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Californians can breathe easier with new tax audit insurance

Yes, there is a way to make IRS audits less frightening: tax audit insurance, now available to California residents from Audit Protection Institute (API).

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Historically, audit protection coverage has only been available for professionally prepared tax returns. API, based in Santa Rosa, Calif., is the first company to sell individual taxpayers coverage for audits. The policies are available online at API's Web site.

"Nobody wants to tangle with the IRS."

The coverage costs between $55 and $300 per year, depending on the buyer's tax audit history, and covers a tax return for four years. (The IRS statute of limitation for audits is three years.) The plan pays all audit costs, including IRS-assessed taxes and fees, and representation by your tax professional. If you don't have a tax professional, API pays for one of its own to represent you during your audit. However, if your audit results from fraud, the insurance doesn't cover any costs.

"People could try to defraud us, but that doesn't happen very often," says Dan Walker, CEO of API. "That would be like getting car insurance and thinking, 'Now I can drive recklessly.' The truth is, nobody wants to tangle with the IRS."

Most audits, according to Walker, result from "gray areas," where the IRS disputes a deduction and the taxpayer is unable to defend his claim. Even the most organized taxpayer may have lost his receipts by the time the IRS comes knocking. In this case, Walker says, the IRS generally accepts a compromise between what the taxpayer reports and what the IRS thinks should have been reported.

Who is most at risk for an audit? According to Walker, there are no hard and fast rules. The IRS maintains a top-secret scoring system that ranks every single tax return, flagging potential deduction errors and other tax mishaps that can then result in an audit. There's no telling whether the scoring system might decide that your tax return looks fishy, although API maintains a proprietary scoring system that can review customers' tax returns and predict their risk of an audit.

API also provides audit-representation services and tax return reviews, but not tax-audit insurance, through a nationwide network of tax specialists. API plans to introduce tax-audit insurance nationwide later this year.

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