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

Recently released IRS statistics indicate that audits of individual taxpayers, which have been on a steady decline, dropped about 45% last year. For fiscal 2000, the audit rate dropped to 0.49% of returns filed, from 0.89% in 1999. By comparison, the audit rate in 1995 was 1.68%. In all, the IRS conducted 618,000 "in-person" or correspondence audits last year, down from 1.1 million in 1999 and 1.9 million in 1995. The IRS attributed the decline to personnel cutbacks, antiquated computer systems and increased responsibilities created by the IRS Restructuring and Reform Act of 1998.

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

Be Neat: Consider preparing your tax return by computer. I 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 on line by using TurboTax for the web at http://www.turbotax.com. If for some reason it's not possible for you to use a computer to prepare your return, for goodness sake 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.

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 computes 2+2 = 5, they might also wonder 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.

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.

Document: 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.

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.

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.

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 October 15th 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 in order to get your late filing wish, and this gambit certainly works best for those of you who aren't expecting a refund.

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, you might want to consider choosing the one with the lowest audit rate.

These are just a few tips that you can use to help you avoid an audit. If you'd like to learn more about other IRS issues such as tax collections, audit appeals, and a number of other tax issues, check out The Motley Fool Investment Tax Guide 2001. A "must have" for every taxpayer. Order your copy today at FoolMart!

Related Links:
Which Tax Records to Keep
Extension, Anybody?
Late Payment and Late Filing Penalties
 

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

March 30, 2001

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