How to Avoid a Tax Audit

Jan. 27, 2011 -- "I've been audited six times and never paid a penny!" crows Steve, a Manhattan author who, for reasons that will soon be obvious, doesn't want his full name used.

Steve is proud to have gone toe to toe with the IRS six times and, six times, emerged unscathed. While that's sweet satisfaction, avoiding being audited in the first place is sweeter still.

Tax professionals and the IRS agree there are simple steps every filer can take to reduce the odds of being audited. 'Reduce,' though, does not mean eliminate: Some filers are audited entirely at random, so there's no way you can cut your odds to zero.

"They match everything," warns Schulman. "That $11 you got as interest on some old bank account? Report it."

It's not the amount that matters. It's your failure to file a complete set of documents. The discrepancy, when discovered, will cause you to receive an automatic audit, in the form of a letter from the IRS asking you to explain. You don't' want to call attention to yourself. You want to pass without friction through the system.

Michael Dunworth, a tax attorney with Pryor Cashman LLP in New York City, says you should steer clear of anyone who promises to work miracles. "If you've had a big gain or received some big slug of income, and somebody claims they can just make it go away, you've got trouble right off the bat," he cautions. "When there are big offsets against big gains, that's a red flag for the IRS. Avoid anything that looks questionable or shaky."

Don't file Form 5213. If you've turned a hobby into a business, you might be tempted to file this form ("Election To Postpone Determination as To Whether the Presumption Applies That an Activity Is Engaged in for Profit"), which, in effect, tells the IRS to chill out for five years until you can prove that your venture is capable of making profits. The joker is that by filing this form you all but guarantee yourself an audit at the end of the five years. Better solution: Document that your venture has the potential to make money. Be able to show, for instance, that there are other people doing it for a profit; that you posses the necessary knowledge and experience; and that you are putting in the amount of time and energy necessary for it someday to succeed.