Educating Rico: Audit or treat?

April 17th, Tax Day, is almost here. If you're still staring at a mound of loose papers, W2s, and receipts, it might be time to consider Plan E -- an extension. Kai talks with Victor Omelczenko, media guy for the IRS.

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KAI RYSSDAL: Our associate producer Rico Gagliano checks in once a month to keep us up-to-speed on his ongoing journey through the labyrinth of personal finance. We like to call the series Educating Rico. And in the spirit of the season, this week he tackles a topic that sends chills down the spine of every taxpayer. It's not for the faint of heart. Or wallet.

RICO GAGLIANO: Hi, I'm Rico. And believe it or not, it's almost holiday time.

[ Song: "Sleigh Ride" by Johnny Mathis ]

Wait -- oh God, no. No no no no no NO!

The other holiday.

[ Creepy organ toccata, chainsaw and screams ]

Yes, Halloween approacheth and everyone around the office is getting super excited.

CINDY: I'm always psyched about Halloween because it's two days after my birthday.

RICO: What are you going as?

CINDY: I know what my boyfriend is going as and I'm trying to figure out if I can work around his costume? He's gonna be the main character from "Bring Me The Head of Alfredo Garcia?"

RICO: Why don't you go as the head?

CINDY: I've thought about that!

RICO: Stephen, you lookin' forward to Halloween?

STEPHEN: Expectantly yes.

RICO: Whatcha going as?

STEPHEN: Thinking about going as a bellman.

RICO: That's not very scary.

STEPHEN: Well, to me it was. I was a bellman. That was my first job. I still get horrifying nightmares about it.

Now see, I'm kind of a Halloween Scrooge. Mainly 'cause I wear these thick glasses, so my costume choices are limited to Buddy Holly, Waldo and for the last four years, Harry Potter.

Still, I figure it's my seasonal duty to brave the scary side of personal finance come Halloween. And it wasn't hard to think of the most monstrous subjects of all.

They're as relentless as zombies and as bloodthirsty as vampires. Can your heart stand the fearsome sound of IRS auditors???!!!!

Think it's too soon to be having nightmares about getting audited? The New Year's not so far off, and planning early can't hurt.

So joining me here in this spooky graveyard is enrolled tax accountant Frank Degen. Hi Frank.

FRANK DEGEN: Hi Rico, it's nice to be with you.
RICO: So what is the first line of defense? What is the audit equivalent of, y'know, carrying around garlic and crucifixes?

FRANK: Make sure that you have all your records. You never can have too much.

RICO: Now I figured that you'd say that but you know is there anything that should be more carefully documented than other things?

FRANK: Well, typically most people who are audited fall into a couple categories: One are employees that may have large business expenses or high charitable contributions or self-employed people. Expenses such as transportation expenses, meals and entertainment expenses and those records are required, very strict substantiation rules. The best thing to do is keep a log.

RICO: So, for instance, car travel. How in the log should I be keeping those records?

FRANK: When you get in your car for business jot down the odometer reading for the beginning of the travel and then when you get to your destination you jot down your odometer reading at that time. Of course we assume that the travel was legitimately done for business which often is an area of contention with the IRS.

RICO: You also mentioned charities. I know that I'd heard a while back that donating your car to a charity was sort of a big red flag? Is that still the case?

FRANK: Yeah that was a big red flag but that's been tightened up. In the past year you are much more limited to your let's say estimation of what the value of the car was worth. Right now you're limited to what the charity actually sells it for.

RICO: So you gotta find out from them what they actually sold it for?

FRANK: Yes and they're required to let you know. You should have a statement from them telling you exactly what they sold it for.

RICO: Alright let's assume the worst has happened: I'm getting audited. How does the IRS let ne know?

FRANK: Well at one time it was all by letter. What they often do now is they make a phone call.

RICO: I have to tell you, that's totally horrifying that I come home from work, I'm ready to relax with a cold 40 in front of the tube and I get a call from, you know, Satan. How should I respond?

FRANK: Well certainly I would tell the IRS 'Thank you, my representative will be in contact with you.' Ask the IRS person for their name, their badge number and the phone number that they can be reached at. Meet with the person who prepared your taxes, give them power of attorney and let them do all the dirty work for you.

RICO: So after I've responded to the call what I do is call you and then you make the monsters go away?

FRANK: Absolutely.

RICO: Do folks like you work on contingency? What's this gonna run me?

FRANK: No most folks work on an hourly basis?

RICO: Alright assuming that I can't afford that and I have to go in by myself, can you tell me what is the environment like? Because I have to tell you, in my head it's literally like a pitch black interrogation room with a single exposed light bulb shining in my eyes. What . . .

FRANK: It's not quite that bad and they don't waterboard you either. You know the IRS has a job. Sometimes there is some disagreement so they may propose that you change your tax return but a taxpayer always has a right to appeal. They're not after your first born, they simply want to collect the right amount of money on that tax return.

RICO: How much leeway will they give me? Like what if I've got a credit card bill for a purchase but I don't have the original receipt or something?

FRANK: The best thing to do always is to have the receipt. There is something called the Cohan Rule. George M. Cohan, the old Yankee Doodle Dandy author was subject to an IRS audit and he didn't have any records. The judge said based upon the fact that there was some evidence that he had done some of these expenditures, that you are able to make an estimate of what those expenditures were. However there is no flexibility in those things about transportation, meals and entertainment, so if you don't have records there you're out of luck.

RICO: OK, thank you very much Frank Degen for the information -- hopefully I will never have to use it.

And we should probably end by reminding listeners the IRS has three years to audit you, longer if they think you owe them a lot, or suspect you of a crime.

So hold on to your tax records for at least 7 years. Because financial woes you thought were long buried… can sometimes rise from the grave.

[ Evil laugh . . . turns to cough ]

Oh, and also, it's flu season -- remember to get your shots.

In Los Angeles, I'm Rico Gagliano for Marketplace Money.

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