Surviving an Audit

The anticipation can be worse than the reality. Here's how to beat the odds when the IRS targets you.

The best way to soften the sting of a tax audit is not to wait until The Letter arrives.

Start right now to protect yourself by keeping complete and accurate records and keeping them in good order so you can replicate every number on your return.

The truth is that audits aren't that frequent anyway. Fewer than 1% of all taxpayers receive that ominous looking letter from the IRS. And the nightmare may be only as bad as organizing your records and sitting through a few tense hours of paper shuffling.

If the devil is in the details, the secret to success is in preparation:

• Review your return and match all the numbers to the proper receipts and account statements. You may even want to run a tape or work up a spreadsheet file of all your income or expenses in a category and attach the tape or printout to the pile of receipts.
  
  Jennifer Long, an auditor in the IRS's Houston district who testified before Congress in 1997, says, "After you've been an auditor for a long time, you can recognize where you're going to get something and where you're not."
  
  And because of time constraints, she explains, auditors hurry through the sections that probably won't yield any changes. "We're limited in time," she says. "We're just trying to get the substantially correct tax. We don't have to have it perfect."
  
  
• Be ready to explain your return. "If an auditor asks you about a deduction you took that you're no longer sure about, just tell him what you did -- just lay it out there," advises J. Randy Penn, a tax research associate at H&R Block's headquarters in Kansas City, Mo. "Tell him this is what I did, this is where I got the number. If it's good, great. If it's not good, let him handle it. Don't volunteer all the things you have questions about."
  
  Long concurs. "If it's not something that's specifically disallowed, it has to meet specific tests," she says. "Is it ordinary and necessary? Would a reasonable person believe that this business would have this type of deduction? If you have something like that, you might want to make a note to yourself at the time you file your return. Then you've got your contemporaneous reasoning down on paper as to why you thought it was deductible."
  
  
• Be courteous. Certainly, you'll gain nothing by being rude or giving the auditor a hard time. Don't be defensive. Auditors are doing their job, and they didn't select you -- a computer did.
  
  
• Be tight-lipped. "The less you say, the better," says Carol Thompson, an enrolled agent (a designation indicating that she has passed an IRS certification exam) in Monterey, Cal., and 20-year veteran of audits. "People get nervous in front of the IRS. And when they get nervous, they start to chatter. And when they chatter," she warns, "they can hang themselves."
  
  Auditors are allowed to ask questions about your lifestyle -- to determine whether you have unreported income -- if you give them a "reasonable indication" that you're hiding income. That's the type of thing that might come to an auditor's attention if you mention a fabulous vacation but your return shows a low income.
  
  The other reason to refrain from talking, Thompson says, is that betraying anger or emotion will not help your cause.
  
  
• Hire a professional? A fee of $50 to $100 or more an hour for professional help from an enrolled agent, CPA or a tax lawyer should buy you superior tax-law knowledge and experience in dealing with audits.
  
  For a complex audit, that money will probably pay for itself, says Martin Nissenbaum, national director of personal income-tax planning at Ernst & Young. And Long says that having a professional sitting in for an audit doesn't necessarily raise an auditor's suspicions.
  
  Handling an audit yourself will generally be fine, though, if the issues simply involve matching receipts to the numbers on your return. That's assuming, of course, that you're sure you can keep your composure.
  
  
• Be prepared to appeal. "The most important thing is to know how to say, 'Who is your boss?'" explains Thompson. "If you've got an auditor who is giving you a hard time and is not cooperative, and you've gone in fully organized, you have the right to go to the supervisor on the spot."
  
  What's more, she says, you can go to a supervisor if you disagree with the auditor's final assessment. Even if the supervisor agrees with the auditor's assessment, you still have further redress. "You can appeal any audit result to the office of appeals," says Robert Nath, a Fairfax, Va., tax lawyer. "Its mandate is to be neutral. Beyond that, there is always the U.S. Tax Court."

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