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What are the Audit Flags for the IRS?

Oct 29th 2019
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Tax tidbits
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In fourteen previous columns, I discussed my use of “tax tidbits” to enliven conversations when talking taxes with clients, speaking to groups like business owners, retirees, investors and home sellers, or teaching adult education courses at places like high schools and community colleges. The tidbits discuss, among other things, Internal Revenue Service rulings, law changes, court decisions and tactics that trim taxes for this year and even future ones.

I‘d like to share more of my favorites with you here.

How the IRS decides which 1040s to audit. Many filers mistakenly believe that the IRS is less likely to audit returns that are submitted late in the filing season, rather than early. Not true.

All returns, whether filed early or late, go through the IRS’s ever-vigilant computers that scan them for arithmetic errors and single out returns for audit on the basis of a top-secret scoring system. The agency then scrutinizes high scorers, as well as some Form 1040s chosen purely at random, to determine which ones to actually examine. One important element in the selection process is how the amounts you claim for, say, charitable contributions and medical expenses as itemized deductions on Schedule A of Form 1040 compare with the totals taken by other individuals with comparable income levels.

Is there a difference between tax avoidance and tax evasion? There is, and the difference isn’t academic.

Avoidance is perfectly legal, whereas, evasion is a criminal offense that carries a jail sentence of as much as to five years, plus a nondeductible fine of as much as $100,000. (Internal Revenue Code Section 7201)

A drastically under-funded and under-staffed IRS lacks the resources to undertake criminal prosecutions against most evaders. That doesn’t mean the IRS is a paper tiger and that evaders can rest easy. The can look forward to more tax tribulations.

The IRS routinely launches civil actions against cheats and requires them to pay sizable, nondeductible civil penalties for fraud. Those penalties are in addition to back taxes and interest charges. 

Here are some words to the wise from a book, “Criminal Tax Fraud: Representing the Taxpayer Before Trial,” published by the Practicing Law Institute: “It is surprising how many ‘witnesses’ or ‘observers’ a taxpayer can create in the process of understating his taxes. A man's mistress can observe that he always pays cash when with her. An estranged wife might have a very good idea of who is being entertained on the ‘business trip’ to Miami. Any bookkeeper told not to record certain payments may be your bookkeeper for life. And it is very difficult to fire an insurance broker who has been giving you kickbacks for years.”

Those admonitions on how to avoid a stay in the slammer should have been heeded by the late Leona Helmsley. She was overheard by her housekeeper to say, "We don't pay taxes. Only the little people pay taxes." The housekeeper's testimony about the Queen of Mean's indiscreet remark helped Uncle Sam convict the premier New York hotelier and send her to Club Fed on April 15, 1992, to serve a four-year sentence for tax evasion. Unsurprisingly, the media-savvy feds selected the 1040 filing deadline as the date to announce her sentencing.

Senators Max Bacus of Montana and Russell Long of Louisiana on tax reform. Mr. Bacus at the Senate Finance Committee hearings on enactment of the Tax Reform Act of 1986:”The last time this committee met to review the tax code from top to bottom, Eisenhower was president, Joe DiMaggio was married to Marilyn Monroe, and there were no major league baseball teams west of Kansas City.”

Inevitably, there are largely silent winners and vocal losers; reform, said Mr. Long, means “Don't tax you, don't tax me. Tax that fellow behind the tree.” 

Look for more tidbits in future columns.

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 300 and counting). 

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