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Friday, November 6, 2009

How to Audit-Proof Your Tax Return: Don't e-File

Forbes, Ten Ways To Audit Proof Your Tax Return, by Robert W. Wood (Wood & Porter, San Francisco):

While what-triggers-an-audit theories abound, there are some basic things you can do to reduce your chances of being picked for an audit or at least to make any interactions with the IRS less traumatic. ...

3. Don't file electronically. I'll take considerable heat for my opinion on this, since the IRS encourages electronic filing, as do many accountants. In fact, the IRS boasts that two out of three 2008 returns were filed electronically. Clearly, electronic filing is the thing of the future and will be required for every return someday soon.

Until then, I suggest filing the old fashioned way, particularly if you're worried about an audit. Why? Paper filing means it's more work for the IRS to access all the information in your return. Your duty as a taxpayer is to be truthful and accurate, but you don't have to make it easy for the IRS.

Before I get a blizzard of e-mails about my view of electronic filing, I recognize there are tradeoffs. Indeed, many people think electronic filing is the greatest thing since the mouse was invented. Electronic filing is faster, and if you are entitled to a refund, you can receive it faster. The cost (in time or fees paid to professionals or software providers) may be lower. You save paper, and you don't deal with the post office.

Yet you are giving the IRS easy electronic access to information it would otherwise have to enter, enabling the agency to examine your return and mine the data more easily than it otherwise could. If you still think I'm nuts, one variable may be the nature of returns. Most individual tax returns are short form (Form 1040EZ or 1040A). If your return is in that category, my anti-electronic filing mantra matters less if at all. But if your return is complicated, I'd stick with paper.

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Tracked on Nov 9, 2009 4:04:25 AM

Comments

I like number 2 the best! Er, the "use a tax professional" part, not the "use tax software" part.

Posted by: Pete Terranova | Nov 6, 2009 6:25:16 AM

If you're 'entitled' to a refund, you're doing it wrong.

Unless, of course, your goal is to make an interest-free loan to the government.

Posted by: John Galt | Nov 6, 2009 11:08:12 AM

Is there any research to back this up? Are people who file electronically more likely to be audited, all other things held constant?

This makes some intuitive sense, but it also sounds like one of those urban legends that some research study will disprove in a few years.

Posted by: rob | Nov 6, 2009 11:20:44 AM

Would it really matter? Once the paper return arrives at the IRS processing center, a data entry clerk enters the data into their processing system. I am not sure that e-filing really provides any more convenient means for the IRS to review return data than paper filing does.

Once they enter the data, it's all right there.

Posted by: Dan D | Nov 6, 2009 11:21:14 AM

I agree.

I guess I was audited - anyway the IRS questioned my 2007 1099 statement.

If I didn't have my paper copy, how could I respond to what they received?

So, I re-mailed them my 2007 return and all is OK now ... I hope ...

Posted by: Monte Meals | Nov 6, 2009 12:04:54 PM

Damn right. It's partly for this reason I'll file on paper as long as it's legal. Furthermore, I hand-write it. Neatly, of course, so any human being can understand it immediately -- but it can't be scanned by a cheap optical character recognition program, to peel out the numbers at very little cost. There's no way they're going to get my data without paying a human being to sit down and read the return. And the IRS doesn't have, and will probably never have, the money to pay human beings to read each and every of 110 million tax returns.

I most definitely don't want my tax data run through some bright-eyed eager-beaver's latest data-mining algorithm, so that I can spend six months trying to drive sense about what I've legally done into wooden Washington heads.

It honestly blows my mind that citizens get bugged about, say, the Federal government using computer programs to monitor overseas satellite phone calls to Afghanistan OMFG! My privacy is breached! Can the black helicopters be far behind? but they're totally blasé about having all their most private financial data neatly available for the government to paw over. Talk about penny wise, pound foolish.

Posted by: Carl Pham | Nov 6, 2009 12:08:03 PM

Yeah, Tim Geithner showed us what happens when you use professional software without a professional preparer.

Posted by: Woody | Nov 6, 2009 12:17:10 PM

Depends on what you mean by "audit". If you mean getting-your-paperwork-together and sitting-down-with-an-agent, then it makes no difference which way you file. IRS fraud detection is applied equally to both. If you mean "some human looking at my tax return information", then filing on paper increases your chances many times over. Someone opens the return, passes it on to others who look at it and prepare it for data entry. Data entry people often make errors, which cause the return to kick out, at which point others scrutinize it. Filing on paper is definitely NOT the way to avoid having people look at your return.

Posted by: not_so_fast | Nov 6, 2009 12:33:10 PM

The analysis is accurate. What makes an efile easier for them to process your return, also makes it easier for them to audit your return.

Posted by: scf | Nov 6, 2009 12:56:59 PM

I think that makes sense, I have been surmising that myself for quite some time. I am sure that they have some programs that can easily scan a return that was e-filed and flag anything questionable. With paper it is a much longer process. Knowing that they only audit x% of returns every year it seems the e-filers would be a more obvious target. Not to mention e-filing implies that the person used Turbo Tax or a similar program which generally makes it easier to fudge things because you can tweak things endlessly to come out where you want. I am sure the IRS understands this too. I also have a theory that having a CPA's name on the return also reduces your audit risk, the thought being they are less likely to risk their reputation on a false return. Just a theory...

Posted by: Ken Royall | Nov 6, 2009 1:02:11 PM

4) Be a high ranking Democrat

Posted by: EvilDave | Nov 6, 2009 1:30:27 PM

Wouldn't the availability of OCR software to scan the paper tax return and convert it back into electronic format sort of negate any inconvenience that the IRS might incur in viewing your records? I cannot imagine that the IRS actually retains the physical paper documents that you file; they would have to be scanned in order to be found.

Posted by: Ken Mitchell | Nov 6, 2009 2:13:28 PM

That has to be the dumbest thing I ever read on taxes.

The forms you mail are scanned when received by the IRS, then processed by a sophisticated software to make an electronic file.

Posted by: patch | Nov 6, 2009 3:08:11 PM

Nah, all Geitner proved to us was that he was "Too big to FILE!"

Posted by: BR | Nov 6, 2009 3:10:45 PM

I also understand from the Secretary of the Treasury that if we use TurboTax any mistakes will be overlooked, even if TurboTax gives a warning.

Posted by: malclave | Nov 6, 2009 3:32:35 PM

Use the electronic providers to create the return, do the calculations, etc., print out the return and mail it in.

The best of both worlds.

Posted by: Sean | Nov 6, 2009 4:21:47 PM

I know an IRS agent and I have simple advice for avoiding being audited.

Don't have a good full-time paying job that pays you xxx,xxx or x,xxx,xxx dollars a year or be a couple that has that two jobs that equal that, and then have a side "real estate business" or hobby that generates no actual revenue and huge entertainment or mileage related losses so you have little to no taxable income.

You'd be surprised the number of audits that are the above story.

Posted by: T | Nov 6, 2009 7:53:27 PM

When I paper filed, I always attached the charitable contributions receipts, knowing that as a statistical outlier I would likely trigger an audit. I have efiled the last three years.

I just went through an audit requiring me to come in and justify my contributions for 2007. This would suggest that the inability to include supporting documents right up front with efiling made me more vulnerable to an audit.

Not proof, just an indicator.

Posted by: Assistant Village Idiot | Nov 6, 2009 7:59:35 PM