Fear of being audited by the Internal Revenue Service can leave even an honest taxpayer unnerved. It's important to be truthful when filing your taxes, of course, but it's even more critical to be prepared to substantiate your return with complete records if and when the IRS comes knocking.

What is an Audit?
An IRS audit is generally a review of your tax return to determine its accuracy. It is not an accusation of wrongdoing. But it is important to know that you, the taxpayer, have the burden of proving that your return is accurate. The IRS does not have to disprove anything. For example, if you gave $100 worth of old clothing to a charity but did not receive a receipt or have other proof that such a gift was made, you could be in trouble if you're audited. If the IRS questions the deduction and you cannot provide proper evidence that a gift, in such amount, was made, the deduction may be disallowed.

Why Me?
There are three categories of people most likely to be audited: people in cash businesses, certain professionals and people taking unusually large deductions.

• Cash businesses are easy targets for the IRS. Many people in these businesses don't declare all their income, and the IRS knows it. If, for example, your occupation is listed as a hairdresser, waiter or bartender, it may raise a red flag. If you regularly receive cash for your work, be sure to report all the money you earn, including tips.
• Professionals such as doctors, lawyers and accountants are also targeted. That's because they generally run their own businesses and do their own bookkeeping.
• Large, unusual deductions are easily picked up by IRS computers. Although these deductions may be justified, they may still raise a red flag.

Which Deductions Are Likely to Be Challenged?
The IRS mandates that certain deductions must exceed a minimum percentage of your income before you can claim them. For example, medical deductions must exceed 7.5 percent of your income, and casualty loss deductions must exceed 10 percent before you can claim them. Only a small number of taxpayers qualify, so if you claim these deductions, keep careful records.

The IRS is also likely to look at your contributions to charity. If you deduct more than the IRS' statistical norms, you may be audited. You must have a receipt (not just a canceled check) for any single donation of $250 or more. If you do not have a receipt, the IRS may disallow the deduction. Rules of documentation have been enhanced. A home office deduction may also be questioned. If you deduct expenses related to a home office, that office must be used solely for business-related activities. You must also perform the majority of your business in that office. A doctor who uses a room at home to do bookkeeping would not qualify for a deduction because it is not his or her main place of business. If the hospital where the doctor works does not provide an office and there is no other office, then the doctor in this case may be OK.

The IRS may also audit if they receive a tip that you are cheating on your tax returns.

What Now?
If you are notified that you will be audited, take it seriously but don't panic. First, read the letter from the IRS carefully and figure out what you are being asked to do. It may be as simple as signing your return. There are three basic types of audits, and the letter will explain which one applies to you:

• A correspondence audit is for minor mistakes. A letter from the IRS will tell you what documentation to send them through the mail. Once the IRS is satisfied that it has the correct paperwork, the matter will be closed.
• A field audit is one in which the auditor comes to your business or home to verify the accuracy of your return. This type of audit is usually done if the return is complicated and involves business operations. If your records are neat and in order, it will suggest to the auditor that you are a conscientious business person.
• An office audit requires that you physically appear on a specific date and time at an IRS facility and bring your documentation. Bring only the documents asked for. Otherwise, you will leave yourself open to an examination of all your records, even if they are not in dispute. If you are unable to keep a scheduled audit appointment, phone and reschedule as soon as possible.

Do I Need Professional Help?
Probably. Taxation is very complicated and technical, and you will benefit from having an expert on your side. If you had an attorney or Certified Public Accountant prepare your return, you may want to bring that person to the audit. Professional tax preparation services will sometimes send someone to accompany you to an audit. Weigh the amount of tax in question against the cost of bringing a professional with you.

Can I Appeal the Findings?
You can either agree or disagree with the auditor's findings. If you agree, your experience with the IRS is finished upon completion of some paperwork and payment of any outstanding amounts. If you disagree with the auditor, the issues in question can be reviewed informally with the auditor's supervisor or you can appeal to the IRS appeals office, which is independent of the local IRS office that conducted the audit. If you do not reach an agreement with the appeals officer, you may take your case to the U.S. Tax Court, U.S. Claims Court or U.S. District Court. The Tax Court generally hears cases before any tax is assessed or paid. The Claims Court and District Court generally hear tax cases only after you have paid the tax and filed a claim for refund.

If you cannot decide to agree or disagree, the IRS has formal procedures to help you make up your mind. Within a few weeks of your audit, you will receive a letter that gives you 30 days to either agree with the auditor or file a formal appeal. The letter will explain the steps to take, depending on your choice of action. If you do not respond to the 30-day letter, or if you do not reach an agreement with the appeals officer, the IRS will send you a "statutory notice of deficiency," giving you 90 days to bring your case to the Tax Court. If you take no action, you lose your right to go to Tax Court, and the IRS will assess the additional tax against you.

Audit Advice

• FIRST of all read IRS Publication 1, which explains your rights under the Taxpayers' Bill of Rights, prior to your audit.
• Do your best to delay the audit. Request more time whenever you need it to get your records in order.
• You are allowed to reconstruct any missing documents or receipts.
• Research any tax legal issues by using the free IRS publications and commercial tax guides. If you’re still unsure about the tax law or how to present your documents, consult a tax professional before the audit.
• Don't let the IRS perform the audit at your business or home. They prefer this, especially where home-based businesses are concerned. Instead, go to the IRS office or have your tax professional represent you.
• You have the right to schedule the audit at a time and place that is convenient for you. Use this right to sufficiently prepare yourself and avoid being caught off-guard.
• You also have the right to limit the scope of the audit to avoid the time and trouble of discussing issues which are not relevant to your tax liability.
• Don't talk any more than you have to during the audit; answer questions and then be quiet. Don’t give the auditor any more information than he or she is entitled to.
• Don't bring any documents that were not specifically requested, or do not pertain to the year under audit. Don't give copies of other years' tax returns to the auditor; don’t lie about anything, but don’t provide more information than is absolutely required.
• If you feel that the audit isn't going well, you are within your rights to demand a recess to consult with your tax professional.
• If you feel that you’re being treated badly or unfairly, ask to speak to the auditor’s manager.
• Don't try to haggle over the amount of the taxes that they say you owe; instead, attempt to negotiate the tax issues.
• If the subject of tax fraud arises, don't try to handle it yourself. Get the help of a tax professional.
• When you receive the audit report, call the auditor if you don't understand or agree with it. Meet with the auditor or manager to try to reach a compromise.