Avoiding red flags can keep you out of auditor's office

It's the letter Americans dread most -- a cordial invitation to visit the local Internal Revenue Service office for an audit.

Although the number of audits has decreased in recent years, they remain an important government tool to ensure compliance with the nation's tax laws. Last year, some 732,000 individual returns -- about one out of every 170 that were filed -- were audited, the IRS said. About two-thirds involved mail inquiries, while the rest required a sit-down meeting with an auditor.

This year, nearly 50,000 additional tax returns will be subjected to special "national research program" audits so the IRS can develop new baselines for checking future returns.

Tax experts say there are a number of things taxpayers can do when they prepare their forms to reduce the odds that they will be called on to defend their filings.

Neatness can count a lot.

"A sloppy return suggests a person's finances may be sloppy and his reporting to the government may be sloppy," said Jacob I. Friedman, chairman of the tax department at Proskauer Rose LLP in New York. "Lack of neatness can be a red flag to the IRS."

One way to improve a return's appearance is to use one of the many computer programs now available for tax preparation, Friedman said. "There also an assumption the math is correct when you use a computer," he added.

Other things to watch out for:

Accuracy in numbers

In recent years, the government has stepped up its document-matching program, which cross-checks what taxpayers report against forms filed separately by their employers, banks and brokers.

That means the numbers on your tax return should faithfully reflect the numbers on your W-2 wage statements and 1099 interest and dividend documents, said Bob D. Scharin, editor of Warren, Gorham & Lamont's Practical Tax Strategies.

Correct Social Security numbers are important, too, he said.

"The IRS uses Social Security numbers to make sure a child isn't claimed as a dependent by more than one person," Scharin said. "They're also used to make sure that an ex-spouse receiving alimony reports it as income and pays taxes," he said.

Doubtful deductions

Heavy medical expenses, undocumented charitable contributions and home office deductions can all draw IRS scrutiny, said Martin S. Kaplan, a New York accountant who wrote "What the IRS Doesn't Want You to Know."

Medical expenses must exceed 7 1/2 percent of your adjust gross income to be deductible, according to the tax law.

"People can run up horrendous bills if they're dealing with a major illness," Kaplan pointed out. "But it's so hard to go over 7 1/2 percent of AGI, that the IRS generally assumes you're telling the truth."

Not so with large home office deductions, Kaplan warned.

"People tend to go overboard," he said. "They'll claim they're using 50 percent of a one-bedroom apartment for work. That's a red flag." Kaplan said that "if you exceed 30 percent, you're taking a chance."

Charitable to a fault

Kaplan believes taxpayers "have a lot of leeway" when it comes to deductions for charitable contributions.

Most people get written receipts to prove cash contributions. Noncash donations are more problematic.

"If they're under $500, you don't have to include a schedule," he points out. "Over $500, you need to list fair market value."

Kaplan suggests that taxpayers check the "valuation guide" at the Salvation Army's Web site, www.salvationarmy.org, to price clothing and household donations "because that's what the IRS uses." For pricey donations, such as a car valued at $5,000 or more, you must get formal appraisals.

All of the experts emphasized that taxpayers should claim all the exemptions and deductions they believe they're due -- and keep the paperwork to back them up.

If called for an audit, Proskauer Rose's Friedman suggests the taxpayer shouldn't try to fight the battle alone but should enlist a tax preparer, accountant or lawyer to handle it.

"People get nervous, their blood pressure rises and they give the wrong answers and get themselves into trouble," he said. "They don't know the law as well as professionals do."

He added that about one-quarter of audits result in no additional taxes being levied.