Avoid That Audit

I know you've heard it before, all the usual advice about keeping the IRS away.

Avoid tax shelters. Make sure your side business earns money, at least once in a while. Make sure its deductions and the home office are legit. Don't refile your return.

But you know what? Even without a side business or any special deductions, you still might be in the IRS cross hairs. Now, full disclosure: I strongly support paying the taxes you're legally required to pay. But no more. And if you're paying what you should be, and can explain it, an audit shouldn't be a problem.

But why take the chance? Good tax planning means paying as little as possible -- and not waking the sleeping tiger.

First, let me share a little insight into how the IRS does business.

The IRS uses a complex mathematical model known as the DIF, or Discriminate Index Function system. (I know, how'd you like to meet the folks who came up with that name?) Some call it the "audit lottery," but it's really more than that. It's not chance but rather a data-mining tool that creates a three-digit score much like a credit score. Only in this case, you want your score to be low.

The IRS doesn't release much about the formula -- it's guarded better than the recipe for Coke. Most IRS agents and employees have no idea how it works.

Here's what I can tell you: DIF uses your deductions to assign a score that considers your potential income and wealth, your occupation, your zip code, your tax history and what's "normal" for others like you.

Click here for the video version of this story from Jennifer Openshaw.