Eleven Simple Steps to Avoid an IRS Audit

Does this sound like your annual tax ritual? Scramble to complete your returns, rush to mail them by April 15, and then panic once the envelope is out of your grasp. We all dread receiving notice from the Internal Revenue Service that we made an error -- or worse – are about to be audited. IRS audits are stressful, time-consuming, and potentially very expensive.

The good news is that there is a lot you can do to prevent them. Most of us think audits are totally random. Not so. While you can never be one hundred percent sure you won’t be audited, the following are eleven simple rules you can follow to minimize the chance that the IRS will take an interest in you.

1. Come clean. Yes, that means you. Accurately report all of your taxable income, including not only your W-2 and your interest income, but also income from other sources such as capital gains and alimony payments. Once you file, the IRS calculates what it calls your Discriminate Information Function (DIF) score, which rates the probability of inaccurate information on the return. More recently, they started also calculating an Unreported Income Discriminate Information Function (or UI DIF) score. For example, if you have a huge mortgage but little taxable income (and that mortgage payment is right there for them to see on the same document), you might earn a dangerously high UIDIF score. Returns with the highest DIF and UI DIF scores are the most likely to be selected by the IRS for audits.

2. Don’t make mistakes. And if you do, fix them. Double and triple check your figures. Like a strict math teacher, the IRS pays closer attention when you’ve made simple arithmetic errors or entered figures incorrectly. If you send off your tax form and realize later you have made a mistake, it is better to call attention to your innocent mistake by fixing it than by hoping they don’t notice.

3. Remember, neatness does count. If you have to fill in your tax forms by hand, remember that your third grade teacher was correct -- penmanship counts. If your nines look like fours to Mr. IRS, you’re in trouble. Using electronic forms on the computer is not just easier and faster, it is neater and can save you heartache later. If you aren’t great on the computer, then go to a tax preparation company like H&R Block that can prepare your taxes for you with very little expense and hassle.

4. Don’t be unfashionably early -- or late. If the IRS owes you a refund, your instinct is to report your taxes as early as possible. But, remember, random audits are chosen from the existing pool of tax reports and, before the 15th of April, there are fewer returns to choose from. That doesn’t mean you should file late -- the IRS notices if you consistently send in your taxes a few days past the deadline. And you want to give yourself enough time to fill out the forms and check your work. Statistics show that people who wait until the last minute to file are more prone to errors.

5. Preemptive strikes work. If you have an unusually large deduction to report -- a big medical expense or a large one-time charity donation -- it will attract the eyes of the IRS. Don’t give it the chance to question you. Instead, attach a disclosure Form 8275 or documentation explaining the reason for this deduction. If you are willing to explain and provide documentation up front, then the IRS may have its curiosity sated.

6. Keep notes, save receipts and get organized. If you are itemizing your deductions, good records are crucial. Having a paper trail is the best defense should you get audited. Make sure all of your reported deductions are legitimate and that you have back-up receipts for everything. I drop all of my receipts and tax information into one box all year and then, when it is time to prepare, I have all my records in one place -- no searching around the house or waiting for credit card companies and banks to send duplicate copies of missing data.

7. Beware of the pitfalls of certain jobs. Face it. If you are self-employed or have a job that traditionally pays in cash, you are more likely to be audited. Those who must attach a Schedule C to their taxes are three times as likely to be audited – and those in certain professions, like cab drivers and waiters, or those who work from home (and deduct their home office), are also under closer scrutiny by the IRS. Short of changing your type of employment, there is nothing you can do about it – except make absolutely sure you follow Rule #1 (“come clean”) and Rule #6 (“keep notes, save receipts and get organized”).

8. Make timely and accurate estimated tax payments. Remember to make your quarterly estimated tax payments and don’t underestimate the amounts. Neglecting to make payments or underestimating the amount you owe will attract IRS attention. It may cost a little more today to overpay on those estimates -- but it is worth it. If you underestimate what you owe in the current year in question, this could result not only in interest that you will owe, but also penalties.

9. Bring in a pro. Don’t take tax advice from your best friend’s brother, or your mailman, or your dog. If you have a complex tax situation, hire an accountant or a tax preparation company to help you. The added benefit, as I indicated before, is that these professionals know how to prepare neat and organized tax returns in a timely fashion and, of course, they know the rules.

10. Sign your return. You wouldn’t believe how many people who are thrilled to be done with the chore of tax preparation actually forget to sign their returns. Don’t make the same mistake! No signature means an IRS flag goes up.

11. Try electronic filing. The IRS has to hire workers to hand-enter all paper filings -- a costly and time consuming endeavor. More than half of all tax returns are now filed electronically and that number is growing significantly. Electronic filing decreases the IRS’s statistical probability of an audit because there are more electronic filers in the pool and, thus, your chances of an audit decrease. When it comes to avoiding an audit, it is always better to get lost in the crowd.

Hilary Kramer is a Financial Editor for AOL and top authority on investing and personal finance. She has appeared regularly on Fox News and CNBC, writes for the New York Post and served on the Wall Street Journal Women in Business Board. Hilary was an investment banker at Lehman Brothers and Morgan Stanley, and Senior Managing Director of the Cisneros Group. She is president of A&G Capital and appears daily on the national radio show Doug Stephan's Good Day. Visit her at hilarykramer.com.