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We received a Christmas gift from the Internal Revenue Service this year: one audit notice.

When my mom — who receives and reviews our mail — started reading the letter to us, neither she nor we knew what it was. She skipped around as she usually does, first reading out our tax ID number, then a section about what to bring to our “examination,” and then she moved on to something about our rights. I turned to Brian, “Are we being audited?”

Mom faxed the notice to us; sure enough, my business expenses were being audited for 2008 & 2009. Furthermore, since we talk about mail only every couple of weeks or so, we had already reached the response deadline, a scary date after which you’ll be assessed additional penalties and fees.

We spent some serious time wondering how the heck we were going to deal with an audit from Australia, and if we would have to return home and rifle through our storage unit.

Well, I’m happy to report that the process went pretty smoothly. Here’s what we learned:

• Keep good records. If you don’t already, retain copies of key business receipts and statements, and store them for the recommended periods. In particular, keep any statements containing tax-deductible expenses for three years, until the risk of an audit passes. This is really easy with electronic statements, which we’ll definitely keep from now on.
• Before leaving home for extended travel, scan your tax returns and take electronic copies with you. Then, leave the originals and supporting documentation in safe (and accessible) hands. In our case, my mom had our returns and our other records were in storage in California.
• Carry the contact information and account numbers for your banks and credit cards.
• If you are likely to be targeted for an audit because you have a small business or prepare your own taxes, it’s probably a good idea to pre-pay for audit defense. Even though TurboTax had indicated our returns were unlikely to be audited when we filed, Brian had erred on the side of caution and prepaid for audit defense at a rate of $50 per year. If you wait until you receive an audit notice, it costs between $350-$2,500 for audit defense, depending on the scope of the case.
• Upon receiving the IRS notice, immediately call your audit defense service. Do not call the IRS. Anything you say to the examiner can be used against you, so it’s best to let an expert speak on your behalf. The audit defense service handled all communication with the IRS on our behalf, and I think being in Australia and later Thailand — 19 hours and 15 hours ahead of our representative, respectively — actually worked to our benefit.  Our representative explained our situation to the examiner and arranged a correspondence audit, whereby the defender and examiner conferred via mail vs. in person.
• Your audit will likely only cover certain schedules or line-items on your tax return but you may have to provide more complete information to your audit defense team. We had to provide all of our bank and credit card statements for the years in question, along with several hotel receipts related to my business travel. Most of the companies were wonderful and faxed us the information we requested quickly, but our CA-based credit union charged us $5 per statement (we’ll be happy to tell you who they are if you email us) and Capital One made a bit of a mess by mailing our statements to the wrong address and updating our personal records incorrectly. At least we didn’t have to fly to California!

The whole process was time consuming, however. Brian spent hours compiling our evidence in a spreadsheet and cross-referencing it, in order to give our defender a complete picture of the expenses in question. In the interim, the IRS sent us a bill for more than $18,000 before considering any of our evidence. Then we submitted everything and waited. There were a few back-and-forths in which the examiner asked for additional details and evidence, and our audit representative handled most issues without too much of our involvement.

Finally, almost three months after we received our notice, it was over. Much like the transition from the year of the tiger to the year of the hare — in with a roar and out with a whimper — everything came to a quick and quiet resolution. Upon our return to the States last week, we found an official notice that no change would be made to our standing tax returns. Yep, that’s right. We owe nothing more!

After the stress and extra work, I feel properly vindicated. Anyone who knows Brian knows he takes honesty to the extreme. He would never get “creative,” much less actually cheat, on our taxes. He worries sometimes when we tell people partial truths to save them the full story. And, if anything, I underreported my business expenses because I only claim things for which I can find receipts. I don’t know how people who make up their returns do it, but that’s another conversation.

I hope you never have to defend yourself against an audit, but in the event that you do, I hope our story will help you be better prepared. I read a few days ago that Obama’s 2012 budget would increase funding to the IRS for tax enforcement. I think we all know what that means…

Cheers,