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How to avoid a tax audit, virtual or otherwise

A tax audit is among the scariest things in the world. It doesn't matter if it's a correspondence audit, where you and the IRS trade tax information via mail, or a face-to-face encounter with a tax examiner.

And the audit process might soon be online.

In its effort to do more of its work electronically, the IRS is testing a system that allows taxpayers to get answers to tax questions and problems via live video conferences.

CNNMoney reports that the IRS launched the pilot program in 12 locations late last year. Under the system, taxpayers can log into computers with video conferencing capabilities and talk online with an IRS agent about tax issues.

If the online assistance test is successful, look for the program to expand. 

Eventual online audits: So what's the next logical step in the IRS' electronic future? Virtual audits.

That's the hope of National Taxpayer Advocate Nina E. Olson. In her blog this week, Olson calls virtual face-to-face audits a prescription for curing the ailing correspondence examination process.

Olson didn't testify at a recent IRS Oversight Board hearing on correspondence audits, but she has plenty to say on the subject.

She characterizes the correspondence, or corr, audit process "an unnavigable labyrinth" that is exacerbated by confusing notices and an automated examination system in which no one IRS employee is assigned to work or is held accountable for specific cases, thereby prolonging the process.

"The answer to these problems is not to give up on corr exams and replace them with IRS audits in taxpayers' homes and businesses. Instead, we need to harness technology so that taxpayers and the IRS can recreate a face-to-face office audit virtually," writes Olson.

Avoiding audits altogether: Of course the best plan is to steer clear of the auditor in the first place.

You can't do that by avoiding common tax filing mistakes, such as math errors or incorrectly claimed dependents or income you forgot to report.

You also don't want to raise any of the audit red flags that catch an IRS examiner's eye. The agency is particularly interested in professions where most payments are made in cash since that lack of third-party reporting makes it easier for filers to under-report their taxable income.

The IRS also looks at deductions for meals and entertainment and, say some tax pros, home office claims.

But what really catches an auditor's eye is when a return stands out from similar ones. That's right, as much as we all love attention, it's better at tax time to blend in with the crowd.

The IRS  uses a system known as Discrimination Information Function, or DIF, to compare individual tax returns to a computer model. That program then rates returns by the probability of inaccurate tax filing information.

You're more likely to get a suspicious DIF rating if your itemized deductions deviate a great deal from the claims of most of your taxpaying peers in your income bracket.

So what's normal? Each year tax information publisher and software maker CCH takes the most up-to-date available IRS filing data (that's 2009 this year; remember, it takes a while for all our numbers to percolate thorugh the system) and puts together a table showing the average amount of popular deductions in various income ranges.

Average deductions 2009 tax year_CCH WBoT Click image for a larger view. Source: CCH

Where do your deductions fit in this table, accounting of course for a bit of an inflationary adjustment? Do you think your medical or taxes paid or charitable donation claims on Schedule A are different enough to prompt the IRS to look more closely at your return?

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