Avoiding or Dealing With a Tax Audit

There are two pieces of advice that you should keep in mind about audits:

• If you've done your homework, kept good records, and your return is truthful, you don't have anything to worry about.
• It's better not to be audited.

Minimizing the risk of being audited. First, let's talk about the second point.

The average taxpayer has a very small chance of being audited. But if you are self-employed, your return is definitely not typical of the millions of returns filed by employees. You may be waving some red flags at the IRS and increasing your chances of being audited.

What to Expect if You Are Audited

The IRS has several different levels of audits.

Correspondence audits. If questions arise about your math, items seem to be omitted from your return, or your figures don't match those on your W-2s, 1099s, or 1098s, the IRS may simply request a correction or explanation by mail.

Respond to the request as quickly as possible and, if you have doubts about the answer, consult your tax professional if you have one.

Work Smart The IRS makes mistakes, too. Don't assume the IRS notice is correct. Check things out. Computer-generated forms, which include the forms most commonly sent out to deal with small errors, are notorious for automatically adding penalties that may not apply in your situation. If you are in doubt, call the IRS and ask them about anything you don't understand.

Office audits. The first level of inquiry that can truly be considered an "audit" occurs when you get a letter requesting that you come into the IRS office to review one or more areas on your return. This is a true audit because the IRS is asking for proof of items on your return that goes beyond your word.

Work Smart You can attend an audit yourself, but you don't have to. And maybe you shouldn't. Instead, you can authorize your accountant, lawyer, or other tax professional to handle it without you. Often this is the best way to prevent the audit from escalating beyond the original areas that piqued the IRS's interest. Experienced professional advisors are less likely to become emotional or to make statements that lead to more IRS questioning.

If you have kept records, including bills, receipts, and canceled checks, you shouldn't worry. The IRS may end up interpreting your situation differently than you, but there is no crime in having differences of opinion. Nevertheless, professional help may be in order with an office audit, particularly if you yourself suspect that there are errors or omissions in your tax return.

Field audits. As rare as audits are, the dreaded knock on the door from the IRS agent is even rarer. Individuals are almost never audited in this way. On-site or "field audits" are used mainly for larger businesses, particularly when records are not portable. If you do get a notice of a field audit, professional help is definitely recommended.

Suggestions for Minimizing Audit Risk

The IRS does not provide details on its audit criteria - in fact, they are a closely guarded secret. However, we offer the following suggestions for minimizing your risk:

• Make sure that the information provided on any W-2 forms you receive from employers, and 1099s or 1098s you receive from banks, mutual funds, brokerages, retirement plans, or any other source, are accurately reflected on your return. If there is a mistake, get the issuer of the form to correct it. The IRS computer matches these figures with the figures on your return, and it will question any mismatch. If you have many of these forms, report each one separately somewhere on your tax return. The computer will not catch it if you lump the numbers together.
• If you are claiming an unusual deduction or there is something confusing on your return, attach a written explanation. Any statements should be as brief and to the point as possible - don't ramble or provide unessential details.
• If you are claiming home office expenses or significant travel or entertainment expenses, make sure you have the records. The IRS scrutinizes these expenses very carefully. The same is true of all business expenses if you haven't yet established a track record, and especially if your business is not profitable.
• Sign your return. Fill out all the information required. For example, it's common to omit the Social Security number of an ex-spouse from a return, but you are required to supply it if you are paying alimony. Make sure your return is complete.
• Make sure your math is correct. Arithmetic errors are the most common errors turned up by the IRS. If you are doing your own return with a calculator, after you've done all the computations, we suggest you start at the amount of your refund (or tax you owe) and work backwards to check your work (e.g., add back your payments, subtract your other taxes, and add back your credits to see whether you arrive at the same tax amount; continue in this vein for the rest of the return).
• Make sure that all Social Security numbers for your dependents are correct.