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August, 2007 Tax Tip

Enjoy the Rest of Your Summer – This Fall the “Audits From Hell” Return


Run for cover – the random tax audits are coming back!


We have been reading and hearing for quite a while about the “tax gap” and the pressure put on the IRS by Congress to wage war against it.  Simply stated, the tax gap is the difference between what taxpayers owe and what they voluntarily pay.  The tax gap is currently estimated to be nearly $300 billion.  The tax gap is made up of three components: non-filing, underreporting, and underpayment. Non-filing occurs when taxpayers who are required to file a return do not do so on time.  Underreporting  occurs when taxpayers either understate their income or overstate their deductions, exemptions and credits on timely filed returns. Underpayment occurs when taxpayers file their return but fail to remit the amount due by the payment due date.


In an effort to combat the underreporting component, the IRS recently announced that, this fall, it will be reviving the practice of randomly selecting thousands of taxpayers for what practitioners used to refer to as “the audits from Hell”.  Those selected for these audits are not under any suspicion of wrongdoing.  The purpose of the audits is to update the formulas the IRS uses to help select which returns to audit and thus enable it to do a better job of ferreting out tax dodgers.  In other words, those selected are guinea pigs for the masses.


The IRS has stated that, unlike the old random audits where each item on the tax return was scrutinized and taxpayers were required to produce large amounts of supporting documents even for minor items, the new program will be less burdensome and intrusive. 


The IRS reports that research has shown that noncompliance is highest among self-employed individuals who deal in large amounts of cash, don’t have taxes withheld, and whose income isn’t reported to the IRS by way of W-2 or 1099 documents.  Another area of great concern is capital gains, where it is felt that billions of dollars of tax revenue is being lost due to overstatement of cost basis of securities that are sold.  While the IRS is provided with gross proceeds from sales, it is not provided with information pertaining to cost.  Congress is considering legislation proposals that would require brokers and other financial service providers to report to the IRS what investors pay for stocks and other securities.


The majority of the random audit returns will require a face to face meeting with an IRS examiner and, in general, one can expect a more–detailed probe into the tax return than with a normal audit.  The reason for this is the purpose of these audits to begin with – to develop an information base for compliance research.


While a person selected for a random audit may think about representing himself or herself, due to the rapidly growing complexity of the tax laws, most persons who will be faced with detailed and probing questions should consider getting professional help.  This is especially true of a taxpayer who is or may be subject to the alternative minimum tax which disallows several deductions.


TAX TIP:  Be sure to have supporting documentation (including invoice and proof of payment) for each item on your tax return.  In addition, make sure, this information is well organized so that your tax professional won’t have to spend costly hours doing for you what you could do for yourself.



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