A Step Ahead of the IRS

Yesterday, a client shared a tale of woe. During a recent move, he trashed a whole drawer-full of old paperwork. Not two weeks later, he received an IRS audit notice demanding to receive copies of documents now resting at the municipal landfill.

With the IRS subject to Murphy’s Law, its audits wait for no man. They happen in the midst of bar mitzvah preparations, apartment moves, job hunts, and sicknesses. If you are an American citizen living in Israel, don’t rely on “it won’t happen to me.” Instead, take a few easy steps now to be prepared just in case the IRS does decide to take a closer look at your finances.

If the IRS decides to audit you, it will give you one month in order to respond (including the time the letter travels from the US to Israel) and then another two weeks till the document submission deadline (once again, including mail transit). While you can request an extension, it will still be a stressful time with lots of work to do: collect and translate documents, consult a CPA, if necessary, and mail everything back before the deadline.

A small investment of time at a convenient moment now can save you the anxiety-filled mad dash against the deadline later on. By keeping relevant documents accessible and grouping errands, you can have the peace of mind that comes with knowing that you are ready for whatever the IRS may have up its sleeve.

How long should you keep the tax records? By law, the IRS has 3 years to audit a taxpayer from the date a tax return is filed. As of this writing (end of 2012), most US olim are being audited for the years 2009 and 2010. Still, in cases of suspected fraud there is no statute of limitation. For more information, check this table.

The following documents will enable you to meet the IRS requirements for all document categories, which include: Tax return(s), Foreign Residency, Citizenship (both US and Israeli), Israeli Income, Marriage Status, Dependents, and Expenses/Deductions.

Here is what you need to do to audit-proof your family:

1. Get a 2-ring binder and some clear sheet protectors. Use these to file away all the documents you collect.
2. Print out a printer-friendly version of the list and highlight documents relevant to your situation. Check them off as you file them away in the binder.
3. Make sure you have valid copies of all family members’ US and Israeli Passports, Social Security Cards, kids’ birth certificates/consular reports of birth abroad, and your marriage certificate. Photocopy and file away all of these. If you don’t have Social Security cards, apply for them by mail (they take several months to arrive).
4. Check dates before throwing out documents. Keep copies of at least one kupat cholim bill as well as either an arnona or a water bill for each year. If you don’t have copies of arnona or water bills, find copies of your lease agreement. The purpose of these is to prove that your residency in Israel.
5. For older kids, keep the municipal school fee bills three years back. For young children, photocopy the front of the Tipat Chalav booklet or immunization record (it should have the child’s name, date of birth, and address).  This is to prove the existence of your children.
6. If you don’t have the documents to prove the existence of the kids or Israeli residency, make a note to stop by Ministry of Interior (Misrad Hapnim) the next time you or your spouse are in town.  There,  get a copy of an Extract from Population Registry (tamtzit rishum). Contrary to popular belief, the offices work quickly and you are not expected to spend more than 15 to 30 minutes there, depending on location. If you live in the Jerusalem area, make a shopping trip to the Maale Adumim mall. The Misrad Hapnim branch there is fast and efficient.
7. File copies of your US and Israeli tax returns at least three years back.
8. Call your employer’s (employers’) payroll department and ask for End-of-Year 106 forms for at least the past 4 years. Also ask for a copy of one pay stub for each year.
9. If you are self-employed and have filed Form 1031, include a copy for each year.
10. If you have claimed deductions for expenses such as mortgage, child/dependent care, medical bills, or charitable contributions, keep the receipts. Likewise, keep copies of documents about any additional income you may have (rentals, securities, investments etc).
11. If you have been filing FBARs independently and not through a CPA, save printouts of your annual reports in the binder.

If you have the document lying around the house, putting them together in a binder should not take more than an hour.

Budget 1 to 3 hours if you need to hunt some papers down. You can either make a concerted one-day effort to get this done or jot the tasks on your calendar and several errands together by location or method of communication (email, telephone, or in-person). You can even make this fun by doing it with a friend and then returning the favor.

An IRS audit shouldn’t be a nightmare. It won’t be, if you are prepared ahead of time.