Surviving an Audit: Income Documentation
Income Paper Trail
Many people make sure that they have the proper documentation to substantiate deductions taken on their tax returns. However, do you have documentation on your deposits?
Part of the audit procedure, regardless of the audit type, can include a request for all bank records pertaining to your checking accounts and money market accounts for the year or years covering the audit.
Why would the IRS request these documents if they are auditing your home office deduction or travel expenses? The answer is simple, they want to check for unreported income.
Under these conditions the IRS will match all deposits made into your accounts for the purpose of comparing it to your declared income. If your deposits exceed your reported income, guess what? The IRS will want to know where this income came from for the purpose of hitting you with "unreported income" on the difference.
Now, we all know that all the deposits you make into your account is not taxable income. You can receive gifts, inheritances, reimbursed expenses or maybe you obtained a loan that you deposited into your main checking. These all show up as deposits even though they are not taxable income, however unless you can clearly demonstrate where the deposit came from and prove that it was not taxable income the IRS can construe that these deposits are unreported income. Remember that when it comes to the IRS the burden of proof is on you.
You should record and identify the sources of all deposits in your check register. Don't just record these deposits as "Deposit." Instead write it in your checkbook as "Deposit birthday gift from John Dow" or "Deposit mileage reimbursement check from ABC employer."
It is also a good practice to make a copy of the check from all non-taxable items and keep it in your yearly records. If you will take a few extra minutes and keep track of these deposits an IRS audit will certainly be a lot easier.
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