Tips for Avoiding an IRS Audit

The good news: You're a lot less likely to be audited by the IRS today than you would have been five years ago.

The bad news: The IRS has caught heat from Congress for slacking off on audits. Last year, the agency hired 1,300 new agents as part of a campaign to get tougher on tax fraud.

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Here's to a Hassle-Free Tax Return

If you'd rather not be plucked from cozy obscurity and held squirming under a government spotlight, know that certain items on your tax return will act as red flags for IRS auditors.

A few perennial rules are in effect: If you take many deductions or happen to earn a high income, you're more likely to attract scrutiny. Last year, taxpayers with income of at least $100,000 were 27% more likely to undergo an audit.

You may also call attention to yourself through plain old human error. "What generates a tremendous amount of [IRS] correspondence is just stupidity," says Doug Stives, a CPA and personal financial specialist with Wiss & Co., in Red Bank, N.J. "People forget to attach their W-2s. They forget to sign their return. Or my favorite is, they don't put enough postage on and it gets returned."

But lately the IRS has also zeroed in on specific areas of abuse, including itemized deductions for medical expenses and donations to charity.

Taxpayer Bonanza? Over the past seven years, audits have become less common
	FY 2001	FY 1999	FY 1997	FY 1995
Audit rate for all taxpayers	0.58%	0.90%	1.28%	1.67%
Audit rate for taxpayers with salaries $100,000 and up	0.79	1.40	2.74	2.97
Source: IRS

To be able to deduct medical expenses, the total must exceed 7.5% of your adjusted gross income -- a hefty sum. If you were reimbursed by your health insurance for part of those expenses, you can't count them in figuring the total. And sorry, you can't deduct your nose job. "You may look a lot better; maybe you'll get that acting job," says Michael Eisenberg, who runs an accounting firm based in Los Angeles. "But technically, cosmetic surgery is not deductible."

If you itemize, you're allowed to take deductions on charitable donations. But if you're making a contribution of $250 or more, you'll need a receipt from the charity to show the IRS.

The IRS is cracking down on another tax-avoidance scheme involving charities. If you give your car to charity, you're allowed to deduct its fair market value from your taxes. But in the past few years, some taxpayers have tried to sneak in inflated values, prompting the IRS to scrutinize the deductions more closely. If you donate a car worth more than $5,000, you should get a written appraisal of your car's value by a professional car dealer and attach it to your tax return.

Tips for Business Owners

If you're self-employed or run your own business, the government may look at your return extra carefully. Taxpayers who file a Schedule C return are three times as likely to be audited as those who file the standard 1040, according to CCH, a provider of tax information and software.

That's because Schedule C filers, relative to other taxpayers, are prone to underreport income and take too many deductions. "If you have a lot of Schedule C income but your net income is very low, that's something that would be looked at for sure," says Eisenberg. "Why do you have a lot of income and not a lot of net profit? That's not to say your return is not legitimate, but there's definitely the potential for it to be looked at."

Take notice that the IRS has started training agents to specialize in a range of small businesses, with the aim of sniffing out fraud more easily. The agency even has a report describing the finances of food carts. You can check out the report specific to your business to get a sense of what your tax return should look like.

Another touchy area for business owners is travel and entertainment. Be aware that if you're self-employed and deduct travel expenses such as airfare and mileage on your return, the IRS could make you prove you weren't reimbursed for those costs by one of your clients.

If you're audited, you may need to show proof that your trips were for legitimate business reasons, not vacation. Not surprisingly, entrepreneurs have been known to abuse the rules in spectacular fashion.

In one case that ended up in tax court, according to CCH, the owner of a liquor store in North Dakota was found to have mischaracterized family vacations at a lake as annual stockholders' meetings. He wrote off gambling trips to Vegas as business trips (while he was there, he gambled with the company's money). Luckily for him, the court found him guilty only of negligence, not fraud.