Close behind the fear of heights and the fear of public speaking is the fear of the IRS. That phobia was fueled even more by Senate hearings a few years ago that uncovered case after case of unscrupulous behavior on the part of some IRS agents as they acted on incorrect information. Sadly, that fear of the IRS can keep people from taking the legal deductions that are rightfully theirs. Some people even overpay their taxes in the mistaken belief that they can somehow appease the auditor with that extra tax payment. The IRS has since made dramatic changes in how it conducts business. Those changes make it even easier to comply with the IRS regulations and take advantage of all of the loopholes available.
The number of IRS audits has dramatically reduced over the past three years. For example, .61 percent of individual returns were audited in 1997, but by 1999 this figure was cut almost in half, to .31 percent. For individuals reporting between $25,000 and $100,000 worth of business income on Schedule C, the rate of audits during the same period fell from 2.04 percent to slightly over 1 percent. While 1.16 percent of corporations with assets less than $250,000 were audited in 1997, the 1999 figure was only .44 percent. Similar drops in audit rates affected most categories of returns.
Even more important, the way the IRS conducts its audits has dramatically changed. Taxpayers whose only income comes from wages and investments will have little or no contact directly with the IRS. All contact with them will be done via the mail, phone or electronically. Auditors are now instructed to use judgment on audits. If after reviewing the books and records of a taxpayer, they see the taxpayer maintains good records, they must end the audit. Focus will be made on delinquent payroll tax reports and payments, with construction companies and restaurants the primary industries targeted. The IRS is also targeting abusive tax shelters such as “pure” or “constitutional” trusts for audit.
The top three reasons audits occur are easily preventable. They are:
1. The math on the return isn’t correct. To prevent this, take the time to manually add up the columns of numbers on your return.
2. The Form 1099 and W-2 amounts reported by third parties do not match the amounts reported on the return.
3. The business code selected for the business shown is not correct.
What if You’re Audited?
The first step in case of an audit is to avoid panic. An audit notice does not mean you are going to jail. Many taxpayers make the decision to appoint a representative to deal with the IRS. I believe this is good policy. Once a representative has been appointed, the IRS is required to deal only with the person you have appointed. For the audit, make sure you have neat and orderly files. File paid invoices and receipts by vendor for the applicable year. The auditor will ask for a copy of your general ledger and financial statements for your business. This is a time when a well-kept computerized accounting system will really pay off. If you have a corporation, the auditor will ask to see copy of the minutes, resolutions and other corporate filings. The best way to get ready is to keep these records current at all times.
With the changes in how audits are conducted, those who are audited will likely find it isn’t nearly as unpleasant as they feared. Good tax planning and record keeping will help you keep more of what you make, legally, morally and ethically.