Top 5 Ways to Avoid an IRS Audit

Everyone has heard that statistics that you only have about a 1% probability of getting audited and it is highly unlikely that your return will be picked. The fact is, some people are much more prone to receiving audits than others because of the choices they make when they do their tax planning or the way they file their tax return. If you understand the top 5 ways to avoid an IRS audit, you can significantly decrease your chances of ever getting audited.

1. Don't Round: You'd be surprised how many people will round to the nearest thousand. This is one of the quickest ways to get audited. The IRS knows that the likelihood of deductions being rounded off is extremely unlikely and they will assume that you are not using actual information if they see rounded numbers. Be sure to use actual and accurate numbers.
2. Don't File a Schedule C: When a schedule C is filed with a tax return the IRS is much more likely to look at the return in more detail. Once the IRS looks at the return in more detail the chances for an audit go up significantly. If you would like to still take the deductions you take with a schedule C, you should consider reorganizing and creating a separate entity to pass the expenses through. You can create an LLC or an S-corporation. A limited liability company and S-corporation both have significantly less audit risk than a sole proprietorship.
   
3. Use tax software or a tax professional to file your return: Many times tax returns are selected for audit because they are incomplete, messy, or have mathematical errors. Using tax software or hiring a tax professional to help you prepare your return will significantly reduce the chances of these types of errors.
   
4. Report all income: The IRS has a complex computer matching system called the Information Returns Processing System (IRP). This computer system will store all information reported from third parties that are required by law to report taxpayer income. This computer system will then match up what you reported to what third parties have reported. If the computer system shows that a third party reported a payment to you and you did not report, they will audit you. This computer matching system is getting more efficient and complex each year, so the likelihood of the IRS missing something is becoming more and more unlikely.
   
5. Be honest: Other than the IRP system mentioned above the IRS also has two other computer systems that check returns for likely errors or fudging of numbers. The main computer system used by the IRS is called the Discriminant Function System (DIF). The DIF system scores the tax return based on many factors, mainly does statistical analysis on the return to weigh the likelihood of it being accurate. The other computer system used is called the Unreported Income Discriminant Function (UIDIF). The UIDIF system is different from the matching system because it does not involve an actual matching of information, it statistically determines if you have unreported income. This is so the IRS can catch those people that have jobs that don't require a third party to report their income to the IRS. This system knows what other people in your profession make, while taking into consideration your location and compares that to your information. If your reported income is statistically different than the average then the IRS will likely choose to audit you.

All in all, the IRS has some pretty good systems in place to catch any problems with individuals and business tax filings. The best possible way to avoid an audit is to file as accurately and honestly as possible. Also, it is important to realize that people do try to cheat on their taxes and that is the reason why the IRS does audit. Being aware of the common audit red flags and ways people try to cheat on their taxes (like schedule C deductions), can help you be aware of the most likely places the IRS will scrutinize information on your return. As long as you play fair, file honest, you shouldn't have anything to worry about, even if you get audited.