Know the law, protect your rights

Try to get the audit settled before it goes any further. But if you can't come to an agreement with the auditor, you have the right to an appeal.
But be forewarned. Appeals officers have even more knowledge of tax law than auditors and by this stage, you're in for a major battle.
If you're shoveling the appeals officer a load of "you know what", you're not going to last long. But, if you have a legally-valid argument, a good appeals officer may find in your favor.

A good tax attorney will be able to guide you through your appeal and hopefully find a fair way to resolve your IRS difficulties.

Here are a few tips and "do's and don'ts" when it comes to avoiding audits:

• Hobby losses - Don't expect to get away with calling your baseball card collecting hobby as a "business," claiming losses year after year, if you're really just chasing after cards that look nice on your mantle or in a folder. If you claim a business loss, it needs to come via a legitimate business, not your favorite pasttime.

• Home office deductions - In these days of internet employment and working from home, any of us claim these deductions - and rightfully so. But you've got to go about it the right way. If your place of business is also your residence, your office space must be used exclusively for business purposes (a desk and computer in your den doesn't really count). The IRS limits deductions to actual square-footage too.
If your office takes up 150 square feet in a 1,500 square foot home, then only 15 percent of your total housing expenses are eligible for that deduction.
Also of note, home office expenses cannot result in a loss.

• Casualty losses - Theft, fire, natural disaster - losses resulting from these events typically are legitimate tax write-offs. Rabbits eating all of the vegetables in your garden, peeling paint on your house and your plasma TV going bad and burning out are NOT deductible losses.

• Stupid mistakes - The IRS will eventually find errors if you make them. Use the services of a tax pro, or get some reliable tax software if you have trouble with recording accurate facts, figures and rules.

• Disagreements in returns - If your state and federal returns show different adjusted incomes, that's going to be a red flag for an IRS audit. This falls under the "stupid mistakes" heading above. Double check all of your returns at all levels.

• Major income changes - If you earned $50,000 last year and report $25,000 in income this year, the IRS will likely wonder why. Be prepared to document such changes if they are in fact true.

For more information about audits and the audit process, visit the IRS's website.