Don't Pay for IRS Protection

"What if I get audited?" Even the most conscientious taxpayer probably asks himself that question just as he's sending in his return. It's a common nightmare, this possibility that you'll be called into the office of a bloodthirsty Internal Revenue Service agent so he can rip apart your 1040 and inflict more financial pain on you: More than 60% of taxpayers recently told the IRS Oversight Board that fear of an audit helps keep them honest on their taxes.

Enter audit protection services. These are essentially insurance plans purchased from a tax preparer or lawyer at the time of filing that promise to assist you if you get audited and to pay any additional penalties or fees arising from a tax preparer's mistake.

Audit protection, however, does not protect you from paying for mistakes or fraud committed on your end, such as forgetting to include a 1099 or faking a deductible expense.

Many tax preparers include such a policy in their standard services, but others charge an additional 5% to 10% of the cost of your return for audit protection. You can also buy the service if you do your own taxes: TurboTax, for example, allows you to buy "Audit Defense" for $40, entitling you to have a third party represent you before the IRS and help you develop a strategy for dealing with the agency. (As is the case with other tax-prep software, you don't have to pay extra for reimbursement of penalties and interest incurred because of a program calculation error.)

If your preparer charges for audit protection and you have a pretty vanilla tax return, you can probably pass on the extra insurance. "Audit protection would be a waste of money for someone with most of their income reported on a W-2 and relatively simple expenses. I don't even know why you would consider it," says Robert Willens, a professor of taxation at Columbia Business School and president of a tax consulting firm.

The chances of getting audited are about 1 in 100, and many people go their entire lives without being audited, so you're likely paying for something that you won't actually use. And most audits are pretty straightforward requests for documentation on a specific item. Either you've got the documentation or you don't, and you can probably handle the correspondence with the IRS yourself.

Audit protection services may make sense if you've got a more complicated tax return or a return with a greater chance of being audited. If you've got your own business or made an unusually large charitable contribution, for example, an audit protection policy might be a wise move. But if that's the case, you may be better off going with a tax preparer that includes such services in their initial fee. Since they're on the hook to stand by their work no matter what, they just might be a little more diligent in their preparations.

Bottom line: If you're worried that the IRS might come after you for a poorly-filed return, skip the audit protection and use the cash to buy a receipt organizer instead. That way, in the unlikely event that the IRS actually does come a-knockin', you'll be ready.

Updated 2/25/10

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