The Internal Revenue Service recently released statistics about income tax return filings and audits for tax year 2010. The agency disclosed that more than 184 million tax returns were filed for all entities. Of that amount, a little over 1.7 million returns were either examined through mail correspondence or field audits (in person). That represents .9% of all returns filed, a small percentage indeed. Individual returns were audited 1.1% of the time, small C-corporations were audited 1.0% of the time, while large C-corporations were audited 17.6% of the time. The most individual returns audited, 12.5%, were those returns with total positive income of $1 million or more. The greatest percentage of corporate returns audited, 95.6%, were those with $20 billion or more in assets. Roughly half of all corporation returns with total assets between $5 billion and $20 billion in assets were audited. S-corporations and partnership returns were each audited only .4% of the time.

Of the individual returns that were audited, 21% resulted in no change in tax owed, while returns with additional tax assessed saw an average increase of $15,187 for field (in person) audits and $7,421 for mail correspondence audits.

These figures represent a lot of dry information, but how can you benefit from this knowledge? While the budget for the IRS has continually been reduced over the years, it’s still a good idea to take steps to reduce your audit risk. Individuals should keep good records of all income, such as W-2 forms for salaries and wages and 1099s for contract work, interest and dividend income, capital gains and losses, unemployment and social security benefits, gambling and prize winnings, and forgiven debts. Documentation should also be kept for alimony payments, retirement plan contributions, self-employed health insurance premiums paid, certain deductible education and tuition expenses, etc.

Homeowners should keep 1098 forms for mortgage interest paid as well as real estate taxes if part of an impound account. Otherwise, bank statements and records of cancelled checks should be retained. Deductible medical expenses, other property taxes, theft and casualty losses, charitable contributions and miscellaneous deductible expenses should be well documented as well. Taxpayers with rental income should keep good records for all expenses related to rental property.

Business owners would be best served by keeping their business income and expenses using commercial accounting software. Keep all business records for a minimum of seven years. Auto expenses should be documented using a mileage log that lists the date of business-related driving, beginning and ending odometer readings, the name of the person and purpose of the business meeting or trips  for business purposes. If you operate a business from home, certain expenses that would otherwise not be deductible may be deducted if your exclusive business area benefits from the expense.

Good record keeping will not only reduce the chances of additional tax assessments from an audit, but minimize the cost of using a tax professional to represent you during an audit. Filing timely income tax returns or filing extensions when you can’t file by the tax filing deadline will also keep you off of he IRS’s radar and avoid late filing penalties. Be sure to pay any taxes you may owe when filing an extension to avoid underpayment penalties. Above all, avoid making any frivolous claims that raise suspicion.

I.R.S. Returns, Audit Statistics and How to Avoid Tax Audits