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Recent articles by Jeff Schnepper: • Take a working vacation -- and a deduction, 7/31/2005 • Salary reduction plans adds cash to your wallet, 7/31/2005 • Get the most out of itemizing on taxes, 7/30/2005 More... |
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| Deduct it: Odds against an audit are good | |||||||||||||||
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The odds that you'll actually get tapped for an IRS audit are still extremely low. Should you be more aggressive in your tax planning? Sure -- so long as you can justify what you're doing. By Jeff Schnepper Have you ever thought of bungee jumping? Have you skydived or thought about exploring the ocean floors? Would you rather gamble in Las Vegas or lie on the beach? Just how much risk do you enjoy taking? If you really get off on the adrenalin rush of risk taking, then the tax game may be for you. No, Im not advocating cheating on your taxes. What I am suggesting is that there are situations where the tax law may be vague or subject to different interpretations and, with good substantiation, you can use the law to trim your tax bill. But there's risk in the strategy. The IRS might disallow your move, and you have to pay up. Remember, our tax code is not known for its clarity or its simplicity. There have been many tax decisions where four out of nine of our top jurists on the Supreme Court got the answer wrong!
But, how about the know-it-alls from the IRS? Try calling the IRS. In 2002, they only answered 68% of calls into their toll free lines. And, if you got through, how accurate were their answers? With respect to tax law questions, they were WRONG 19% of the time. If you asked a question about your own account, they were still WRONG 26% of the time! In a study by IRS investigators from July to December 2002, IRS Service Centers gave incorrect answers to 43% of the tax law questions. About 500,000 taxpayers who visited the Centers during that period were estimated to have received incorrect responses. Things werent much better in 2003 when the Treasury Inspector General for Tax Administration (TIGTA) did a survey and found that the IRS incorrectly prepared the tax returns of anonymous agents 83% of the time! 2004 was an improvement. The TIGTA reported that the accuracy of answers to tax questions posed by taxpayers at Internal Revenue Service offices improved to 67%. But, thats still 33% WRONG answers! You might be better off just calling. The TIGTA report showed that only 6% of taxpayers failed to get complete and accurate information on monitored calls. So, if you're going to push the envelope, will you get audited? Probably not, but you need to understand how people come to be audited. Here's what you need to know. Fewer of us are being audited Recent years have seen big declines in the audit rate -- the number of returns examined divided by the total number of returns filed the previous year. It dropped from 1.67% in 1995 and 1996 to a low of 0.49% for 2000 and $0.57% in 2002. In 2003 and 2004, the audit rates have moved higher. But it's hard to say a 0.77% audit rate -- 1 return in 130 -- represents a huge increase. The total number of individual returns examined in 2004 topped 1 million for the first time since 1999. Audits of returns showing income of more than $100,000 moved higher as well, up to 1.47%. Thats about one out of every 68 tax returns. That could double and still be lower than the comparable 1996 level. But here's what's gives the Bush administration and Congress fits. The General Accounting Office estimates that 1 million to 2 million Americans have credit-card accounts in tax-haven countries, and fraudulent activities cost the Treasury $20 billion to $40 billion a year. The offshore tax-shelter business has flourished because theres really little real financial risk. Investors are shielded from basic IRS penalties by attorney's opinion letters ratifying the deals. As a result of this, the IRS has been fighting back, including getting banks and credit-card companies to disclose the names of customers with offshore accounts set up to conceal income. But the IRS has suspended the so-called "audits from hell" program, where the agency was going to do some serious digging. Still, in many cases, the difference between a legitimate tax shelter and abusive noncompliance is whether you win the lottery of the numbers. Are you doing something out of the ordinary? Most individuals are selected for audit on a random selection basis or on whats known as your DIF score. Thats where the IRS compares your deductions with other taxpayers comparable to you. If you have a Beverly Hills, Calif. ZIP code, the IRS might want to know why your income is so low. Alternatively, if your ZIP code puts you in a distressed neighborhood and you report minimal income, the IRS is going to question a five-figure charitable deduction. The more inconsistencies that exist, the more the computer is going to click and the greater the odds that a real human being is going to review your return. Substantiation is the key If youre way above average for a specific deduction, I strongly recommend that you attach substantiating documentation to your return. That is, quantify exactly the deduction you're claiming, and be able to point to the section of the tax law that permits it. Here are two possible -- albeit extreme -- scenarios so you know what I mean.
The IRS doesnt want to audit those who know the rules and are ready with substantiation. That costs them examination time and doesnt generate any additional revenue. Get aggressive! Whats your downside? As long as its not clearly fraud, if you have at least an arguable position, youre probably only facing having to pay the tax you would have paid anyway, plus an interest charge, currently at 5% a year. But youve had the use of the dollars you would have paid in taxes. Its like borrowing the money at a 5% rate, with no points. If thats your cost, and only if you get audited, your actual risk is minimal -- especially with an audit rate of 0.77%. But what if . . . You don't have perfect substantiation? If you have a legitimate expense or charitable contribution and you lost your receipt, dont be afraid to claim that deduction. Even with the IRS again doing "super audits," where every number on your return is subject to review, the odds are still in your favor that you wont be audited. After all, according to the IRS's own Audit Guidelines for Examiners, adequate evidence does not require complete documentation. Statements made by the taxpayer or others may serve as adequate evidence in an audit. And, if you do get caught, a 2003 Senate Finance Committee hearing revealed that 60% of identified tax debts are not pursued and that 75% of taxpayers who dont even file a return get away with it. Do you feel lucky? If so, when in doubt, deduct it out. | |||||||||||||||
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