With the announcement of the hiring of nearly 3,500 new IRS enforcement employees, tax compliance is more important than ever. This hiring initiative is the largest in recent history and includes more than 2,000 tax auditors and tax collectors. The IRS Director of Collection Policy has equated that the sending out of these employees to the field is the tantamount to a military “deployment”.
The IRS has vowed to improve collection efforts through additions to collection personnel, better technology, and an increase in the number of audits. Taxpayers should be proactive and ensure their books are straight before the hiring initiative takes full effect. These new young IRS employees are likely to be very aggressive and tech savvy.
In recent years, the improvements in computer technology have made audits more effective by identifying returns that are likely to have errors. Two IRS audit selection methods that utilize this new technology are computer scoring and information matching. With computer scoring, computer programs give each return numeric “scores”. The Discriminant Function System (DIF) score rates the potential for an adjustment, based on past IRS experience with similar returns. The Unreported Income DIF (UIDIF) score rates the return for the potential of unreported income. Once these scores are assigned, IRS personnel review the highest-scoring returns, select some for audit and identify the items on these returns that are most likely to need review.
Although the formula that calculates the DIF score remains “top secret,” there are likely to be some items that make the selection of the return for audit more probable. Small businesses that claim large amounts of car and truck expenses, travel, meals, entertainment, and “other” expenses are particularly vulnerable to an IRS audit. Additionally, expenses related to “business use of your home” are also subject to strict scrutiny by the IRS. Individual taxpayers that claim large amounts of itemized deductions in proportion to their income or claim large business losses that offset other sources of income may be more likely to be selected for an audit.
Taxpayers should take precautions as early as possible to guard themselves against an IRS attack and a potential IRS adjustment. This is important as an adjustment can be significant, triggering the imposition of penalties, which can sometimes exceed seventy-five percent of the tax due. These penalties, coupled with interest, could create a large assessment which turns into an economic catastrophe for a taxpayer.
Precautions start with maintaining organized books and records and having your tax return prepared by a trained, reputable individual. Some taxpayers, despite doing all of the above, may still be selected for audit. At this point it is imperative that taxpayers understand their rights and prepare themselves. Taxpayers should hire an experienced representative who is well-versed with the Internal Revenue laws and can ensure that the taxpayer’s rights are not violated.
During an IRS audit, the burden of proof is on the taxpayer to prove that income, deductions, and the calculation of tax are accurate. Therefore, books and records should be submitted to the IRS auditor in an organized fashion. These records should tie into each of the positions taken on the tax return. Convincing the auditor that organized and accurate records were kept helps build credibility between the auditor and the taxpayer. Credibility is valuable in that it may limit the scope of the audit and may limit the audit to the year being examined. If there are more serious issues involved with a return, such as unreported income, it is important to proceed with the utmost care to ensure a referral is not made to the Criminal Investigation Division of the IRS.
Taxpayers who are aware of tax discrepancies before an IRS audit or investigation begins may be able to take advantage of the Voluntary Disclosure Program. It has been the practice of the IRS not to recommend criminal prosecution for taxpayers who qualify for the program, comply with its procedures, come forward, and make good faith arrangements to address their tax liabilities. These arrangements may include filing previously unfiled tax returns, amending previously filed tax returns, and making arrangements to pay any balance owed.