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7 Ways to Fight a Tax Audit

Be ready. IRS agents will be poring over returns

by: Sid Kirchheimer, from: AARP Bulletin

5. Document your donations

The IRS knows that many taxpayers are extraordinarily generous, at least in the charitable contributions they declare. Claims of giving, say, 10 percent of income may trigger attention, as the norm is about 2 percent. So be prepared to back up claims with written proof. As you give, collect letters or receipts from charities, both for monetary and in-kind donations — especially those over $250.

"When you donate to Goodwill, it's no longer enough to leave a bag of clothing outside the door," says H&R Block master tax adviser Elaine Smith. "You need a receipt."

For a big item such as a donated car, you used to be able to deduct fair market value, no matter what the charity did with the car. Now you can claim that amount only if the charity uses the car. If it's sold at auction, you can only deduct the usually much lower price that the car actually commanded. Your receipt should specify what happened to the car and if it was sold, for how much. And you should have detailed paperwork on any car donation worth $500 or more.

6. Keep records beyond receipts

At audit time, you might need to demonstrate that a restaurant receipt actually represents dinner with a potential client, not a night on the town with your spouse. "Receipts don't talk," says Daily, so for those whose relevance isn't obvious, jot down notes as you go along. "It can be nothing more than 'dinner with John Smith, prospective sales client,' " he adds. But such a log will add credibility to your claim. It's unlikely the IRS will contact your dinner partner, unless there's suspected fraud.

7. Track your bank transfers

If your return is flagged, the auditor will run a total of all the deposits in your bank accounts, says Rosenberg, "and if you move a lot of money between different accounts, it could appear as though you have three or four times more money than you really do." So be prepared to document these transfers carefully to show that a deposit doesn't necessarily equal new income. Not having such proof causes "more trouble in audits than any other issue," she says.

Sid Kirchheimer writes about consumer and health issues.

Updated November 2011

What Triggers an Audit?

A return can be flagged randomly in an IRS study of the behavior of similar taxpayers, such as those in the same profession. But more often, audits result from:

Document mismatches. This includes the income you report not jibing with figures in W2s, 1099s and other statements.
A high "DIF" score. A top-secret IRS computer program, the Discriminant Inventory Function System, assigns a score to each individual return. "For instance, DIF compares your auto deductions with others in the same profession, your income in relation to others in your ZIP code," says tax attorney Frederick W. Daily. The further your amounts are outside the averages, the higher your DIF and chance of audit.
High income. If you make under $200,000 a year, your chances of an audit are about 1 percent. The risk is more than 3 percent among people making $200,000 to $1 million. In 2010, 8.3 percent of people earning more than $1 million were audited.
Working for yourself. Self-employed workers and small-business owners have a higher risk than W2 wage earners, because "they have more opportunity to cheat," notes Daily.