How to Avoid a Tax Audit

The possibility of a tax audit frightens many people. If you're one of them, I have a double dose of good news for you.

For starters, you can significantly reduce your chances of being audited by heeding a few guidelines. Former IRS agents who used to conduct audits suggest that you stick to the following steps.

Be neat. If IRS agents can't figure out what you wrote on your return, they'll very possibly come knocking to ask. Make their lives (and yours) easier by writing legibly. It can also help to use any preprinted labels that come with your return forms.

Be correct. Make sure you include the correct Social Security numbers for yourself and any anyone else on your return. (Innocently and accidentally transposing two numbers can get your return noticed.)

Correctness is important throughout your return, including how you report your stock sales. The exact length of time you held a stock might seem like a little detail, but whether you held for 363 days or 367 can determine the difference between a short-term and long-term gain. Short-term gains are taxed at your ordinary income rate, while most of us currently pay 15% on long-term gains.

Assuming the wrong holding period can make a big difference, as this sample chart of widely held stocks demonstrates:

Company	1-Year Gain on $10,000 Invested*	33% Short-Term Tax on Gain	25% Short-Term Tax on Gain	15% Long-Term Tax on Gain
Pfizer (NYSE: PFE  )	$3,180	$1,049	$795	$477
Texas Instruments (NYSE: TXN  )	$5,400	$1,782	$1,350	$810
Altria (NYSE: MO  )	$3,620	$1,195	$905	$543
McDonald's (NYSE: MCD  )	$2,610	$861	$653	$392
AT&T (NYSE: T  )	$760	$251	$190	$114

*For the trailing-12-month period ended April 7, 2010.

Clearly, attention to detail can help you keep more of your money.

Be complete. If you received 1099 forms from four different banks and brokerages, make sure you account for all of them. The IRS will likely be aware of all of them, and will expect you to include them all. If you should be filling out several schedules, make sure you do so and include them. And of course, don't make the mistake that finally nailed Al Capone; always report all of your income.

Make them yawn
Be unsurprising. An unusually high or low number anywhere can trigger an audit. If taxpayers report atypically large donations to charity, list an unusually high number of miles driven for work, or claim a much-higher-than-average portion of their homes as home offices, the IRS gets suspicious. Numbers that don't stand out reduce your chance of drawing unwanted attention. Then again, if you did contribute a lot to charity, or your office does take up 75% of your home, you should absolutely tell the truth.

Get help. The complexity of the tax code can make it very hard to be correct. If you change one number somewhere, lots of other numbers may also change. Software such as Intuit's (Nasdaq: INTU  ) TurboTax, or a tax professional from H&R Block (NYSE: HRB  ) or other tax-prep organizations, might be a big help.

It may not matter
Even if you're audited, it's not necessarily a big deal, as long as you've made a good-faith effort to follow the rules and file an honest return. If those charitable deductions triggered an audit, simply provide the receipts to substantiate them, and you'll likely bring the audit to a quick end. IRS agents usually aren't trying to put people in jail. They just want to clear up irregularities or resolve unanswered questions.

Finally, rest assured that your odds of being audited are very low. Only 1% of individual tax returns filed in 2008 were audited, with more than two-thirds of those audits done through the mail. However, the IRS has been focusing more on wealthy taxpayers lately. Audits of those earning between $1 million and $5 million rose 33% during 2009. If you rank among those high-income taxpayers, be especially careful.

Learn more about the world of taxes, and get lots of money-saving tips, by visiting our Tax Center.