Audits

The word audit is one term that absolutely no taxpayer wants to hear. Each year, over one million tax returns are audited. Although that sounds like a significant amount, it actually represents less than 1 percent of all returns. Audits are nothing to be afraid of or upset about if you've been honest and forthright in the preparation of your tax forms, and if you've kept good records of your income and expenses. However, it's also important to understand that, while it may seem somewhat tempting to fudge on your tax forms, it could cause you serious trouble. There are a number of ways that you, with the help of a good tax professional, can legally cut your income tax bill without resorting to falsehoods and misrepresentations.

Some of the things that might raise a 'red flag' and trigger an audit include reporting an income of over $100,000, claiming a significantly higher number and amount of deductions than you did on last year's return, and filing a Schedule C for self-employment. Additionally, claiming deductions for a home office and having mathematical errors on your return (or even filing a handwritten return) may also increase the chances of your being audited.

There are four main types of audits that the IRS conducts:

1. Correspondence audits. If there is a minor problem, such as a math error or a deduction that isn't allowable, it's usually handled by mail. You may only have to complete some forms or submit copies of receipts to handle this type of audit.
2. Field audits. These audits are usually targeted toward businesses. An IRS agent handling the case will notify you of suspected problems, and arrange a time to visit your home or business to review your records. If there are home office questions involved, it will be scrutinized at this time.
3. Office audits. This is the most common form of audit. You'll be asked to bring records relating to all items in question to the local IRS office where they can be examined. Some of the most investigated deduction areas include childcare expenses, automobile and entertainment deductions, cash contributions to organizations, and losses from natural disasters.
4. Criminal audits. This type of audit could result in severe penalties or even a jail sentence. If you're going to be criminally audited, it's wise to hire an attorney. If you've been honest on your tax returns, you have little to worry about, although four out of five of those who are criminally audited do end up paying something. Only a very small percentage pay nothing or receive a refund.

When meeting with an IRS agent it's best to remain calm, professional, and polite. Don't get angry or lose your temper; it will only make the situation more tense. Act courteously, and look for areas of compromise. If the questions that you're asked are beyond the most basic in scope, ask for a postponement of the meeting so that you can gather the information the agent needs (and at the next meeting, make sure that your tax professional accompanies you). And don't volunteer any information that isn't specifically asked for; you might open doors to other avenues of questioning. Don't give them that opportunity.

If it's determined that you do owe but can't pay, work out an installment plan with the IRS. If you feel that the ruling against you is unfair, you have the right to appeal the decision in Tax Court. But remember, fighting the IRS can be time-consuming and quite expensive. It's to your benefit to be forthcoming and truthful both at tax time and – if it comes – during an audit.