Tips To Avoid An Audit

CNNMoney.com ran an article last week about 5 Audit Red Flags.

Think you know how the IRS picks its audit victims? You may want to reconsider that notion.

Even most accountants say they don't know how to crack the IRS' audit formula.

But with the tax agency auditing 1.2 million individuals last year and the IRS ramping up its enforcement spending in recent years, experts say it might be worth taking a look at your return to make sure you aren't making yourself a target for the tax man.

Overkill on charitable contributions
While giving to your favorite non-profit can be rewarding both personally and for the tax break, giving to charity could attract the attention of the IRS, especially if the donation is disproportionate to your annual income.

And you might even want to think long and hard before you start inflating the value of that 1982 Dodge Diplomat you donated this summer or the Paul Cezanne painting you gave to charity, says Jeffrey Kelson, a partner at the New York offices of accounting firm BDO Seidman.

Many individuals, says Kelson, will overvalue those items and think that the IRS won't notice.
"You have to be careful if you take large, non-cash contributions," says Kelson. "You have to back them up with receipts."

Too many deductions for the self-employed
For those Americans that are self-employed or run a small business, the IRS is really watching you. "That's part of the territory," says Kathy Burlison, the director of tax implementation at H&R Block.

While filing a Schedule C alone may not be a red flag, the IRS is wary of these taxpayers since they contributed about $68 billion to the $345 billion tax gap as of 2001.

The tax man knows there is a temptation by self-employed taxpayers to blur the distinction between personal and business expenses, such as a mileage deduction on your car or calling that room in the basement of your home your office.

But don't think you're fooling anyone with that trick, says Burlison. In fact, the IRS will probably size up your expenses relative to your business to make sure your return is honest. "Those are areas that the IRS tends to be more concerned about being abused so they are more likely to be audited," she says.

Above-average deductions
Martin Kaplan, a certified public accountant and the author of "What the IRS Doesn't Want You To Know," says that the IRS is also closely looking at unusually high deductions.

If you earned $100,000 from your day job, but gambled in the real estate market this year and claimed a $40,000 loss, you might become audit material. "The [IRS] computer definitely generates a much greater amount of audits based on categories where incomes and losses are offsetting each other," says Kaplan.

At the same time, the tax man will weigh the deductions and expenses on your return against other taxpayers in your income bracket (see chart). While you might not be able to do anything about that $20,000 medical bill or the inheritance you received from a departed relative last year, if your deductions or expenses tend to be higher than normal that could raise a red flag.

Making six figures
It may not be promising news for those individuals on the higher end of the tax strata, but believe it or not, if you make over $100,000 a year, that could draw some attention to your tax return.

During the fiscal year 2005, audits of taxpayers taking home over $100,000 annually reached 221,000, double the number in 2001.

And if that's not enough to convince you, in November, IRS Commissioner Mark Everson said in a statement that the coverage of this category "still too low".

According to tax experts, those individuals are lucrative targets for the IRS. "They are focusing on taxpayers making $100,000," says Kelson. "They want to get a return on those returns."

Careless omissions
Kaplan, who has served as a certified public accountant in New York City for the past 35 years, also stressed the importance of keeping your return as neat and slim as possible.

That means filing electronically instead of handwriting your return and avoid attaching out any unnecessary forms to your tax return. "If there is a need for additional info they'll ask for it," says Kaplan. "You're trying to avoid someone putting hands on your return."

But maybe the best advice, says H&R Block's Burlison, is to provide as transparent a return as possible. "The number one thing to avoid contact from the IRS is to make sure you report everything."