Audit Flags

IRS Lifestyle Audits, State Agency Task Force and Other New Techniques to Collect Tax

The Federal and State governments are aggressively looking for money and using new techniques to find it. Some of the aggressive techniques are:

Intimidating tax practitioners from taking deductions.

IRS is using intimidation techniques in an attempt to prevent tax practitioners from giving better than standard tax reduction advice by sending out news releases and distributing warnings to the tax practitioner community.

  • IRS is assessing more severe preparer penalties for more aggressive interpretations of the tax code and publicizing their seizures, levies and settlements and court victories.
  • IRS is auditing more bad tax practitioners and their clients
  • IRS is imposing more regulations, more requirements for compliance for both businesses and tax practitioners, thus creating more chance for penalties
  • IRS and State agencies are using the internet for information. Searches for tax dodgers typically begin with examinations of bank, employment, tax and motor-vehicle records.
  • Using Google. Now, when a tax dodger can't be found agents often turn to Google. One agent collected $30,000 of unpaid tax from a resident after a Google search found him listed as a high-ranking local marketing rep for a national firm.
  • Facebook or Myspace. If a Google online name search isn't productive, agents use social sites or chat rooms in a last-chance hunt for their quarry. Tax agencies are gleaning info from social websites like Facebook and Myspace to locate and levy on deadbeat parents, tax protesters and those under reporting income via relocation announcements, professional profiles or financial boasts. The default settings for adults on MySpace create a public profile, while the default settings on Facebook create a profile only viewable by an approved list of friends. Agents are not allowed to 'friend' someone using false information. The same ethics rules hold in California, according to a spokesman for the state's Franchise Tax Board.

In Minnesota, authorities were able to levy back taxes on the wages of a long-sought tax evader after he announced on MySpace that he would be returning to his hometown to work as a real-estate broker and gave his employer's name. The state collected several thousand dollars, the full amount due.

Nebraska collected $2,000 from a deejay after he advertised on his MySpace page that he would be working at a big public party.

IRS is gleaning mortgage application information for disclosure of income.

When a taxpayer is assessed taxes on the stated income on the mortgage application, they are often given the choice to pay the taxes or go to jail for mortgage fraud. They often choose to pay the taxes even if they actually overstated their income.

IRS auditing more taxpayers through the mail

Correspondence audits typically focus on one or two narrow issues in which a taxpayer is sent a letter that, for example, says their charitable or un-reimbursed employee business deductions will be denied and a certain amount of extra taxes assessed unless they provide acceptable documentation supporting the deductions within 30 days.

These notices from the IRS are often inaccurate and the taxes overstated. Often there are significant mail processing delays and it is often difficult to connect with the agent working the file. These delays can cause taxpayers who respond with documentation within the required time to be assessed extra taxes because their responses don't get to the right IRS employee in time. TIGTA* found that documents are often misplaced by the IRS or the files contained multiple copies of requested documents, each having different IRS stamp dates.

Then, in order to get the penalties abated, it often requires an audit reconsideration, which causes the taxpayer more stress and expenses in challenging the IRS—when it is often an erroneous tax assessment.

IRS often misplaces information and denies ever receiving it even when sent by a tax professional in defending their client. Correspondence audits have more than doubled in the past few years. The IRS is using correspondence audits in the self-employed and small-business division too to challenge items on Schedule Cs, reporting self-employment income, and Schedule Es, for rental real estate.

This has been a successful cost-effective program for the Feds. Often taxpayers don't actually owe anything, but are afraid of the IRS and simply send in money anyway. Over the past four years, the percentage of folks whose cases resulted in no change—meaning after they sent in their documents the IRS agreed they didn't owe anything extra was about 26%. Taxpayers agreed to pay the deficiency in 36% of the total cases.

In fiscal year 2007, about 20,000 audit reconsideration cases were closed. Based on a sample of cases, TIGTA found that in 78% of them, the IRS reduced or threw out its own assessment, leading to 68% of the assessed tax dollars in closed cases to be abated. TIGTA estimates that of the $785 million in assessments the IRS credited to the discretionary audits, $44 million was later wiped out during audit reconsiderations.

*TIGTA—The Treasury Inspector General for Tax Administration was established under the IRS Restructuring and Reform Act of 1998 to provide independent oversight of IRS activities. TIGTA promotes the economy, efficiency, and effectiveness in the administration of the internal revenue laws. It is also committed to the prevention and detection of fraud, waste, and abuse within the IRS and related entities.

Lifestyle Audits

IRS has been using this technique in which they tax you on the amount of income they believe you must have earned for your household lifestyle. This is usually imposed on self-employed individuals and those who operate business through closely-held entities, since they have more control over how much is reported in their name.

Example: A self-employed married taxpayer with two children, a mortgage, auto payment and contributions to charity. IRS asks how was the taxpayer’s family supported on the low profit reported on tax return? IRS may factor in the expenses to operate household, such as mortgage payment, property taxes, homeowners insurance, expenses on two automobiles, such as fuel, maintenance, insurance and a car payment on one of the vehicles, average household expenses for family of four in geographic area, such as groceries, utilities, etc.

Note: The IRS will often back off on pursuing the reconstruction of phantom income, if it can be shown that the taxpayer supplemented living expenses from loans, credit cards or help from family members.

IRS challenging closely-held corporations that are not acting like corps When corporate compliance requirements are not followed, a corporation could be taxed as a general partnership, thus subject to the higher Self-Employment Tax and could lose its asset protection nature.

Sharing of information between agencies:

IRS, FTB, EDD, SBOE, Unemployment, Workers Compensation, Labor Board, OSHA, and/or EPA = New California Task Force.

This is a new technique by California creating much intimidation. Three or four CA regulatory agencies visit a business without notice and ask probing questions of the employees and contractors. A new client of mine was away from the job site, his staff and a couple of independent contractors were asked questions about their licenses, OSHA found a safety violation regarding the scaffolding which resulted in a fine. Later when OSHA approached him about the fine, they indicated the amount would be variable depending on how many of the agencies in which he was compliant.