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The Audits Are Coming!

With an increased enforcement budget, the IRS is threatening to conduct more audits. Should you be worried?

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Resisting any moves toward tax hikes, the Bush administration wants the IRS to step up enforcement, presumably to help offset the ballooning budget deficit. That could mean more audits for individuals and businesses, a daunting prospect for busy entrepreneurs.

In February, the administration asked Congress for an extra $500 million for the IRS, raising the agency's enforcement budget to $6.89 billion--a 7.8 percent increase over last year's budget. Many observers, however, dismiss the increased funding as simple saber rattling.

According to the Transactional Records Access Clearinghouse, a research center at Syracuse University in Syracuse, New York, despite several years of IRS claims of crackdowns, business audits have steeply declined since 1996, from 5.6 audits per 1,000 business returns to 2 audits per 1,000 returns in fiscal year 2003. Even businesses caught cheating don't face much punishment beyond paying what they owe. TRAC statistics also show that the number of penalties levied against corporations fell from 62 in 1999 to 12 in 2003, while civil fraud penalties dropped from 247 to 170 during the same time period.

These days, an audit isn't always a tense, face-to-face encounter with an agent. A letter from the IRS saying you added wrong also counts as an audit, at least in the eyes of the Treasury Department.

While it appears that the chances of being audited remain somewhat slim, you can further reduce your vulnerability by avoiding tax shelters, which are the subject of increased scrutiny, as well as deductions that are unusual for your industry. "One thing I tell taxpayers is, 'Be consistent,'" says John Maddox, a CPA with Maddox Ungar PLLC in Bingham Farms, Michigan.

In the event you do face an audit, Maddox suggests that restraint is your best ally, next to your accountant. Provide only the information the IRS specifically asks for without going overboard. The main thing is not to panic. "Just because the IRS asks about something," Maddox says, "doesn't mean you've done anything wrong."