The IRS and state taxing authorities are auditing more than ever these days, and for good reason: huge budget deficits and a taxpaying population that has become more agressive in misreporting their income. Since the pickings are so easy, expect many more audits in the coming years.
What is the best way to protect yourself? The best protection is planning ahead and practicing good record keeping. The best place to start is with your receipts.
Because of trend toward payment on the Internet, many people are not keeping access to their receipts. The taxing authorities know this, which makes your claimed deductions a great target of for audit. This is one the reasons that those who file a Schedule C (which basically is an income statement for a sole proprietorship) is a target of choice. The problem is that by the time the audit comes, which is normally two years after filing, access to the reciepts is confusing or lost.
The answer is to make sure that you always print out your receipts, or make sure they are easily accessible electronically. You can still verify the fact that you spend the money with your credit card statement or bank statement, but these statements only show date, payee and amount. They don’t show the detail of what was purchased. Without this detail, the IRS can claim that you failed to show the business purpose of the payment, and it may be denied. Therefore, be sure to maintain access to all of your receipts that support business deductions.