How to Avoid an Audit

Audits are frightening. You can lessen the chances for an audit by putting a little extra attention into preparing your return. And if you do face an audit, you can keep the damage to the minimum, by preparing careful documentation.

For most people, the chances of being audited are pretty low. About 0.58% of the individual returns filed for calendar year 1999 were audited, according to the latest statistics published by the government. But don’t take the chance of triggering an audit.

The best way to avoid being audited, or to protect yourself if you do get audited, is to review your return before you file it and look carefully at items that might draw the IRS’s attention. Here are a few questions to explore:

Are you taking a deduction on a sizable loss for expenses you incurred while running a part-time business? This deduction may help shelter your wage income from taxes but it get you some unwanted attention at the IRS. In 1998, the IRS audited over 2.6% of the returns with business income or losses reported on Schedule C. Make sure that you can document your business loss with receipts, to defend the deduction if you do get audited Also, locate anything that can prove your intent to make a profit in your business, so you can show your business is for real, even if it is temporarily losing money.
Have you reported all of the income for which you received a tax document? For example, if you worked for a company on a per-diem basis, you will receive Form 1099-MISC, which reports the amount of money you were paid for your services. Remember that the IRS also gets a copy of this form, so be sure to report this income.

The same applies to Forms 1099-INT for interest income, 1099-DIV for dividends, and all other types of Form 1099. If a bank or company reported income on a Form 1099 under your name and Social Security number and you believe that the income is not yours, or the amount is wrong, ask the bank or company to issue a corrected 1099. If this isn’t possible, list the income on the correct schedule in your return, then show a subtraction of the same amount. Include an explanation as to why it’s not your income.

Are you taking a deduction for expenses related to a home office? This deduction draws IRS attention, especially if you’re an employee of a company. See IRS Publication 587: Business Use of Your Home for the rules for deducting these expenses. The rules outlining who qualifies for home office deductions were relaxed in 1999, so it’s worth your time to investigate whether you qualify for this deduction.
Are you taking a deduction for a charitable donation that isn’t in line with the income you’ve reported? Don’t do it. If you donate more than $500 of goods (not counting cash) to charities, you need to fill out Form 8283 to list your charitable contributions. This form asks you for the name and address of each charity, a description of what you donated, how much you originally paid for it, and the current market value of each donated item. You deduct the market value on your return. To determine the market value for an item, see what a thrift shop charges for a similarly used item.

Keep good records supporting your donations. What you Can and Cannot Deduct. See IRS Publication 526: Charitable Contributions for general information about charitable contributions, and IRS Publication 561:Determining the Value of Donated Property for more information about determining the market value of your donations.

If you are following the guidelines and have supporting documentation for your deductions (stored with your copy of the tax return), you don’t have to avoid taking a legitimate deduction, even if it might stand out on your return. You might even consider attaching a copy of the receipt or other supporting documentation right to the return. If the documentation appears legitimate, the IRS may pass up examination of your deduction.

What to Do if You’re Selected for an Audit

If you’re selected for an audit, you will be notified by mail. The letter tells you what kind of audit the IRS wants to conduct.

If it’s a correspondence audit, you receive a letter asking you for more information about certain items on your return, such as support for a particular donation to a charity, or a medical expense. You respond by sending in the appropriate documentation.
If it’s an office audit, the IRS schedules a meeting with you at your local IRS office, and you will need to bring in your paperwork. These audits usually cover only a few items on your return that the IRS is interested in.
If it’s a field audit, the IRS examiner will visit your home or place of business. These examinations are not very common for individuals; they are usually for business returns. You’ll need to prepare your paperwork for the visit.

The IRS usually mentions which items it’s questioning, so if you’re scheduled for an office audit, assemble the records supporting those areas first. Get a feel for how comfortable you are with what you reported. Here’s how:

Thoroughly review your return and gather as much proof as possible to support the items the IRS is questioning. If you took a deduction that’s fairly questionable, evaluate how much of it is defensible and think about how much of a disallowance you can handle. Don’t volunteer this information to the agent, however: just prepare yourself mentally for the discussion.
Consider engaging the services of a tax professional if your return includes complicated issues or risky deductions. You can authorize an attorney, a CPA, or an enrolled agent to represent you at the examination—you don’t even have to be present. If you’re concerned that you will owe a lot in taxes, penalties, and interest if the IRS prevails, it’s a good idea to get a professional involved early on.
Do not volunteer information about items on your return that the IRS isn’t questioning.
Organize your paperwork before you arrive. Producing your documentation immediately when asked will speed the process and create a favorable impression.
Don’t bring extra paperwork supporting deductions other than the ones the IRS is investigating. These aren’t necessary, and allowing the examiner to review them could possibly open up issues better left alone.
Make sure that your interaction with the examiner is professional, firm, and even-tempered.

The most important part of handling an IRS audit is your preparation. You’ll save yourself time in the long run if you are thoroughly prepared for inquiries, and if your paperwork is organized.