By Kathleen M. Lach
Bid adieu to the days of the 'kinder, gentler' Internal Revenue Service ( IRS ) , and, as we move into the height of tax season, beware that the IRS has developed new initiatives focused on tax enforcement. IRS audits are on the rise and its collection activities are increasing. Mark Everson, commissioner of the IRS, is pleased. His goal of 'enhanced enforcement activities to ensure everyone pays their fair share' is moving forward. The Service is making strides in its renewed focus on collection and enforcement activities. The job is not done, however, and Everson promises ongoing efforts to close the 'tax gap.'
The tax gap is the difference between the tax owed to the IRS, and the tax which is paid on time. It is estimated that the gap in 2001 was more than $300 billion, so it's no wonder that in 2003, when Everson took the helm of the IRS, one of his targets was improved enforcement.
Most of the 'gap' is attributable to non-filing of returns, underreported tax or unpaid tax. Underreporting of income tax, employment tax and other taxes represent a significant portion of the gap. The IRS reports: 'The single largest sub-component of underreporting involves individuals understating their incomes, taking improper deductions, overstating business expenses and erroneously claiming credits. Individual underreporting represents about half of the total tax gap. Individual income tax also accounts for about half of all tax liabilities.' Hence, in its efforts to close the gap, the IRS has turned its attention to audits.
Everson reported that in 2005, the total number of individual returns that were audited increased by over 20 percent to more than 1.2 million. This is the highest audit level since 1998. Audits of individual returns reflecting incomes over $100,000 increased to over 221,000, the highest number in 10 years, and more than twice the 92,000 audits that were completed in 2001. Everson's position is that ' [ t ] he coverage rate in this category is still too low, but at 1.58 percet is double what it was four years ago.'
Audits of businesses have also increased. In 2005, more than 17,000 small business audits were conducted, compared to 7,294 in 2004. For large corporations, with assets over $10 million, the audit rate has increased 14 percent to 10,878.
The IRS has received full funding of its appropriation request for this year, and an increase in audits of high income individuals will continue, reports Kevin Brown, commissioner of the small business/self-employed division of the IRS. He also stated the service will earmark some of these additional resources for new target groups, such as audits of individuals with incomes over $200,000. Another factor which is certain to flag a return for audit includes continual losses reflected on a return in combination with a residential zip code matching an affluent suburb.
An IRS audit may take different forms, depending on why a return was selected for examination. An information matching system at the IRS centralized service centers may catch math errors, or other reporting omissions, triggering a service center audit. This type of audit is conducted by correspondence generated from the service center. In an 'office audit,' a taxpayer is summoned to a local IRS office to meet with an agent, often holding the title of 'tax compliance officer', who will generally only look at certain target issues. Finally, the most comprehensive audit is the 'field audit.' An IRS revenue agent will request a full review of financial records including bank statements, cancelled checks, invoices and proof of payment, as well as any other support for the numbers on the return under examination.
What does this increased scrutiny mean for the average taxpayer? Individuals and business should not be afraid to consider every legal tax advantage when filing a return. It is the questionable transaction, unreported income, and overstated deduction which are sure to come under close scrutiny in any review. Individuals and businesses with accurate returns and proper supporting documentation for the items reflected on their returns will generally be able to work through an audit with little difficulty, and should not fear these increased compliance efforts by the IRS.
So sharpen your pencil, face that box of receipts, and plug in those numbers. Of course you may always take the easy way out and hire a competent professional to do the job, but in either case, tax filing and paying requirements are clear, and a timely, well-supported and accurate return, with payment if necessary, is a sure way to keep the 'tax man' at bay.
Kathleen M. Lach is an attorney at Arnstein & Lehr LLP. Her practice is primarily focused on representing individuals and businesses before the Internal Revenue Service and Illinois Department of Revenue.
