Recently released statistics regarding IRS audits reveals that taxpayers are winning some major reductions in their tax liabilities by fighting the IRS in Tax Court. You can end up paying half or often much less by not settling with the IRS and exercising your right to appeal an unfavorable decision of IRS to the United States Tax Court. The statistics published for the fiscal year 1996 show the following ranges of disputed amounts and the percent actually paid by the taxpayers of the amount determined to be owed by the IRS including interest and penalties.
Original Amount Assessed % Paid Paid Less than $10,000 51 $10,000 - $100,000 48 $100,000 - $1 Million 44 $1 Million - $10 Million 35 More than $10 Million 12
As you can see these figures, which exclude tax shelter cases, indicate that on the average, you will save at least 49%, (less the cost of competent representation), should you choose to fight the IRS in Tax Court. These are just averages and each case is decided on its own merits which is not necessarily the case with the decisions made by the IRS. Sure wish sports book offer odds like these! But before you put on the gloves, you may want to consider some more statistics.
What are your chances for getting audited? The following figures represent the percentage of individual tax returns being audited by income level. Although we are interested in what is happening today, we also want to keep our eyes on trends, therefore we have included the figures for 1988 as well as 1995.
Audited Income Level 1995 1988 Less that $25,000 (using short form) 1.3% 1.0% Less that $25,000 (using long form) 2.0% 1.0% $25,000 - $50,000 9.0% 1.7% $50,000 - $100,000 1.1% 1.5% $100,00 or greater 2.8% 11.4%
These figures support the testimony recently given by current and ex IRS agents at the Senate Finance Committee Oversight hearings regarding the IRS, when some asserted that the IRS targets those that cannot afford to defend themselves. As you can see from the figure above, that they have greatly reduced the % of the large income returns audited. The IRS has been forced to focus on the less complex returns because of a combination of factors. One of the major reasons is the downsizing and reorganization which has occurred in the past few years. Another factors is the larger returns can be extremely complicated which increases greatly the time involved, the expense incurred and the expertise required. Add to this the fact (see above) that the Tax Court gives it back at a much higher rate to the high rollers, we can begin to understand the new IRS attitude, "Big audit…big problems, small audits…small problems".
So what was been the effect of these changes within the IRS? Well considering that in 1995 the IRS assessed taxpayers a record additional $7.8 billion in taxes and penalties from 1.9 million audits, it looks like they are raising more money with these tactics. The data below illustrates the effect of the change in focus and the results.
* Assessments included additional taxes, penalties and interest.
Year Returns Filed (millions) Total Audited (millions) % Audited Assessed by IRS* (billions) 1988 103.3 1.6 1.57 6.0 1989 107.0 1.4 1.29 4.7 1990 109.9 1.1 1.04 5.3 1991 112.3 1.3 1.17 6.9 1992 113.8 1.2 1.06 6.3 1993 114.7 1.0 0.92 5.7 1994 113.8 1.2 1.08 6.2 1995 114.7 1.9 1.67 7.8
Just how does the IRS pick who gets audited. The actual criteria the IRS uses to select returns is a highly guarded secret but we can see from the above chart that the criteria changes from year to year. The audit selection process is multifaceted. First, all returns are reviewed routinely for simple and obvious errors, such a missing signatures or social security numbers. Next, the Automatic Data Processing (ADP) program performs a variety of additional validations and verification functions. The Information Document Matching program matches data on a return with information supplied by a third party, such as a W-2 or a W-2G. Still another part of the ADP program, called the Mathematical/Clerical Error program, checks every return for mathematical errors. The Unallowable Items program identifies deductions that have been claimed which are not allowed under the law such as claiming a deduction for federal income tax paid or an incorrect filing status. This program is performed both by computer and by IRS personnel. Should a discrepancy be uncovered in this manner, the IRS automatically makes the appropriate corrections, recalculates the tax owed and sends a letter informing the taxpayer of the changes. If additional tax is due, the taxpayer is given 10 days to make the payment without having to pay interest or penalties. If the taxpayer, can explain the discrepancy to the satisfaction of the IRS, the assessment of the additional tax is abated. However, the case will be continued as either a correspondence or office audit, if the taxpayer's response is deemed unsatisfactory.
After the preliminary review by the ADP system at the regional service centers, all returns are transmitted to the national office on computer tape which is then run through a computer program that rates each return on its audit potential. This is done by means of applying an undisclosed and always changing formula (Discriminate Function Formula) which applies various mathematical weights to items on the return. A composite value, called the DIF score, is then calculated. The higher the DIF score, the higher the probability of a favorable (to the IRS) result of an audit. The returns with the highest DIF scores are selected for manual examination which yields about 10% of the returns filed. If the cause for the high DIF score is not explained to the satisfaction of the reviewer, the return is forwarded to the Examination Division of the appropriate district office to be audited. About 10% of the returns of the manually reviewed are flagged for audit (or 1% of the total filed). The majority of returns that are audited are selected in this manner, but other methods can be used on individual returns with income in excess of $50,000 or on which a large refund is claimed. Tips from individuals can also trigger an audit and occasionally the IRS will target an industry such as card clubs and often concentrates on a specific issues such as the handling of tips to employees. These "industry reviews" often result in "industry guidelines" which if followed will exempt the items covered in the guidelines from audit.
Should you be selected for audit it is our recommendation that you should retain a qualified tax practitioner to represent you with the IRS. Once you obtain representation, you never have to talk to the IRS yourself or even go to their office, your representative should handle it all. Be advised that only Enrolled Agents, CPA’s and attorneys are authorized to "practice" before the IRS and the Tax Court. Remember it is often the case that you have to go to Tax Court to get justice. Now may be a good time to settle up with the IRS in light of the scrutiny the IRS is under due to the Senate hearings and the resulting press coverage.
Remember R.B.S. is better than their BS... © Copyright R.B.S. Tax Services, 2000