Odds on audit: a long shot
© St. Petersburg Times, published April 8, 2001
Nothing strikes fear in the heart of a taxpayer like an IRS summons to an audit.
"It's a very intimidating feeling," said St. Petersburg accountant Wayne N. "Skipp" Fraser, a partner with Fraser, Culbreth & Co. "It humbles the biggest executives. Some people get freaked out."
But the odds of it happening to you get smaller each year. Last year, five returns out of 1,000 were pulled for audit, less than a third the number being audited five years earlier. And most audits now take place by mail, requiring only a written response, rather than through face-to-face encounters with the IRS.
While nobody enjoys being audited, the precipitous drop-off is creating concern at the IRS and among some members of Congress.
"The greatest risk is that the average taxpayer who honestly pays taxes loses confidence if the IRS fails to act effectively and efficiently to collect from those who do not pay what they owe," IRS Commissioner Charles O. Rossotti told Congress last week.
He said there is no need to go back to the old days when audits were more frequent, but the IRS does want more money to halt the continuing decline and to focus enforcement efforts on areas where they are most needed.
The agency has been criticized for going after the easy targets, such as low-income people fraudulently claiming the earned income credit, while ignoring high-level tax cheats whose international activities and webs of corporations make them more difficult to catch.
Although the chances of being audited are slim, tax publisher CCH Inc. points out that you still are more likely to be audited than to be hit by lightning, so you might as well take a few precautions. That is particularly true if your return fits into one of the categories that score high as IRS audit bait.
Returns selected for audit typically involve one of the following:
Deductions that are large relative to the amount of income reported. Just how large they have to be to trigger IRS interest is a closely guarded secret.
The earned income tax credit, a focal point for anti-fraud efforts.
Business expenses on a Schedule C, especially if they involve an industry the IRS has targeted for more thorough examination.
Trusts or tax shelters the IRS considers abusive.
What should you do if you think the IRS might find your return ... interesting?
"Prepare an accurate tax return," said W.H. Simon, a former IRS enforcement manager whose Clearwater company, W.H. Simon & Co., helps taxpayers work out their problems with the agency.
The first step to escaping IRS scrutiny is to follow the directions and get the numbers right. That means carefully copying Social Security numbers and all those numbers from W-2, 1099 and K-1 forms. If one of those forms has a wrong number, you need to get a corrected form issued rather than simply correcting it yourself on your return.
Be sure to write numbers in the right place on your return, double-checking the math and including all the necessary attachments. For example, non-cash contributions to charity, such as that garage full of stuff you gave to Goodwill, require a special form if you are claiming they are worth more than $500.
Failure to keep all your forms and numbers straight likely will prompt an IRS computer to send you a letter but probably will not, by itself, trigger an audit.
One reason the IRS promotes electronic filing so heavily is that it eliminates many basic errors. You put in the information and the tax software takes care of filling out the correct forms and doing the math.
Contrary to popular myth, electronic filing does not make it any more likely that a return will be selected for audit. Nor does a big change in your income or deductions from one year to the next. However, if you are audited, the IRS may look at your returns for more than one year.
Simon said people who have business expenses also should pay special attention to classifying the items correctly rather than lumping them together as miscellaneous expenses. Any unusual items should be accompanied by a brief explanation, which requires filing by mail rather than electronically.
The next essential step is keeping accurate records to support deductions and business expenses, particularly in any areas you know the IRS might question.
CCH, which has an office in St. Petersburg, says these are some of areas the IRS often checks:
If you are claiming business expenses for a car, a computer or other items that also could be used for pleasure, are you deducting only for business use?
If you live on the premises of rental property, are you writing off all the expenses (including depreciation) or just the portion related to the part you rent out?
Are you deducting too much for business meals and entertainment expenses? Usually only 50 percent of the cost is allowed.
Are you deducting expenses that your company reimbursed?
Are you running personal investments through your business?
Could fringe benefits provided by your business be considered personal expenses that solely benefit your family?
If your business issues 1099 forms for services from independent contractors, could the IRS claim they are employees?
If you sold property on which you previously claimed depreciation deductions, is the gain or loss you are claiming consistent with prior returns?
If you have been audited before, are you repeating the same mistakes you made then?
Is a deduction you claim obviously illegal? Items in this category include a loss on the sale of your home, a medical deduction for funeral expenses, an interest deduction for credit card debt or car loans or a deduction for sales tax or auto tag fees.
"If you run any kind of a business, there's always stuff that the IRS can pick up and challenge," Fraser said. "One thing they love to get you on is automobile mileage and whether it is properly documented with a log. Employee business expenses are another area the IRS tends to focus on because it's easily manipulated and abused. A lot of people guess rather than have things fully documented."
People who work in cash businesses such as beauty salons and restaurants also are frequent targets of IRS agents looking for unreported income. And recently the IRS has turned its attention to trusts and offshore bank accounts being promoted as ways to avoid taxes.
Simon, the former IRS enforcement manager, said he thinks the IRS has begun stepping up its enforcement activity, doing more criminal investigations of people who do not pay their taxes. But the level of enforcement is still far less than it was a few years ago, and he said that has made some people bolder about taking questionable deductions.
"They say, "I deducted half of them last year and I didn't get an audit so let's be aggressive,' " he said. "Aggressive pretty soon steps over the line to cheating."
But accountant Fraser said most of his clients are not interested in taking extra risks.
"As long as they keep sending things out that have "IRS' on the envelope," he said, "you know big brother is watching."
- Helen Huntley can be reached at firstname.lastname@example.org or (727) 893-8230.
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