"I won't get audited because [insert common audit myth here]."

I've been in the tax biz for decades, and I've heard many ways to complete that sentence. I'm regularly amazed by what some people say and, sadly, believe when it comes to the IRS and the dreaded audit.

Make no mistake: There will be more audits on the horizon. The IRS has recently said that it would be adding 2,200 new positions to its audit operations in 2005. Between 1996 and 2002, IRS audit staff declined by more than 25%, and the IRS is ramping up to recoup some of the audit money that was lost during that period.

While IRS audits have been around for many years, there are still a number of misconceptions as to what might cause an audit, or what can be done to avoid one. Here are the top five audit myths that can used to complete the sentence found at the top of this article.

1. "I received my refund."
Simply because you received your refund check doesn't mean that the IRS has reviewed your return and has given its blessing. Sure, the IRS checks for obvious errors and suspicious deductions, and may hold up your refund check while it investigates. But simply receiving a refund doesn't mean that you're home free.

In fact, audit determination is made long after the refund check is issued. After your return has been filed and you've received your refund, your tax return goes through another computer check in order to compare the return to a computer model. Then the return receives a DIF (Discrimination Information Function) score.

The IRS calculates the DIF score by using a very closely guarded formula. Returns with high DIF scores are then pulled and reviewed by skilled and experienced IRS agents to determine which tax returns have the greatest potential for yielding additional taxes, interest, and penalties.

Generally, the IRS has three years from the time a return is filed to perform an audit. While the IRS likes to begin the audit process three to four months after the tax return filing deadline, many returns aren't audited until 18 and even 24 months later.

2. "I'm lucky."
True, if your income is less than $25,000, you have less than a 1% chance for audit. Even if your income is greater than $100,000, your chance for audit is still less than 2%. But that doesn't mean returns are randomly selected for audit. As mentioned above, the return is reviewed and scored by a computer and then sent to an examiner.

So regardless of your income level or your luck, if you have questionable items on your tax return, you'll have a greater chance of being audited. Putting false numbers on your tax return and hoping to win the "audit lottery" is more like playing "audit roulette."

3. "I don't file until after audit 'testing' season."
This has been an ongoing myth for a number of years, and is still hotly debated by tax professionals. Here's the strategy: File an extension of time to submit your return, and don't actually file it until Oct. 15.

But regardless of when you file, all returns are run through the computer and given a DIF score. If your score exceeds that which is considered the cut-off point, your return has a high audit potential. It's true that the DIF score "norms" might fluctuate as more returns are put into the system, but it doesn't mean that a return filed later will pass muster simply because it came in at the tail end of the filing season. Heck, the audit selection process isn't even started until the end of June, well over two months after the filing deadline of April 15.

Again, many tax pros will tell you that a return filed in October will be less likely to get audited than a return filed in March or April. I can only tell you that after almost 25 years in practice, I've seen returns audited regardless of the ultimate filing date. Do you want to go through the hassle (and expense, if you're using a tax pro) of filing two extensions in order to file using the Oct. 15 deadline? I guess it's up to you. It certainly won't hurt, but I'm not sure that it'll help.

4. "I deal in cash only and they can't audit cash."
This is perhaps the silliest and most reckless statement of them all. With the advent of computers, "Big Brother" knows more about you than even you might be aware. Don't you think that an IRS eyebrow might be raised if you live in a $1 million house with reported income of about $30,000 per year?

Many of the folks who deal in unreported cash end up putting that money right in their bank accounts. Can you get any dumber than that?

Not to mention that the IRS has techniques that allow them to "look through" your reported income and arrive at your estimated (and many times confirmed) real economic income. Although the so-called "lifestyle" audits have been placed on the back burner, the IRS and Congress realize that unreported income remains one of the biggest problems facing the tax system, and are making plans to do something about it.

Finally, deliberately understating your income is nothing more than tax evasion, and the penalties for this crime are quite severe. Do the names Al Capone, Pete Rose, or Leona Helmsley ring any bells?

5. "I have an accountant who knows what you can get away with."
Taking advantage of all of the legal deductions available to you isn't the problem here. It seems that some tax professionals (and I use the term loosely here) pop up every tax filing season and urge their clients to pump up their itemized deductions to the "average" deductions computed and released by the IRS.

However, these averages vary by state and region, and aren't necessarily used exclusively to compute the DIF score. Any tax preparer that urges you to claim deductions that you don't have simply because you're under the average isn't doing you any favors. In fact, most of these so-called professionals are long gone when the IRS taps you on the shoulder and asks you to provide the documents to support your deductions.

Don't believe any of these popular audit myths. Take advantage of the legal loopholes, report all of your income, and take every allowable deduction. Then stop right there.

Related Links:
Before You File Your Taxes
Paperwork for Tax Preparation
Tax Scams and Frauds

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: 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 5, 2004

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