IRS Tax Audits - How can I avoid them?

by M.E. Hansen, All rights reserved. Do not duplicate without permission

Audit Facts that the IRS Doesn't Want You to Know!

The odds of a "real" audit are much lower than the IRS would have you believe. By "real" I mean an audit at IRS headquarters during which you sit across the desk from a revenue agent. Official government statistics show an IRS audit rate of 1.6%. But that figure includes what the IRS calls correspondence audits, which make up more than half of all audits done in a given year. Correspondence audits are handled completely by mail. The IRS simply asks you to mail in proof for an item they have questioned.

IRS audit technology is in a shambles. Recently, IRS officials revealed that they had wasted $4 billion trying to update their data processing systems. Despite this outlay, the IRS's computer software is woefully outmoded. This can be a blessing for taxpayers who are audited. While the examining agent can call up your current return on the computer screen, he/she won't get a clue from the computer about what you filed in previous years. The IRS can retrieve--by hand-an original return you filed in the past, but it will take at least 60 days to dig it up and maybe much longer. If an IRS auditor asks you for a copy of an old return and you can't easily locate it, let the IRS find the original. Your audit can proceed while they look--it may even be completed before the auditor gets a copy of the old return.

Important technological exception: The IRS's document matching program is first-rate. If you fail to include even the smallest amount of income reported by payers to the IRS, you'll get a computer-generated notice. Be diligent about reporting all of your income. Report it accurately, in the right place on your return, with the correct name of the payer, etc.

The IRS depends on you for information it needs to review your return. The IRS has no choice but to let you estimate figures for which you haven't kept records. Such as when the IRS needs to know the tax cost (basis) of property to verify your calculation of capital gains, real estate depreciation, oil and gas depletion, loss carry forwards, etc. If you haven't kept paper proof, make estimates of your tax cost based on your best efforts to put the facts together. Don't fabricate numbers, however. Be sure you have a rationale to justify your estimates if you're ever questioned.

Low-skilled IRS personnel are in charge of correspondence audits. Typically, these people are clerks who have received only rudimentary training from the IRS. They make mistakes. You should know that you can beat the IRS on an issue provoked by a correspondence audit if the facts are on your side and you can prove them. Never automatically pay a bill produced by a correspondence audit. Check the "auditor's" facts and figures.

Tax auditors handling "office audits" (those generally done in an IRS office) work from "kits" provided by the IRS. The auditors who perform these audits tend to be savvier than those working on correspondence audits, but they're certainly not "tax professionals." Typically, they work from a manual covering one area of the tax law (such as charitable contributions or medical expenses) and they go by the book. Here again, they often make mistakes and you can sustain your deductions if the facts are on your side.

Beware of dirty tricks: The Internal Revenue Manual actually suggests that auditors pause during office audits, encouraging taxpayers to fill in the silence with - they hope - unintended disclosures. Don't fall for this scripted silent treatment. Keep your mouth shut. Never ever volunteer information to a tax auditor, no matter how innocuous it seems.

Warning: IRS revenue (field) agents are, in fact, genuine tax professionals. They're the ones who come to your home or business to do an audit. Many revenue agents have had extensive experience in private industry prior to joining the IRS. If you're subject to a field audit, be sure to hire your own tax professional to represent you.

Next Tax Audit Page: Keeping Proper Records