Audit-Proof Your Tax Return

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By Roy Lewis
March 1, 2002

Is there really such a thing? Is there really some way that you can prepare your tax return that will guarantee you won't be subject to an audit? Of course not. But there are methods you can use that will certainly minimize your risk. But before we look at some of those methods, let's review some filing and audit facts. 

Audits of individual taxpayers, which have been on a steady decline, dropped again last year. But before you think that you have a better chance of hitting the lottery than getting hit with an audit, don't think that the IRS is completely asleep at the wheel. In fact, IRS Commissioner Charles O. Rossotti cautioned taxpayers not to assume the lower audit rates provide an opportunity to cheat. "Although the number of audits may be down, it is not an excuse to ignore the nation's tax laws," he said. "People need to remember that the IRS still has an extensive system to catch people who don't report their income. For example, we have an aggressive document-matching program in place to cross-check wages, interest, and investment income to make sure people pay the right amount."

So take heed of Commissioner Rossotti's statements. You don't want to step on Superman's cape and thumb your nose at Uncle Sam thinking that an audit won't happen to you. It just might. And if it does, you should be prepared. But what can you do that might make your tax return less susceptible to the eagle eyes of the IRS? Well, here are eight ways to reduce the chances that YOUR tax return will be selected for audit.

1. Be Neat!
Consider preparing your tax return by computer. A neatly prepared, computer-generated return looks much better to the IRS staffer (called a "classifier") who will be making the decision to audit your return or not. Virtually all tax pros now complete their returns using computers. There are a number of really good computer programs for either the PC or Mac. My favorite: Turbo Tax. Heck, you can even prepare your return online by using TurboTax for the Web at turbotax.com. If for some reason it's not possible for you to use a computer to prepare your return, at least print clearly and carefully. Don't decide to get your revenge on the IRS by preparing your return with a red crayon. A messy return -- cross-outs, sloppy handwriting, and smudges -- is like hanging a sign on your return that says, "Audit me!" It also might give the IRS the impression that you are careless and disorganized.

2. Be Accurate!
The only thing worse than a messy return is a return that isn't correct. And when I say correct, I mean that all of your numbers should add and subtract accurately. This is another reason that preparing your return by computer is really in your best interest since computers can add and subtract correctly. Remember that your tax return will be loaded into the IRS computers, and those computers will check your return for math errors. If they find that your return states that 2+2=5, they might also be wondering about some of your deductions. Don't give 'em a chance to wonder about the rest of your tax return. Make sure that you double-check your numbers before you mail your return.

3. Watch Schedule C!
Avoid filing an income tax return with a Schedule C (Profit or Loss for Business) that reports a net loss from a small business venture. This is especially true when your main source of income comes from W-2 wages. IRS auditors go after these returns like politicians go after money. Why? Because in order for these business losses to stand up, you must pass both the "passive loss" and "hobby loss" rules. You aren't familiar with those rules? Proves my point -- most taxpayer's aren't. And the IRS knows it.

4. Documentation!
If you claim large deductions for unusual items, such as an earthquake, flood, or fire loss, attach documentary proof to the back of your tax return. Copies of repair receipts, canceled checks, insurance reports, and pictures are always a good idea. This won't stop the IRS computer from flagging your return, but the documents should catch the attention of the IRS employee (remember our friendly "classifier"?) who screens the computer-selected returns for audit potential. If the classifier thinks your documentation looks reasonable, you'll likely not get audited.

5. Be Square!
Whatever you do, don't use round numbers. For example, if you report $1,000 or $12,000 instead of $978 or $12,127, it's an indication that you are estimating things rather than keeping good records and reporting the actual correct amount.

6. E-File at Your Own Risk!
Don't use electronic filing or the IRS preprinted address label on your tax return.  Now, Uncle Sammy will tell you that neither of these will increase your chances for audit. That may be true, but it would seem to me that these enable the IRS to get your return into the processing cycle, including the audit cycle, more quickly than otherwise would happen. And, in my opinion, anything that slows down the IRS juggernaut can't be all bad. But, on the other hand, using electronic filing or the label usually means that any refund will come faster. So if you expect a refund but fear an audit, you'll have to balance both sides of the scale to see which way you might want to turn.

7. File Late!
Again, the IRS will tell you that filing an extension will neither increase nor decrease your chance of audit. But I'm not so sure. It has been a common practice for many tax pros to tell their clients who have some possible audit exposure to file for an extension, usually all the way until the Oct. 15 deadline. This goes hand in hand with our warning about e-filing: You might want to wait to get your return into the processing cycle. Obviously, you must file valid extensions, and this gambit certainly works best for those of you who aren't expecting a refund.

8. Live Small!
Live in a low-audit area. I'm not kidding! Audit exposure is different from city to city and state to state. Did you know that Nevada taxpayers are audited four times more than people in Wisconsin? Does that mean that you should move to Oshkosh? Not necessarily. But if you have several homes, travel extensively, or otherwise have some flexibility in selecting your tax-reporting address, choose the one with the lowest audit rate.

These are just a few tips that you can use to help avoid an audit. If you'd like to learn more about other IRS issues, such as tax collections and audit appeals, check out The Motley Fool Investment Tax Guide 2002. A must-have for every taxpayer.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.