Daily Deduction: How to Survive an Audit

It is the letter that we all dread: an audit notification from the IRS. Storm clouds gather, babies cry, pets hide, and grown men and women tremble. But a tax audit doesn’t have to be as scary as many people think. MainStreet has some helpful tips on how to avoid an audit, and if worse comes to worst, how to survive one.

The IRS has three ways of selecting returns for an audit. First, it uses a computer program that compares your return with thousands of others in your income bracket. If your return looks drastically different from the others, you are a likely audit candidate. Second, the IRS also has boots on the ground to investigate taxpayers. It gathers information from returns, from banks and brokerages, and even from newspapers. If it suspects that you may be cheating, you’ll receive a call. Finally, some audits are simply random. The IRS conducts these sorts of audits just to keep us on our toes.

How can you avoid falling into the audit trap? Here are our favorite tips:

1. Like your second grade teacher said, “check your work.” Math errors are one of the primary reasons IRS agents pull returns for examination. A math error usually won’t trigger a full audit, but if something else on your return looks out of place, you can be sure that the IRS will contact you.

2. Substantiate your deductions. If you made an unusual donation to charity, or had a huge unexpected medical expense, the IRS’s computer program might take an interest in your return. Including proof of your unusual tax item might prevent a full audit. Of course, the computer won’t read a copy of your hospital bill, but the agent who decides whether or not to audit you will. It can’t hurt to try, right?

3. Don’t pull a Richard Hatch. Remember Richard Hatch? He won $1 million on the first season of CBS’s (Stock Quote: CBS) Survivor. Every news show worth its salt mentioned him at least once, and the IRS was watching. When Hatch failed to report his income, an agent was ready and waiting. Even if you don’t make the national news, don’t forget to report cash that you receive from someone other than your employer. There’s a good chance that the person who paid you will report your income to the IRS. If you’re not sure about whether you should report something, ask a professional. It’s far better to pay now than to suffer through an audit later (or to end up like Hatch, who was recently released from jail).

4. Pay the price. If you hire someone to prepare your tax return, make sure that the person is reputable. In the past few years, the IRS has vigorously pursued the clients of tax preparers who are known to inflate their clients’ deductions and credits. Why would your tax preparer lie to the IRS? If you receive your refund from the preparer before the government approves your return, your return preparer has a real incentive to artificially inflate your refund. After all, he’ll receive it, not you. You, however, will receive the audit notice, which will come as an unpleasant surprise. Here at the Daily Deduction, we recommend that you find a reputable accountant, even if it costs you a little bit more.

But what if you try our suggestions, and the IRS pulls your number anyway? There is no need to worry, unless, of course, you know that you’ve been cheating. In most audits, the IRS simply asks for copies of documents or additional information. In fact, many audits are conducted entirely by mail. If you get that dreaded letter, here are some helpful bits of advice:

1. If you can afford one, call a tax pro right away. Your audit notice has a deadline, and tax attorneys and accountants are busy people. The sooner your tax professional starts working for you, the better your chances of success are. Can’t afford to hire some help? If you used tax software to prepare your return, don’t forget that you’ve got people. Of course, if the IRS just made a simple mistake and you’re feeling intrepid, go it alone. In most cases, though, it’s better to have someone on your side.

2. Open the envelope, read the notice and respond. It sounds silly, but many taxpayers bury their audit notices in a stack of unopened mail and hope for the best. That’s a huge, huge mistake. If you don’t respond to your audit notice within 30 days, you will lose the opportunity to prove your case to the IRS. Your agent will simply send you a bill, and that will be the story of your audit—game, set and match. Don’t let this happen to you. The single most important thing you can do in an audit is respond to the notice.