Now is the time to get your year-end tax planning in order. This year, you can make audit-proofing your return one of your goals. The best way to do that is to (1) have good documentation for your deductions, (2) hire a good tax preparer and (3) avoid the red flags that might cause an audit!

Every year millions of Americans make mistakes that red flag their tax returns for audit. It's scary to get the notice that your return has been selected for audit. That audit anxiety is what the IRS uses to help keep taxpayers honest. Audit anxiety is an important part of our voluntary compliance system.

Interestingly enough, the IRS tells us each year what they're going to be looking for in their annual "Dirty Dozen" report. Plus, they make the audit statistics available so it's possible to see what they really did audit. Following are the top five red flags for audits. Interestingly enough, it's not what you might suspect that might get you audited!

1. Location. Where you live makes a difference in determining whether you're more at risk from an audit. You're more likely to get an audit if you live in one of these places:

• Los Angeles
  
• North Central District (ND, SD, MN)
  
• Southern California
  
• Northern California
  
• Manhattan
  
• Central California
  
• Brooklyn
  
• Southwest (AZ, NV, NM)
  
• South Florida
  
• Houston

For a free, complete list of audit location hot spots, please go to a this site.

2. How Much You Make. I found this statistic fascinating. It would seem to make sense that the IRS is more likely to audit people who make more money. But, the fact is that they are actually more likely to audit people who make LESS money. In fact, the most likely return to be audited is a return that includes a business that makes less than $25,000 per year. If you don't have a business, you have the most chance for an audit if you file a Form 1040A and make less than $25,000 per year.

3. Business Entities. If you have a business, you are much more likely to be audited if you operate in a Sole Proprietorship (Schedule C). In fact, you're ten times more likely to be audited as a Sole Proprietorship than if you're an S Corporation or C Corporation. Why? That's because most Sole Proprietorships don't have great record-keeping systems and the IRS knows that.

4. Under-reporting Income. The IRS receives copies of your K-1s (from Limited Partnerships and S Corporations), 1099s (from interest, dividends and sales) and W-2s. If you don't report these items on your return, or you report a different amount, your return will get pulled for inquiry.

   If you receive one of these documents and it's wrong, the best strategy is to fully report the amount that is shown on the document and then deduct the amount in error in a separate line item. Include a disclosure with your tax return to put the IRS on notice that you've made a change. That gets the clock ticking for statute of limitation purposes.

5. Who Files Your Return Matters. If you have a complex return and prepared it yourself or if your return was prepared by someone on the IRS's problem preparer list, you are more likely to be audited. Ask your return preparer, as part of the interview process, about his or her experience with the IRS. If they go off on a rant about how unfair the IRS is, you might want to pass.

Would you like more examples of mistakes that taxpayers make each year? There is a free special report disclosing 25 of the top problems that will cost you an IRS audit by clicking here.

Published: October 11, 2006

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