A tax audit creates fear and anger in individuals and business owners. It also creates a need. The need for documentation to prove income and expenses when the auditor is scrutinizing them. It is not uncommon for documents to be lost or discarded by business owners and individuals.
As soon as a taxpayer is notified of an audit, a “financial intervention” must begin. The taxpayer should gather any and all documentation that is available. In the case of a natural disaster, there may be absolutely nothing left.
Documentation will include both paper records and digital records. Taxpayers should gather bank statements, canceled checks, deposit slips, credit card statements, and expense receipts. Missing data could be recovered from banks, credit card companies, and companies with which the taxpayer did business.
When solid documentation is received from sources such as banks and credit card companies, the process of recreating the taxpayer.s books and records is fairly straightforward. However, gaps in data are best filled with the help of a forensic accountant.
There are several ways to help substantiate deductions during an audit:
* Oral explanations or testimony can be used to support deductions. If the taxpayer is credible and the explanation is supported by the facts, the deduction can be allowed.
* Affidavits from people or businesses that can support your deductions can be helpful.
* Use data from other months, quarters, or years to prove patterns in numbers.
* Ratio analysis may help a forensic accountant estimate expenses
* Available industry data also may be used to estimate a reasonable level of expenses.
These are not the only ways to prove income and expenses, but are among the most common. It is important that the taxpayer make every effort possible to gather documentation that supports reported income and expenses for the year under audit.
Working with an expert who is familiar with methods used to recreate books and records is also a critical part of the audit process. Utilize an advocate who can be creative and aggressive to calculate numbers that are useful and believable, and which help the taxpayer achieve the best result possible from the audit.
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