Could You Face an IRS Audit in 2008?
Here's How to Protect Yourself

It’s that letter most Americans don’t want to get. While corporate America may have less to fear from the Internal Revenue Service than it used to, audits of individuals and regular small businesses are on the rise.

The IRS’s scrutiny of the biggest U.S. companies is running at a 20-year low, according to a study conducted by Transactional Records Access Clearinghouse (TRAC), a research group affiliated with Syracuse University. The study described a “historic collapse” in audits for corporations holding assets of $250 million or more. These corporations now have a one in four chance of being audited, down from about three in four in 1990.

But the TRAC report concluded that the IRS was concentrating on regular small and mid-sized companies to boost audit numbers. Individuals have about a 10 percent chance of being audited, more than double the odds in 2000, according to the IRS.

In 2007, the IRS filed 3.8 million levies and almost 700,000 liens, an increase from 2006.

The new IRS commissioner, Douglas Shulman, said he intends to make “targeting noncompliance with our tax laws . . . a high priority.” Total enforcement revenues in the 2007 budget year, from collections and appeals activities, were $59.2 billion, up from $48.7 billion the previous year, according to the IRS.

Even if you aren’t that wealthy, the increasing number of self-employed individuals may also be part of the government’s expanding tax dragnet. In any event, it’s always smart to be vigilant against the expensive and stressful possibility of a tax audit. A qualified tax professional can assist you in the preparation of your return to minimize the chances of questions on your return.

There are three types of audits:

Correspondence audits happen when the IRS sends a letter asking for clarification on relatively simple items. It’s usually handled and completed through the mail.

Office audits are conducted on the IRS’s turf. You meet with an examiner who wants to see documentation intended to answer their specific questions. It’s wise not to volunteer any other information beyond what they ask.

Field audits are the stuff of TV cop shows. That’s when the IRS comes to your home and starts nosing around to see why that Jaguar is sitting in the driveway of someone who reported $28,000 in income last year. These tend to be pretty serious.

However, the government looks for particular signs and signals that may put you in the audit pile. The following measures won’t guarantee you’ll avoid an audit, but they’re key issues that the IRS focuses on when deciding which returns to target:

Incomplete or sloppy returns: Remember to sign the return, add the Social Security.

Number and double-check the math. Fill out every applicable line. Or better yet, get a tax preparer to do it since professionally prepared returns tend to be easier to read and understand because you’re paying qualified people to get it right. Bottom line -- sloppy returns tend to draw scrutiny.

Rounding can be a problem: Precise numbers suggest precision. It’s always best to use the precise number you need for an item than rounding up or down – rounded numbers tend to draw attention from the IRS, even if you’re trying to be conservative.

Note sales of stocks or bonds carefully: Anytime you sell stocks or bonds, the IRS and the taxpayer receives a 1099 noting the sale price. Your tax professional can show you the proper way to account for these sales on your return. Also remember that income items such as interest, dividends and other sources of income are matched with the return from documents that are already on file with the IRS.

Scores are everywhere: In case you didn’t know, the IRS – like the lending industry – assigns you a score. It’s called the Discriminate Information Function (DIF), a computer program that compares, among other things, the deductions you’re taking against others in your income bracket. It’s the way an increasingly technology driven IRS is screening for suspicious returns. One of the best ways to avoid a high DIF score is to report all income – don’t let yourself think that any amount is not worth reporting.

Reporting a high income: High income earners likely have more complex tax returns, which puts them at a greater risk for making mistakes. Since these individuals also make more money, catching a mistake is far more lucrative for the IRS.

Itemized deductions: You should claim every deduction the law entitles you to, but a good tax professional can advise you of reasonable limits that are less likely to trip your return. In particular, the IRS looks for overblown charitable deductions –make cash contributions by check or credit card so there’s a record, and that all donations above $250 have receipts or other acknowledgement from the charity. If you get audited, you need to prove the original value of the items donated and their fair market value.

Being self-employed or owning a business. The IRS will be scrutinizing your deductions since it’s easy to abuse deductions in this area. Be especially careful if you reported a loss on your return. Claiming a loss year after year may raise the question of whether you are running a legitimate business or claiming losses on a personal hobby.

Keep scrupulous mileage records: If you use your vehicle for work or business, keep a notebook or chart in the car so you can log mileage. List beginning and ending odometer figures, location and reason for the trip. Keep records for mileage claimed for medical expense and charitable purposes.

Watch that home office: Even though the government loosened restrictions on home office deductions in 1999, make sure you can substantiate that business area of your home if you’re asked.

Bottom Line: These precautions don’t mean you should avoid claiming legitimate deductions. Don’t hesitate to take deductions you can substantiate. Take every deduction you are legally entitled to take, as long as you retain supporting documentation.

Salim Omar, CPA is a leading tax authority for small businesses in New Jersey. He is the author of Straight Talk About Small Business Success In New Jersey, available in Barnes and Noble bookstores and on Amazon.com. More free information can be accessed at www.OmarGroupCPA.com or by calling (732) 566-3660.