The Motley Fool: How to face an IRS audit without fear

It’s audit season! Our tax expert, Roy Lewis, says that your best bet is to have a qualified tax pro battle with the auditor for you. If you insist on doing it yourself, here are a few tips.

“ Don’t ignore the audit notice, or the next correspondence you receive may be a bill. The notice will tell you exactly what items are being examined, helping you determine what to bring to the audit. Bring only what you’re asked for. Extra items could raise further questions. Also, bring only copies, not originals, of documents to prevent anything from getting lost.

“ Organize your records. Making the auditor’s job easier will win you some points. The auditor will at least believe that you’re an organized person and that all of your items are documented and justified. Remember, it’s your legal responsibility to prove your deductions.

“ Replace missing records. The auditor won’t skip some items just because you can’t find your documents. At worst, a deduction in question may be denied if there are no supporting documents.

“Stay on point. When you meet with the auditor, you’re essentially providing testimony. Answer as many questions as possible with a simple “yes” or “no.” If you must explain, keep it brief. Chatting about an expensive trip you’ve taken, for example, might raise some unwanted questions.

“ Know your rights as a taxpayer. Remember that an audit is like a small trial. It’s important to know your rights, the audit process and the law behind the deductions you’re claiming. It’s generally best to settle any difference at the audit level, but if you can’t come to an agreement, you have rights that allow you to request a conference with the IRS Appeals Division.

Lewis reiterates that “a qualified tax pro can be worth every dollar of his or her fee,” given the complexities of our tax code. He adds, “If you ever decide to remove your own appendix, well, good luck with that, too.” Learn much more at www.fool.com/taxes.

Ask the Fool

Q: Can you explain “good will”? — D.L., Vail, Colo.

A: Good will usually appears on a balance sheet if one company has acquired another and has paid more than the acquiree’s appraised net worth (approximately its book value). Imagine that Roadrunner Industries (ticker: BEEEP) acquires the Acme Explosives Co. (ticker: KBOOM). Let’s say that Acme is considered a gem among explosives manufacturers and that other companies would be happy to acquire it. If so, Roadrunner probably can’t get away with paying just what the company is worth — offering merely that might trigger counterbids for Acme. So it pays a premium. This difference between the price paid and the book value of the acquiree is entered onto the acquirer’s sheet as “good will.”

Imagine that Roadrunner’s book value was $100 million before the acquisition. Acme was calculated to be worth $20 million, but Roadrunner offered $25 million in cash. Roadrunner’s value won’t change. It will still be worth $100 million, but it wouldn’t have the $25 million in cash that it paid listed as an asset on its balance sheet. That sum would be replaced by the $20 million value of Acme as well as a new $5 million value designated as good will. Meanwhile, just as capital assets such as factory equipment depreciate over time, with their value on the balance sheet decreased eventually to zero, good will is also incrementally reduced to zero.

My smartest investment

While at a gas station in the late ‘90s, pumping gas for less than I’d paid for it in the previous decade, it occurred to me how crazy that was. So I went home and bought $10,000 worth of the Vanguard Energy Fund, which is now worth nearly $50,000. So now when the price of gas rises, I just laugh and think of my “hedge fund” at Vanguard. — Frank, Flower Mound, Texas

The Fool Responds: That fund has indeed been a strong performer over the past decade, averaging an annual return of nearly 17 percent. It offers an easy way to instantly be invested in the likes of ExxonMobil, Chevron, ConocoPhillips, Valero Energy and more. Still, make sure that your overall portfolio is diversified into other industries.

www.fool.com/mutualfunds/ mutualfunds.htm and www.morningstar.com.