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Facing an audit? First, take a deep breath - but then what?

As we said in our May 2 post, the average American taxpayer has a 1 percent chance of being audited by the IRS. The chance increases to 3.26 percent, though, for taxpayers earning $200,000 in 2013. If you earned more than $1 million -- not unheard of in the Bay Area -- your chances increase to almost 11 percent.

It is important to remember that the IRS rarely identifies either a person or a business for an audit at random. Audits are not conducted on a statistically significant basis, and they are not decided based on a roll of the dice. Computers now perform complicated algorithms on all tax returns to identify anomalies. Too many unusual items on a return will generally trigger what taxpayers think of as The Audit Letter.

Budget cuts have forced the IRS to cut back on the number of audits, so those unusual items are fairly easy to guess. Reporting charitable donations worth $30,000 on your $60,000 salary, for example, will probably earn you a red flag and, perhaps, the ensuing audit. Similarly, a small business return that lists 100 percent of the owner's car as a business expense will probably raise a red flag.

So what do you do if you get The Audit Letter? There is an old theater expression that everyone should remember: First we panic; then we overreact. It is ironic, of course. This is exactly what a taxpayer should not do.

We will discuss what a taxpayer should do in our next post.

Source: Fox Business, "What to Do if Your Receive an Audit Letter from IRS," Donna Fuscaldo, May 9, 2014

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