Avoiding An Audit

By now, you should have received your W-2 forms in the mail, so that you - or your accountant - can begin to prepare your 2006 tax returns. You can avoid a penalty by filing before April 17th, but do you know how to avoid an audit? Ray Hennessey, editor of SmartMoney.com, has some tips.

First, be sure to limit home-office deductions. You can only deduct home-office expenses if your company doesn't provide you with a work space. "We like to work from home, we like to telecommute," says Hennessey, "but that doesn't mean that you can deduct money that you spend to do that."

Also, don't deduct for hobbies, even if you're trying to make money off of it. "In order to qualify for losses from that business, you have to have shown that you're going to make a profit from it in five years... The IRS doesn't treat that as a second job," says Hennessey. So try not to deduct for hobbies, unless you think it is a serious business with serious earning potential.

Be sure to watch out for non-cash charitable gifts. You can't automatically deduct that old couch that you donated to the charity of your choice; now, it has to be in good condition. "You can't take the stuff that you would otherwise throw out and expect to be able to deduct things," says Hennessey. Also, according to Hennessey, if you deduct too many non-cash charitable donations, the IRS is more likely to audit you.

Finally, if you do end up being audited, and you've done your taxes yourself, be sure you have some sort of legal representation. "Get a tax attorney together, make sure you have all your receipts," says Hennessey. "Be prepared to defend the way you've done your taxes for the last three to five years." Once an audit has been opened, the IRS will often look back at your last few tax returns. For this reason, says Hennessey, It's important to keep all tax documents for at least five years.

For more information about your tax returns and avoiding an audit, visit SmartMoney.com or click here.

By Erin Petrun