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April 15 countdown: How to avoid a tax audit

BY KATHY KRISTOF | Los Angeles Times

11:59 AM EDT, March 28, 2008

As you file your tax return, do you wonder whether you're likely to get audited?

You can take some comfort in knowing that audits are remarkably rare, hitting about 1 percent of taxpayers each year. However, the rate is rising, and if you happen to pull a few audit triggers, your chance of getting that ominous letter or phone call from the Internal Revenue Service can soar tenfold or more, experts say.

"I am hearing about more audits than I ever have," said Roni Deutch, a California tax attorney who has been practicing for 17 years. "People will try to alleviate your fears and tell you that an audit is not a big deal. It is a big deal. It's like having a root canal without Novocain."

The number of returns audited by the IRS jumped 7 percent last year to 1.38 million, up from 1.29 million in 2006. If you're an honest taxpayer, you should never avoid taking a legitimate deduction just because it might trigger an audit, said Jeff Schnepper, author of "How to Pay Zero Taxes."

But you do need to be aware of the things that might get you audited, the different kinds of audits, and how you ought to deal with them.

The triggers
Your odds of an audit hinge partly on something called a DIF score. The formula is closely guarded by the IRS, but tax experts have identified some factors that are likely to boost your score and thus your chance of an audit:

Unusually high deductions. Deductions that stray from a normal range will cause your return to get further scrutiny. But what's normal? Each year the IRS publishes a "Statistics of Income" book that shows the averages. The one caveat: The average in each category takes into account only those people who claimed deductions in that category. As a result, the averages overstate how much a typical taxpayer deducts.

For example, for people earning between $15,000 and $30,000, the average deductions are $6,229 for medical expenses, $2,761 for taxes, $6,664 for interest and $1,969 for charitable contributions. But if you earned $15,000 and claimed all those deductions, you'd be writing off $17,623 -- more than you earned. Even though each deduction was "average," would you be audited? Without a doubt.

High income. Your neighbors may envy you if you make $1 million or more, but they won't be so envious of your status as an IRS target. In its latest fiscal year, the agency audited 31,382 million-dollar earners, up 84 percent from the year before.

That meant your chance of getting audited was 9.3 percent if your income topped $1 million, compared with only 1 percent for taxpayers overall.

You don't have to be a millionaire to garner more than your share of IRS scrutiny, either.

The agency targets anyone with more than $100,000 in income. And your chance of getting audited jumps with every big step up. If you earn less than $100,000, you have a 0.93 percent chance of being audited, for example. Earn more than $100,000, and you have a 1.77 percent chance. Earn more than $200,000, and your audit odds jump to 2.87 percent.

Cash businesses. If you have a job in which you might be paid in cash -- say you're a bartender or a hairdresser -- the IRS is likely to look closely at your gross income to determine whether you failed to report everything you earned. A telltale sign: You deposit more in your bank or brokerage accounts each year than you report as earnings on your tax return.

Self-employment. Tax authorities target self-employed people because they're often aggressive in writing off day-to-day expenses.

As long as your deductions are legitimate, Schnepper said, you should take them. And many can be legitimate. "There's very little that you can spend money on that I cannot make deductible for someone who owns their own business," he said.

But if you do write off aggressively, know that your deductions are likely to be scrutinized.

Errors. You gave $1,100 to charity, but your finger stuck on the "zero" key when doing your taxes and you reported $11,000 instead. Or you transposed two digits in your child's Social Security number -- or failed to report $57 in income from your bank checking account. All these errors are understandable, but they're going to cause the IRS computer system to toss your return out so that a human can ask you for more information.

Types of audits
There are two types of IRS audits: correspondence audits and field audits. The good news is the vast majority of audits are correspondence audits, which can be as simple as the IRS asking you a question by mail and having you respond by mail. The simple errors described above, for instance, are likely to generate a letter asking you to explain the discrepancy.