How to Survive a Tax Audit

On the IRS Hit List

The IRS admittedly has audit priorities. Those who receive much of their income in cash are traditionally on the radar screen of IRS agents looking for unreported income. A few years ago, "offshore credit-card users" -- Americans with credit card accounts in tax-haven countries -- were the bulls-eye in the audit dart board.

Today, it's the self-employed and small businesses. If you are self-employed or have your own business, you have more opportunity to either "hide" your income or "create" deductions by converting personal expenses into business expenses. To close the estimated $385 billion in uncollected tax receipts, the IRS has pinpointed small businesses and the self-employed as major audit targets.

A Big Mouth

Never brag about how you put one over on the IRS! Informers to the IRS can earn a reward of as much as 30% of the additional tax collected, including fines, penalties and interest. Whistleblowers file Form 211 or call the IRS hotline at 1-800-829-0433.

Big Swings

An IRS computer program compares your deductions to others in your income bracket and weighs the differences. This secret IRS formula, called the DIF Score, is used to select returns with the highest probability of generating additional audit revenue.

For example, a taxpayer with a $50,000 salary would rarely have $10,000 in charitable contributions. This doesn't mean that, if you have only $50,000 in income and actually have $10,000 in charitable contributions, you shouldn't claim those deductions. It only means that if that is the case, be prepared to prove those deductions.

The DIF formula considers not only your income and deductions, but where you live, the size of your family and your profession as well. Rarely will a family of five living in the Hamptons have an income of $30,000 or less. It may happen, but if it does, the IRS will want to know how.

Your Number Popped Up

The IRS also computer-selects many returns for audit on a random basis. Your income, deductions or where you live are irrelevant. Your number just came up; you won the audit lottery.

A student making $3,000 a year is just as likely to be selected as an accountant making $300,000. You just got "lucky."