The current Commissioner of the IRS, Mark W. Everson, has stuck to his guns in stepping up the IRS' enforcement activities. Here's a synopsis of what's going on:

• For the government's fiscal year (FY) ended September 30, 2005, tax revenues generated from audits, matching of tax information, and collection efforts rose to a record $47.3 billion, up 10% from the previous year!

• The number of individual returns audited increased from about 1 million in FY 2004 to a whopping 1.2 million in FY 2005, a rise of 20%!

• Audits of individuals with incomes above $100,000/year surpassed 221,000 -- the highest figure in 10 years -- well over double the 92,000 completed in FY 2001. Your chance of being audited, if you are at this income level, is now 1.58% each year, twice what it was four years ago!

• Audits of small businesses organized as corporations were also stepped up after many years of decline. Nearly 18,000 small business audits were completed in FY 2005 compared with fewer than 7,300 in FY 2004!

• Audits of larger corporations – those with assets over $10 million – have also increased, up 14% from a year ago to 10,878. The risk of an IRS audit for a large corporation is now one in five each year, compared to one in eight only two years ago!

Realistically, there is no bulletproof way to guarantee you will never be audited. However, there are some things we can do to greatly reduce the risk of audit. These include the following techniques:

1. File Extensions Instead of Filing Returns by the First Due Date. Because of budget restrictions, only a certain number of returns are selected for audit each year. For example, the first batch of individual returns are chosen for audit by the IRS during the summer. In order to avoid getting included in Round 1 of the audit selection process, it may make sense to hold off filing by the initial due date of the return. This can be accomplished by filing an extension. You still run some risk of being audited, along with other returns that were not selected in Round 1 of the audit selection process, but at least you will have opted for a bye in that first round and therefore significantly reduced your audit exposure. Naturally, extending the time to file your return doesn't extend the time to pay any taxes you owe. A close estimate of the taxes you owe should be paid with the extension, or else you'll be subject to interest and penalties.

2. Avoid Classifying Large Amounts as "Miscellaneous" or "Other" in Your Accounting Records. Ideally, each and every item of income or expense should be placed in the category that best describes it. Most expenses that clients call "Miscellaneous" or "Other" are, in fact, office expenses or operating costs of one type or another. The IRS presumes that you will be unable to furnish substantiation to support large "Misc." and "Other" deductions, and that will tend to increase the likelihood of an audit.

3. Set up an Entity. If you or your spouse file a Schedule C for a business operated as a sole proprietorship, you are dramatically increasing your risk of audit. The best way to lessen IRS scrutiny is to either incorporate or form a Limited Liability Company (LLC). Small business corporations and LLCs continue to be audited far less frequently than individuals. Our lawmakers may have imposed numerous mathematical limitations on individual income tax deductions; however, many of these limitations are not relevant to corporations and LLCs.

4. Stay within IRS Parameters. The IRS uses a DIF (Discriminate Income Function) system to choose which tax returns to examine. The scoring for the DIF system is set up to identify those returns that, if audited, could result in added tax revenue. Other than IRS employees who are directly involved with the system, hardly anyone can know with certainty the actual DIF ratios. However, some research studies have suggested that if your itemized deductions are more than 45% of your Adjusted Gross Income, the probability of your individual return being audited goes up materially. It also appears that e-filing gives the IRS a lot more information than you are legally required to provide and makes it all the more likely that your DIF score will be calculated quickly, thereby increasing audit risk

5. Avoid Amendments. Amendments should be avoided, especially if a refund is requested. The filing of an amended tax return which asks for money back tends to attract attention by an actual human being that works for the IRS. It increases the risk that both your original and amended return will be audited.

6. Include on your Return all Information Reported to the IRS. If your return reflects less income than has been reported to the IRS by third parties, such as banks and brokerage companies, you may receive a Notice that the IRS could not match this income with your return, and this in turn may trigger an audit. This can happen even with a nominal amount of bank interest for which you did not receive a 1099 form. It can also happen by claiming mortgage interest for which you did not receive a 1098 form.

We at Large & Gilbert, P.C. make every effort to ensure that your tax returns do not contain red flags that would invite an audit. We take great pride in our internal quality control processes, which focus on eliminating such flags in order to allow you to go about your business as free as possible from government intervention. Although an L&G client does occasionally get selected for audit, the chance of audit for tax returns prepared by L&G runs well below the national averages.