Tax Audits

Getting an audit notice from the Internal Revenue Service (IRS) can be intimidating. Understanding the process can help you get through it, and may even help you avoid an audit altogether.

Many people think the Internal Revenue Service (IRS) audits tax returns to increase the amount of money paid by taxpayers. It may seem that way if you're the one being audited, but the IRS says the reason for a tax audit is to ensure taxes are being reported correctly. In fact, the IRS doesn't use the word audit to refer to this process. Instead, the IRS calls it a tax examination.

Are You Likely to be Audited?

The IRS uses the following systems to select tax returns for audit:

• Computer Scoring – Most returns are selected as a result of a computer scoring process called the Discriminant Function System, or DIF, that compares your return to the return of other taxpayers with similar information. If your deductions, for example, are very different from someone else in your tax bracket and profession, it increases your chances of being audited.

• Information Matching – Some returns are audited because information received from employers or banks is reported differently than on the return. For example, if you report the interest on your savings account as $20, and your bank reports the interest as $200, you're more likely to be audited.

• Local Compliance Projects – Returns can be audited in order to gather data on such things as market segmentation or specific people who prepare tax returns. You're likely to be audited if, for example, you're paid primarily in cash, as in a waiter or a self-employed house painter.

• Related Examinations – A return may be audited if it includes issues related to someone else's return being audited. For example, if your business partner is audited, you may be audited too.

Taxpayers with incomes greater than $200,000, self-employed who file Schedule C (the business expenses and income of a sole proprietorship), and people who itemize deductions have a greater chance of being audited.

You should also know the IRS has three years from your file date to audit your return, so you don't have to worry about your tax returns from 10 years ago being audited. This time limit isn't in effect in the case of fraud or extreme under-reporting of income, however. The IRS has stepped up its audits, according to a National Public Radio report of November 2006. Read the summary and listen to the audio of Increased IRS Enforcement Actions Net Billions.

The Audit Process

You'll know you were selected for a tax audit because you'll receive an audit notification letter in the mail. The letter includes the reason for the audit. You may not even have to meet with an IRS auditor to resolve the question, as most audits can be handled with a response letter or phone call. If a face-to-face meeting is necessary, you may represent yourself or send someone else to speak on your behalf. The IRS will tell you which records you'll need for the audit. While you may be tempted to take every document and receipt you can find, you only have to take the information the IRS requests.

After conducting an audit, the auditor will choose one of the following:

• Accept the return as filed, including any supporting documentation that you provided

• Propose you change your return, which may result in you owing money to the IRS or the IRS owing money to you

The Appeal Process

Most taxpayers end the audit process by agreeing to the requested change. If you disagree with the auditor's proposed change, however, you have the right to appeal the ruling to the IRS. After the IRS notifies you of your right to appeal, you have 30 days to file it. See IRS Publication 1: Your Rights as a Taxpayer.

Avoiding an Audit

While there's no way to guarantee you won't be audited, there are things you can do to minimize the likelihood that it'll happen to you. For example, when filing your tax return, be sure to:

• Verify the accuracy of your personal information

• Fill in all fields completely and accurately

• Use the correct form

• Write legibly

• Report all of your income

• Check your math

• Don't round off amounts more by than $.50

• Attach all required documentation

• Sign and date your return

• Include payment if you owe money

• File on time

For tips on avoiding an IRS tax audit, see the article Audit Avoidance 101: Warding off a Visit from the IRS. For more advice about dealing with an IRS audit, read the article Surviving an Audit at the 360 Degrees of Financial Literacy website.

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Related Income Tax Articles:

• Income Tax Withholding – If you are paying down debt, you can make simple adjustments to your W-4 to get more money back each pay period. Claim more allowances, take advantage of exemptions or benefits that allow you to keep more pre-tax income. Beware of claiming too much--do that and you'll end up owing Uncle Sam more than you can afford to pay come tax-time. Claim too little and Uncle Sam collects interest on your money.

• Getting Ahead on Income Tax Filing – Sometime after the New Year and before April 15th, we all start thinking about filing. For some it’s a breeze and for most of us it’s a nightmare. Sleep with ease by considering these guidelines to get you through the Income Tax Filing season.

• Differences in Tax Deductions – Understanding tax deductions can save you money. Learn which types you may qualify for and start saving now.