How to Stay Cool When the IRS Raises the Heat

Lawmakers here may have put the IRS on a hot seat last month, but don't think that means the Internal Revenue Service won't continue doing the same to taxpayers.

Audits are a fact of life for taxpayers in the United States. The key is knowing how to survive one.

After exposing the tax agency to its harshest public scrutiny in years, lawmakers proclaim the dawn of a kinder, gentler IRS.

But it will take years to rein in the agency, experts say. IRS auditors are still on the prowl; IRS computers still churn through millions of returns.

"Even if the IRS leadership is repentant and sincere, it will take an awfully long time for the attitude to filter down into the ranks," says Dan Pilla, a tax consultant and author of "IRS, Taxes, and the Beast."

Don't tell that to the legislators. The Senate Finance Committee, which held hearings last month chronicling IRS abuses, plans soon to introduce a law to shake up the agency. The House Ways and Means Committee plans similar action.

Still, some experts doubt Congress will sufficiently overhaul an agency of its own creation. After all, Congress built the country's 17,000 pages of tax regulations - a rat's nest of complexity blamed, in part, for IRS abuses.

With the IRS bowed but far from out, experts suggest several ways for taxpayers to shield themselves from what might seem like a "shakedown," which the agency calls an audit.

Taxpayers must know their rights and how the agency picks the roughly 1 percent of returns to be audited.

* Document. Don't be shy about deductions, just document them. "Documentation is king," says Robert Bennington, president of the National Audit Defense Network in Las Vegas, Nev.

IRS computers scan each line of every return, and they attach a score to figures that stand out from averages of taxpayers in the same income group and region.

Those scores trigger most audits. But even if your deductions are above average, claim them - and document them.

"Just about everyone is paying more taxes than they owe because they are afraid to claim legitimate deductions and raise a red flag," says Mr. Pilla.

* Make the first move. If you take an unusual number of deductions, preempt an auditor. File form 8275, a statement that elaborates on unusual figures in a return.

* Get the scoop. Obtain a copy of your IRS master file. Write your IRS district headquarters and invoke the Freedom of Information Act. The file could tell you, months in advance, of a pending audit.

* Beware of red flags. The IRS pays special note to claims for rental property or small businesses, especially those losing more than $5,000. The agency believes many married couples turn hobbies into money-losing businesses in order to write off the loss from full-time employment.

"The IRS is trying to get marginal businesses off the tax rolls," says Fred Daily, a San Francisco tax attorney and author of "Stand Up to the IRS."

* Lawyers take note. Beware if you are an attorney, car dealer, commercial fisherman, mortuary owner, architect, or are involved in other businesses where much of the income comes in cash or where clever bookkeeping can hide or defer income.

The IRS is shifting away from reliance on computer number-crunching in favor of sleuthing professional groups it suspects routinely veil income, Mr. Daily says.

* Tread lightly. Don't antagonize someone who knows of any vulnerabilities in your 1040 form. If they turn you in, the IRS pays a bounty worth 10 percent of additional taxes collected.

* Off the hot seat; into the fridge. Perhaps the most sure-fire - and extreme - way to dodge an audit is to move. The likelihood of an IRS probe varies wildly from state to state: A Nevadan is four times more likely to receive an audit notice than a Wisconsinite.

Books on Dealing with the IRS

IRS, Taxes, and the Beast

By Dan Pilla, Winning Publications

(800-346-6829)

Stand Up to the IRS

By Frederick W. Daily, Nolo Press

(800-955-4775)

How to Beat the IRS at its Own Game

By Amir Aczel, Four Walls Eight Windows

(800-626-4848)