million taxpayers were required to face some type of return examination in the year 2004. Audits of taxpayers who are earning more than $100,000 yearly have more than doubled since the year 2001. What this means for the average taxpayer earning a modest living is that their chances of being picked for an audit are relatively low.

There are some factors that will increase the likelihood that you will be chosen for a tax audit. It helps to bear this in mind. Examples of these include your occupation, your income, where you reside, the kind of tax return you file and the kinds of transactions that you report on your return.

There are certain items that can act as a red flag for the Internal Revenue Service. If any of these red flags exists in your life then your chances of being audited will increase. These items include:

•    Large expenses for your business
•    Large deductions for charities
•    Concealing cash receipts
•    Excessive deductions that are itemized
•    Inaccurate reporting for your W-2 or 1099
•    Tax-shelter losses
•    Prior problems with your taxes and/or prior audits
•    Complex business or investment transactions
•    Informant

Preparing Yourself for the Audit

If you have the misfortune of being chosen for a tax audit then being prepared is your best defense! The first step you should take is to familiarize yourself with the details of your latest tax return. That way all of the pertinent information will be fresh in your mind. Once you are as well acquainted as possible with your return’s contents you need to organize your records in accordance with the questions that have been posed to you by the IRS. Some people choose to be represented by a IRS debt tax attorney

Before the examination get underway it is important for you to establish settlement ranges that you are comfortable with. This should help ease your mind before the grueling part actually takes place. In this way you will be ready when the examiner brings up settlement terms (if the need is there to discuss terms of a settlement that is).

If the matters or issues that are being disputed are something that you feel you could use some extra help with then you may wish to seek the assistance of a person trained in these matters, such as an attorney or a certified public accountant (CPA). If you are the one who attends the examination as opposed to the attorney or CPA then only bring with you the records that are associated with items brought up for investigation in the IRS Notice of Audit.

Do not offer any additional records that are not in question as this could add more fire to the investigation. It could prolong it for you or lead to a further investigation. These are all things that as a taxpayer you do not want to occur! If by chance the examiner asks you about something that was not mentioned in the notice you received from the IRS then it is in your best interests to firmly but politely refuse to answer until at which time a formal request for this information has been filed. It is within your rights to do this.

If the tax audit happens to take place where you are employed then all employees should be instructed to not speak about the business or about the tax audit with the IRS agent that is sent to conduct it. All inquires that come from the IRS agent should be directly referred to you since you are the subject of the audit. Ten days before the interview with the agent you should let the Internal Revenue Service know in writing that you plan to make an audio recording of the interview that will take place with the agent. Be aware that video recordings of this nature are not permitted.

Penalties Imposed by the IRS

If the IRS agent finds that there is sufficient evidence that you underpaid your taxes then you may face a penalty. There are different types of penalties imposed by the IRS. There is a 20 percent penalty, a 75 percent penalty, interest due and in the worst case scenario, prison time.

The 20 percent penalty in most instances applies to tax underpayment that is connected to overvaluation (or undervaluation) of property. It can also apply to negligence, a disregard for the rules and regulations of the IRS and substantial understatement of tax liabilities.

A 75 percent penalty generally applies to tax underpayments that are considered more serious and are related to fraud. If the IRS makes a determination that any portion of the underpayment is fraudulent in any way then it is your responsibility as the taxpayer to prove that this is not the case. If you cannot prove your case then the total tax underpayment will be deemed as fraudulent and you will be subject to a penalty of 75 percent.

If you are found guilty of tax violations such as negligence, fraud, failure to file your taxes on time and under or overvaluation of property then the interest on the amount owing will begin to accumulate from the date that your return is due. This includes any extensions you were given as well. Interest will continue to accumulate until the date on which the penalty has been paid in full. For other types of penalties however interest will not be charged if the penalty is paid within a matter of 21 days. This is of course if the penalty is for an amount under $100,000.

While it is not terribly common some taxpayers do face time in prison for tax evasion and other serious crimes that relate to taxes. Incarceration is the very worst case scenario. If convicted, you can be subject to significant fines as well as the forfeiture of your property and/or assets.

While tax audits are never something to look forward, to you should always make it a practice to be as organized as possible in terms of your financial records. The better organized and prepared you are the more ready you will be in the event that you happen to be chosen for an audit. The chances of that however are thankfully reasonably small.