The vast majority of taxpayers including digital nomads get through filing a tax return without any major problems. Just in case, here are 3 tips to help you survive an IRS audit.
Many think the IRS has bigger fish to fry. You would be right most of the time; the odds of the average person being audited are quite slim in any given year. But as the saying goes, it’s best to hope for the best but be prepared for the worst.
Let’s review three important tips you can do to be well-prepared to survive an IRS audit.
How to Survive an IRS Audit
1. Keep good records
This is my number one tip for just about anything tax or finance related. If you follow me at all, you’ll think I’m a broken record because I’m always talking about this one item.
BUT the number one thing you can do to stay organized, avoid an IRS audit, survive an IRS audit, fully understand your business finances, know if you’re hitting your goals, and so much more is to keep good records!
Plus, you’ll avoid a major hassle and hours of stressing out getting organized when it comes to tax time or worst case scenario if you receive a nastygram from the IRS.
If you’re not organized, now is the time to start. Keep at least 3 years of tax returns and all the associated documents, bills, receipts, and other items as appropriate. This would include any items related to your income, investments, or tax deductions.
Also, know that the IRS can audit one item on your return. It doesn’t need to be the entire thing they question. For example, maybe your charitable contributions are very high. This can be questioned.
Why keep good records, you ask?
If the IRS disputes any of your figures, you’ll have to have the documentation to back them up. If you don’t have the documentation for a deduction, for example, they may disallow that deduction altogether.
Staying organized is an ongoing process. Take care of your records as you accrue them vs. just once a year. I like to set aside time weekly as a small business owner and digital nomad or monthly for personal finances.
2. Watch out for red flags
If you don’t want to get audited, then avoid red flag items on your tax return. Here are 5 of the things the IRS tends to look for when choosing tax returns to audit.
Large business expenses
Small business owners sometimes try to get away with deducting nearly every expense they have. The IRS knows this. Be careful and only take what is necessary and ordinary to actually run your business
Your “friends”
If you’re trying to pull a fast one, it’s not uncommon for the IRS to get a tip from a friend, family member, or co-worker. The solution is to not do anything wrong in the first place. In lieu of that, don’t tell anyone anything that can come back to haunt you.
Don’t be bragging about how you took all your travel as a digital nomad. Hello, audit.
Complexity
If you’re business or investment transactions are very complex, the IRS might believe that it’s likely you made a mistake somewhere.
Large Charitable Deductions
If you give significantly more to charity than others in a similar financial situation, the IRS might take pause. Also, if your charitable donations increase dramatically, the IRS will be curious.
This is one I’ve actually seen happen. Being generous is amazing and I don’t want to discourage you from doing just that. Just keep those records in case the IRS questions your good intentions.
Inaccuracies on your W-2 or 1099
They figure if the basic documentation is wrong, there could easily be other things wrong as well.
Make sure your numbers match what is reported on your W2 exactly. If you receive 1099s for anything including 1099-INT for bank interest or 1099-DIV for dividend income or the most popular among digital nomads, 1099-NEC, make sure your numbers match what the IRS is receiving on the 1099.
A mismatch can raise the red flag (this is actually checked via a computer nowadays) and is a popular audit reason.
High Mileage
High mileage is a big red flag. Yes. There are some industries where high mileage is expected but not all of them.
I have actually helped a client through a mileage audit. He survived unscathed thankfully but that’s only because he had detailed logs to show the IRS. Without those logs, it would have been a nightmare and he most likely would have lost the mileage deduction.
Large Home Office Deductions
Taxpayers, especially small business owners, like to claim the home office deduction. I mean it is a nice deduction so I get it. But be careful here too. Especially as a digital nomad or RVer, this could get you in trouble.
3. Be prepared
In the event that you are chosen for an audit or even just one piece of your return is questioned, you should immediately prepare yourself. Review your tax return and all associated records.
Remember up above when I said to keep good records. This is ONE of the reasons it’s so important. Many audits are paper only. Meaning the IRS questions something, you provide your paper documentation and the whole thing is cleared up.
It can be that simple or it can get more complicated.
Either way, don’t hesitate to get expert advice if you need it; a tax professional including an enrolled agent can provide valuable insight and guidance through an audit.
What happens if the IRS comes knocking at your mailbox?
During an Audit
At the time of the audit, do not volunteer more records than the auditor requests. Extra records will never help you but they can provide an opportunity for the auditor to find something else wrong
Keep the auditor honest. They can only request information and records related to the official request that you received in the audit notification. If they stray from that, don’t be afraid to politely tell them ‘no’.
They have the option of filing a second official request, but many won’t bother and will simply let it go.
While the odds of being audited are generally quite small, it is unlikely that you’ll exit an audit without paying some additional tax or penalty. After all, the goal of the IRS is to be the goalie and collect all tax due to the government.
However, having the proper documentation for every item on your return lessens the probability that you’ll have to pay. Regardless of which item they question, you need the paperwork to back up what you claim on the return.
Remember, keep good records. Yes. Electronic copies of everything are 100% accepted.
Provided you haven’t intentionally done anything wrong, there is usually nothing significant to worry about. The key is to be honest when filing your taxes and keep your records up to date. If you do these things, you will survive an IRS audit just fine.