Chapter two: the four IRS transcripts you can pull for free, what actually draws an auditor's attention, and how to rebuild records after they are gone.
The IRS has a complete transcript of your tax account going back years, and you have probably never looked at it.
Chapter two of my book, The IRS Survival Guide, is about using the IRS's own tools in your favor. Pulling your transcripts, spotting problems early, and reconstructing records when the documentation is gone.
Watch my full video on this topic below, or watch on YouTube.
Tax account transcripts are your statement of account, similar to a bank statement for your tax year. They show when returns were filed, tax owed, payments, adjustments, and any penalties and interest assessed.
Tax return transcripts summarize your return as you filed it.
Wage and income transcripts list everything third parties reported about you. W-2s, 1099s, 1098s, any information return that reached the IRS.
Record of account combines the account and return information. I would pull the first two separately, because this one is not always updated as often.
All of them are free at irs.gov. Set up an online account and you can usually pull them instantly. If you cannot, you can call the IRS, file the form, or have a representative get them for you.
The IRS is looking at your transcripts regularly. If there is a gap between your return and what third parties reported, they will find it. You want to know first, and where possible you want to check those information returns before you file.
There is a second reason. In my experience most frauds could be caught quickly if a business owner simply reviewed their bank statements and IRS transcripts on a schedule. I have seen employees embezzle by booking payments as tax payments while writing the checks to themselves. A transcript review catches that.
People talk a lot about audit triggers. The honest answer is that you usually cannot tell what triggered an audit. The IRS uses a computer algorithm to score returns, and it also selects returns by project, targeting whatever area it currently sees compliance problems in.
That said, these are the ones I saw audited often on business returns:
None of this means you should skip a legitimate deduction. It means you need documentation you can stand behind.
Fire, flood, a dead hard drive. The IRS does allow reconstruction, but it takes effort and credibility.
Start with bank and credit card statements, invoices from vendors and suppliers, and copies of contracts. A missing mileage log can often be rebuilt from calendar entries showing your business meetings. Email is useful for the same reason.
The key is corroborating evidence. You saying you spent the money is not enough.
There is a judicial rule from a court case, the Cohan rule, that allows taxpayers to estimate expenses when receipts are unavailable. Be careful with it. The IRS generally will not apply it until you reach Tax Court, so it is far better to reconstruct from hard documents.
Before filing, especially after a high income year or anything unusual, ask two questions. Is every income item accounted for, checked against your bank statements and your wage and income transcript? And do I have documentation for every deduction, and would I know where to find it?
Then test one. Take advertising expense. Find the number on the return, find it in your accounting software, open the transactions that make up it, and pull a sample to see if the documentation is there. That is exactly what an auditor does, and what I did hundreds of times.
Compare against prior years too. A new income source, or a missing one, is a good way to find a mistake. If you find an error, consider amending. It is better to get ahead of a mistake than to have the IRS tell you about it.
Go to TheIRSSurvivalGuide.com to get your free PDF copy of my book today.
