Five Mistakes to Avoid When Filing Your Tax Returns

Posted on February 21, 2012 by IRS2_admin

Whether this is the first year you’ve filed your taxes, or you’ve been doing it for years, it’s always a good idea to review the most important rules before you get started. There are plenty of simple mistakes that even a veteran can make, but with a little research, they are certainly avoidable.

If you have serious questions, it is always a good idea to consult a tax lawyer. Tax attorneys have experience researching the tax laws, regulations, case law, and administrative guidance to help get a handle on complicated tax issues. However, in lieu of professional assistance, be sure to at least avoid these five common mistakes when filing tax returns:

Missing the filing date. This one doesn’t even need to be said, right? Wrong. You might be surprised to know how many people let this important April date slide right by (NOTE: it’s April 17th this year, for “individuals,” March 15^th for corporations, instead of April 15th). If you do not have all the information available to file, then you should request an extension to avoid the failure to file penalty. However, it’s important to remember: A TAX RETURN EXTENSION IS NOT AN EXTENSION TO PAY ONLY AN EXTENSION TO FILE. You must pay all tax due by the original, not extended, due date. Even if you cannot pay the tax due, you must file by the appropriate date, inclusive of extensions, to avoid late filing fees and penalties. If you are still uncertain about whether to file, then read our blog dated November 7, 2011, titled “I cannot pay the tax reported on my tax return. Should I file?”
Failing to claim all your income. Your total income often includes more than your yearly salary. How about interest and dividends earned from CDs, savings accounts and investments? Did you include the money you made helping your buddy out with his new marketing business? And if you’re a parent and your child is under 18 years of age and earning dividend or interest income, then you may need to report that income on your tax return. Make sure you include everything, or you risk getting flagged by the IRS and owing more money down the line.
Not itemizing deductions, or missing them altogether. This mistake is easy to make when filing tax returns – and it can end up being costly. Make sure you review the complete, IRS-approved list of deductions to make sure you know exactly what can be deducted. Just a few things to consider: medical and dental expenses, home mortgage points, business use of car / home, casualty and theft loss, and educational expenses.
Incorrect basic information. Believe it or not, it happens all the time. You spend so much time and effort reading the rules and crunching the numbers that you make the mistake of entering incorrect personal information on your tax returns. Have another family member proofread for you, or step away for a few hours before checking it over yourself.
Confusing federal and state laws. Don’t make the mistake of assuming that the same kinds of income are taxable for federal and state purposes. Likewise, don’t assume that similar expenses and deductions are allowable across the board. This is another reason you may wish to consult with a tax lawyer or CPA. Be sure to contact someone who knows not only federal law, but state laws as well.

With attention to detail and persistence, you can avoid these common mistakes when preparing and filing your 2011 tax return.

For more information, and tips on filing your taxes, contact Todd Unger today!

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Mean Girls Ain’t Got Nothing on the IRS

Posted on February 17, 2012 by IRS2_admin

The IRS filed a Notice of Federal Tax lien against Lindsay Lohan in an amount of $140,203.40 for a 2010 back income tax liability. This is nothing new for Lohan as the IRS had filed a Notice of Federal Tax Lien for the 2009 tax year in an amount of $93,000.00.

According to TMZ, Lohan’s personal representative told Page Six that “Lindsay’s personal finances are her business and no one else’s.” Unfortunately, her personal representative is dead wrong: It’s now everyone’s business.

By filing a Notice of Federal Tax Lien, a taxpayer’s creditors are publicly notified that the IRS has a claim against a taxpayer’s property, including property acquired after the lien is filed. The tax lien is used by courts to establish priority in certain situations, such as bankruptcy proceedings or sales of real estate.

A tax lien can have devastating consequences such as tarnishing a taxpayer’s credit, making it difficult to refinance and borrow against property, impairing title, and in some cases, the loss of a job.

If you have been notified by the IRS that it has or is about to file a tax lien against you, the Law Offices of Todd S. Unger, Esq., LLC may be able to help. Call us today at (877) 544-4743, or fill out a contact form and request a consultation.

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Understanding Audit Techniques Can Help When Preparing Unfiled Tax Returns

Posted on February 14, 2012 by IRS2_admin

If you have years of unfiled tax returns or are about to file for the current tax year, then understanding IRS audit techniques may help in preparing your tax return.

An IRS Agent employs either the direct, aka specific item, or indirect method or both to determine unreported income, overstatement of expenses, or fraudulent claims for credits or exemptions.

The IRS prefers the direct method whereby the auditor will review specific evidence such as public records, real estate deeds, or W-2s and 1099s to demonstrate additional income. If direct, specific, information is not available, then the IRS agent will use the indirect method.

The indirect method uses economic reality in which the taxpayer’s records are reconstructed through circumstantial evidence. Common indirect methods are the bank deposit, net worth, and cash expenditures method of proving income.

Bank Deposit Method

When the auditor asks for bank statements, they are beginning to implement the bank deposit method. The auditor will scrutinize all cash inflows and outflows in bank accounts to determine the appropriate income and expenses that should have been reported. To guard against an IRS mistake, it is essential to determine whether or not money deposited is considered “income” and to make sure account transfers are counted once.

Cash Expenditures

This method compares all known sources of income with all known expenditures made during a year. If the cash expenditures exceed your income, the IRS takes the difference as unreported income. A good defense would be to show the IRS agent that someone else paid the expenditures or that you were using funds on hand or took out a loan etc.

Net Worth Method

The IRS likes utilizing the net worth method in criminal tax investigations. The IRS will calculate the taxpayer’s net worth, total assets minus liabilities, at the beginning and ending of a period minus deductions and exemptions to derive at the correct taxable income. The difference between the correct taxable income and what was reported equals unreported taxable income. The net worth method is flawed because not all increases in net worth are the result of taxable income. For example, if you own real estate that appreciated from one year to the next.

How do Audit Techniques Help with Unfiled Tax Return Preparation?

When you prepare a draft of your tax return, you must review it in its entirety and to make sure all income and expenses were reported properly. (See our blog post on September 17, 2012 regarding the audit selection).

Additionally, you must raise questions like an IRS agent utilizing the above techniques. For example, if the draft of your return shows a large business loss with no supplemental income and you also have large itemized expenses, then think about how an IRS agent would utilize the direct and indirect audit methods in reviewing that return.

The IRS agent may inquire about how you paid for your living expenses, utilizing the cash expenditures method, or may inquire about assets at the beginning of the year and at years’ end, utilizing the net worth method. If you’ve been using business expenses to pay for personal expenses, then you probably understated your income or overstated your expenses.

Think about it from the government’s perspective: How is it possible that you made no income, but were able to support your living expenses or buy new assets?

There may be plausible explanations. Maybe, during the course of the year you took out a loan, received an inheritance, or your spouse contributed to family expenses, etc. Another explanation may be that the losses were generated by “tax fiction” such as deductions that are not out of pocket expenses. For example, depreciation is not literally an out of pocket, but nonetheless, taxpayers’ can use depreciation as an expense to reduce taxable income. Taxpayers should never be afraid to take all legitimate expenses; however, you should review a return like an IRS agent and utilize direct and indirect audit methods.

When preparing unfiled tax returns, whether it’s last years’ return or years’ prior, a taxpayer should review all information reported by third parties, i.e. W-2s, 1099s etc, to ward off the IRS’s direct methods’ approach, and make sure what was reported is accurate. Additionally, bank statements and credit card statements, assets purchased during the year, and yearly expenses should be reviewed. Before filing a tax return, don’t just sign and date the tax return, but rather review it using IRS Agent techniques and see if it makes sense.

The Law Office of Todd S. Unger, Esq., LLC. focuses exclusively on IRS representation. If you are experiencing difficulty with the IRS, then we can help. We can help with years of unfiled tax returns, garnishments, levies, seizures, payroll tax disputes, and audits.

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When to Submit a Reasonable Cause Request for the Failure to File Tax Penalty

Posted on February 9, 2012 by IRS2_admin

If a taxpayer does not file by the due date, then they are subject to the failure to file penalty unless they can show that any delay was due to reasonable cause and not willful neglect. Accordingly, it is essential that every taxpayer knows tax deadlines. The IRS provides a list of 2012 tax calendar due dates (click here to view list).

The Failure to File Penalty and Non-Pass-Through Entities

The failure to file penalty runs at 5% per month, up to a maximum of 25%. Additionally, the IRS will tack on a fee of the lesser of $135.00 or the amount of tax due. For a greater understating of the failure to file penalty see our blog on November 7, 2011 titled I Cannot Pay the Tax Reported on my Tax Return. Should I file?

The Failure to File Penalty for Pass-Through Entities

The failure to file penalty has a different application with pass through entities. A pass through entity, such as a partnership or S-Corp, “passes through” taxable income to its owner and pays not taxes. For example, a partnership files its own tax return and then distributes income and distributions to its partners through the use of a K-1. Each partner then reports his/her share of income and distributions on a Form 1040.

The penalty on a pass through entity is $195 for each month or part of a month, up to a maximum of 12 months, the failure continues, multiplied by the total number of partners/shareholders during any part of the tax year. Accordingly, the penalty maxes out at $2,350.00 per partner or shareholder.

When to Submit a Failure to File Penalty Abatement Request in 2011

The 2011 instructions to Partnership Returns (Form 1065) and S-Corp and Corporations (Form 1120-S and Form 1120, respectfully) direct taxpayers to wait until they receive a late filing notice from the IRS before sending a reasonable cause explanation. In earlier years, taxpayers were instructed to attach the explanation to the late filed return. Individual taxpayers should include a reasonable cause explanation with Form 1040.

Todd Unger, Esq. is a tax attorney devoted to resolving tax disputes and has helped taxpayer’s remove or reduce penalties. If you need help applying for tax penalty reductions, aka penalty abatement, please contact us today!

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The IRS May Be a Red Sox Fan…

Posted on January 5, 2012 by IRS2_admin

The U.S. Justice Department is suing the New York Yankees’ managing general partner, Hal Steinbrenner, son of George Steinbrenner, over what it calls an “erroneous” tax refund.

According to Bloomberg News, citing the complaint, the refund originated from an audit involving the New York Yankees’ parent company for the tax years 2001 and 2002. At the conclusion of the tax audit, the late owner, George Steinbrenner and the IRS settled. The settlement resulted in adjustments to the tax returns of the beneficiaries; Hal Steinbrenner had a 25% interest, of a family trust. Hal Steinbrenner paid taxes in 2008, and then filed an amended 2001 tax return in 2009 seeking a refund because of a $6.8 million net operating loss carried back from 2002.

The IRS is claiming the refund claim was filed late and has sued Steinbrenner to recover $670,493.78.

Refund Claims Must Be Filed Timely, Though Amount of Refund May Be Limited

Generally, speaking the timeliness of a refund claim depends on whether a tax return was filed. If a return was filed, the claim must be filed within the later of: (a) 3 years from the time the return was filed, or (b) 2 years from the time the tax was paid.

Even if a claim is timely filed, the amount of the credit of refund may be limited. In general, the amount cannot exceed the tax paid within the 3 year period immediately preceding the filing of the claim.

Suits By United States for Recovery of Erroneous Refunds Must be Timely.

The recovery of an erroneous refund by suit is allowed only if the suit has commenced within 2 years after the making of such refund unless it appears the refund was induced by fraud or misrepresentation. In that case, the suit may be brought at any time within 5 years from the making of the refund.

The case is U.S. v. Harold Z. Steinbrenner and Christina L. Steinbrenner, 11-02840, U.S. District Court for the Middle District of Florida (Tampa).

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IRS Voluntary Worker Classification Settlement Program

Posted on December 28, 2011 by IRS2_admin

Your business has grown substantially and you can no longer build it on your own. You investigate the cost of hiring help which reveals an employee is expensive. In addition to employer-provided benefits, office space, and equipment, you are required to make payments and contributions on behalf of your employees, including:

• Your share of the employee’s Social Security and Medicare taxes, which totals 7.65% of the employee’s compensation;
• State unemployment compensation insurance, and
• Workers’ compensation insurance.

To circumvent the expense, you decide to hire Independent Contractors (ICs) and for years the business is flourishing until the IRS contacts you and reclassifies your ICs as employees.

The mistake of misclassification can destroy everything that you have worked hard to build and can result in labor law violations and back employment tax liability with years of interest and penalties.

The IRS estimates that millions of workers are misclassified as ICs, depriving the federal government of huge sums of tax revenue. In an effort to narrow the tax gap, the IRS and New Jersey, although this blog will focus on the IRS exclusively, are focusing on worker classification issues.

Voluntary Classification Settlement Program

On September 21, 2011, the IRS announced a new program, details are provided in, Announcement 2011-64 and IR-2011-95, called the Voluntary Classification Settlement Program (VCSP) that allow employers the opportunity to get back into compliance.

The VCSP is optional and provides taxpayers with an opportunity to voluntarily reclassify their workers as employees for future tax periods with limited federal employment tax liability for the past non-employee treatment. The relief is similar to the current Classification Settlement Program (CSP) which is available to taxpayers under IRS examination.

To participate in the program, the taxpayer must meet certain eligibility requirements, apply to participate in VCSP, and enter into a closing agreement with the IRS.

Independent Contractor or Employee

Whether a worker is performing services as an employee or an independent contractor depends upon the facts and circumstances and is generally determined under the common law test of whether the service recipient has the right to direct and control the worker as to how to perform the services.

In some factual situations, the determination of the proper worker classification status under the common law may not be clear. For taxpayers under IRS examination, the current CSP is available to resolve federal employment tax issues related to worker misclassification, if certain criteria are met.

The examination CSP permits the prospective reclassification of workers as employees, with reduced federal employment tax liabilities for past non-employee treatment. The CSP allows business and tax examiners to resolve the worker classification issues as early in the administrative process as possible, thereby reducing taxpayer burden and providing efficiencies for both the taxpayer and the government.

In order to facilitate voluntary resolution, meaning before an IRS audit, of worker classification issues and achieve the resulting benefits of increased tax compliance, the IRS has determined that it would be beneficial to provide taxpayers with a program that allows for voluntary reclassification of workers outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes.

Eligibility

The VCSP is available for taxpayers who want to voluntarily change the prospective classification of their workers. The program applies to taxpayers who are currently treating their workers as independent contractors or other nonemployees and want to prospectively treat the workers as employees.

In order to be eligible, the taxpayer:

• Must have consistently treated the workers as nonemployees and filed all required Forms 1099 for the previous three years;
• Cannot be under audit by the IRS, Department of Labor or NJ; and
• Must have complied with the results of a previous audit by the IRS or the Department of Labor concerning worker classification.

Effect of VCSP

A taxpayer who participates in the VCSP will agree to prospectively treat the class of workers as employees for future tax periods. In exchange, the taxpayer will:

1. Pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year as determined under reduced rates;
2. Avoid liability for any interest and penalties on such amount; and
3. Avoid any employment tax audit with respect to the classification of the workers for prior years.

Additionally, a taxpayer participating in the VCSP will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

Is VCSP right for my business?

VCSP may be a viable option, but can also be an unnecessary cost for a business that does not have exposure. A tax attorney can help you determine if VCSP makes sense. Additionally, we can help mitigate risks where your company’s employment practices are questionable or help you fight an IRS or New Jersey audit.

The IRS retains discretion whether to accept a taxpayer’s application for the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.

If you have any questions how going into the VCSP program may impact your business, please contact us.

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IRS Installment Agreements are Palatable in the Current Economic Climate

Posted on December 5, 2011 by IRS2_admin

The Internal Revenue Service announced that interest rates for the calendar quarter beginning January 1, 2012 will be the following:

3 percent for overpayments [2 percent in the case of a corporation];
3 percent for underpayments;
5 percent for large corporate underpayments; and
0.5 percent for the portion of a corporate overpayment exceeding $10,000.

The 3 percent rate will apply to estimated tax underpayments for the first calendar quarter in 2012 and for the first 15 days in April 2012.

The rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus 0.5 of a percentage point.

The interest rates are computed from the federal short-term rate during October 2011 to take effect November 1, 2011, based on daily compounding.

This is good news for taxpayers in IRS installment agreements as the rates for underpayments continue to remain at historic lows. To place into historical perspective, on June 30 2008, the rate for an underpayment on individual taxpayers was 6 percent. While tax interest and penalties continue to accrue during an installment agreement, making IRS payment plans difficult, the low rates make an installment agreement palatable.

Revenue Ruling 2011-32, announcing the rates of interest, will appear in Internal Revenue Bulletin No. 2011-52, dated December 27, 2011.

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I Cannot Pay the Tax Reported on my Tax Return. Should I file?

Posted on November 7, 2011 by IRS2_admin

In short, the answer is YES!

In order to understand why you must file, it is important to grasp the penalties associated with failing to timely file.

IRS Failure to File Tax Return Penalty

The IRS’s failure to file penalty runs at 5% per month, up to a maximum of 25%, or fraction of month that the return is filed after its due date. Accordingly, if the penalty maxes out, you will owe an additional 25% of the tax due.

In addition, the IRS will tack on a fee of the lesser of $135.00 or the amount of tax due.

For example, if a taxpayer owes $100,000.00 and the penalty maxes out, the taxpayer will owe an additional $25,135.00. To make matters worse, interest accrues not only on tax, but also on the penalty. This causes an IRS tax problem to spiral out of control.

The failure to file penalty is reduced by the failure to pay penalty, example below, when the two penalties run concurrently.

Most importantly, the failure to file can lead to serious non-monetary consequences. The failure to file is a misdemeanor punishable up to one year in jail as well as a fine of not more than $25,000 ($100,000 in the case of a corporation). Even worse, a taxpayer who fails to file returns for multiple years commits a separate misdemeanor offense for each year.

The IRS Failure to Pay Tax Penalty is Not an Extension to Pay

An extension of time to file is not an extension to pay taxes owed. Therefore, if you owe tax it must be paid in full by the due date excluding extensions. If you do not timely pay the tax in full, the Internal Revenue Code imposes a penalty of 0.5% per month, up to a maximum of 25%, for late payment.

For example, if the due date for a tax year is April 15 and you file a valid extension, the return will be due on October 15; however, if you owe money, you will be subject to the failure to pay penalty which is assessed on April 15, the due date.

The failure to pay penalty increases to 1% per month if the taxpayer does not pay within 10 days of a notice of intent to levy. The amount of unpaid tax subject to the penalty is reduced by the amount of any tax which is paid on or before the beginning of a month.

Interest on the failure to pay penalty begins to accrue if the taxpayer receives notice and does not pay.

If you negotiate an IRS Installment Agreement, the 0.5% penalty is reduced to 0.25%. This reduction is allowed only if you filed a timely return.

Application of IRS Failure to File and Failure to Pay Penalty

Below is an example of how the failure to file and pay penalties would be assessed if the applicable federal interest rates vary between 3% and 4%.

Example

On April 15, 2011, Taxpayer does not file an extension and owes $100,000.00 of tax. On November 2, 2011, Taxpayer would be subject to the following penalties:

Failure to File: $22,500.00

Please note, the failure to file penalty, $25,000.00 (5 months late), is offset by the failure to pay penalty of $2,500.00 (5 months late) to derive at $22,500.00.

Failure to Pay Penalty: $3,500.00 (7 months late at .5% rate)

Interest: $2,227.06 (Interest rates of 3% to 4%)

Penalty Interest: $501.09 (Interest rates of 3% to 4% based on the Failure to File Penalty)

Total: $128,728.15 (includes the minimum failure to file penalty which is $135.00)

In the same example, let’s assume you filed a tax return:

Failure to File Penalty: $0.00

Failure to Pay Penalty: $3,500.00

Interest: $2,227.06

Penalty Interest: $0.00 (example assumes IRS did not send the Taxpayer notice)

Tax Savings: $23,000.00

Conclusion

While it is true it may take the IRS longer to find you if you do not file a tax return, you will save yourself money and avoid any potential, although rare, criminal exposure. With both penalties maxing out, the taxpayer faces an additional 50% of tax plus interest. Therefore, if you owe tax, it is essential you timely file your tax return.

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A Taxpayer’s Lifestyle Can Preclude Discharging Taxes through Bankruptcy

Posted on September 25, 2011 by IRS2_admin

Recently, a bankruptcy court decided that the co-founder of the video gaming corp., Electronic Arts, tax shelter liabilities were excepted from discharge because of willful tax evasion. Hawkins v. Franchise Tax Board, 447 B.R. 291 (N.D. Cal. 2011).

Generally, under 11 USC §§ 507 & 523, income taxes and penalties may be discharged during a bankruptcy proceeding if the following conditions are met:

The tax debt is at least three (3) years old from the due date plus extensions;
The tax return must have been filed more than two (2) years prior to the filing of the bankruptcy;
The tax assessment must be at least two hundred and forty (240) days old; and
Fraud or willful tax evasion is not present.

Hawkins, the co-founder of Electronic Arts (“EA”) obtained stock options in EA. Following the advice of his tax advisor, Hawkins participated in two tax shelters. The Internal Revenue Service (“IRS”) deemed the tax shelters invalid and notified Hawkins that it was auditing his 1997 federal income tax return.

Hawkins demonstrated an understanding that this would carry a significant tax burden when, in a memorandum filed in family court, he indicated that he owed $25 million to the IRS and California Franchise Tax Board and that he was insolvent and further discussed the possibility of filing for bankruptcy. The IRS subsequently assessed the taxpayer approximately $21 million in aggregate assessments for the tax years 1997 through 2000.

Hawkins filed an Offer In Compromise after the tax assessment. In the 433 (Collection Information Statement for Wage Earners and Self-Employed Individuals), the debtor reported wages of approximately $17,000 per month and expenses of approximately $95,000 per month.

These expenses, amongst others, included over $7,000 per month for Food, Clothing, and Misc, $33,600 per month for Housing and Utilities, $2,700 per month for Transportation, $4,500 per month for Child/Dependent care, and $40,550 per month for Other Expenses. The transportation expense included monthly payments of $1,207.61 on a Cadillac Escalade which Hawkins and his wife bought for $69,974.28 in October 2004 to serve as the fourth vehicle for their family of two drivers.

In September 2006, Hawkins filed a bankruptcy petition. The bankruptcy court concluded that the debtor’s tax liabilities were not dischargeable because the taxpayer was willfully attempting to evade taxes because he knew he had substantial tax liabilities, knew he was insolvent, and continued to make unnecessary expenditures despite the knowledge of his finances.

Hawkins argued that court applied wrong standards, mischaracterized his expenditures, or lacked sufficient evidence to support willful evasion finding. He argued that in order to determine that the debtor acted with specific intent to evade or defeat taxes, the IRS must prove the mental state and willful intent to evade taxes. He cited other bankruptcy cases in which the debtor’s payment of expenses to other creditors, rather than paying a known tax, was not sufficient to establish a willful attempt to evade or defeat the tax debt without some additional showing of an effort to conceal assets or deceive a tax agency.

The bankruptcy court concluded in each of those cases the taxpayer made a good faith effort to meet their tax obligations and did not know the extent of their tax obligations. Here, Hawkins knew he was insolvent and that he owed federal and state income taxes in the amount of $25 million yet continued to have “truly exceptional” living expenses. The court noted that Hawkins had two multimillion dollar residences and had bought a $70,000 vehicle to serve as the fourth vehicle for a family of only two drivers.

Therefore, the court concluded the mental state requirement was satisfied because the debtor had a duty under the law, the debtor know he had that duty, and the debtor voluntarily and intentionally violated that duty. The court held that the debtor violated that duty when he spent funds extravagantly.

This case is significant because it sets the precedent that the spending funds after the taxpayer is aware of a tax liability, living a nice lifestyle may preclude discharging tax liabilities through bankruptcy.

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Audits Increased for Individual, Corporate, and S Corporation Tax Returns

Posted on September 17, 2011 by IRS2_admin

A Treasury Inspector General for Tax Administration Report (number 2011-30-071) reported that the number of audits increased for individual, corporate, and S corporation tax returns in the 2010 Fiscal Year. Despite the increase, the report noted a decrease in the number of partnership audits.

The report attributed the rise to an increased number of IRS agents and tax compliance officers resulting in the greatest amount of tax returns examined over the past five years,

The majority of these examinations were conducted by correspondence as opposed to an office audit, or field audit.

Why am I being audited?

Below discusses several possibilities as to why you are being audited

Discriminate Function System

A Discriminate Function System (DIF) is a statistical profile that is computed by comparing income, expenses, and deductions using data for taxpayers in similar income brackets. The DIF score can identify which returns deviate from the norm.

The IRS matching Program

The IRS receives tax information from third parties such as the following:

Employers/Wages (Form W-2)
Greater than $600 for individual services (Form 1099-Misc)
Gambling/Casinos (Form W-2 G)
Pensions/Annuities (Form 1099-R)
Mutual Funds/Financial Planners (Form 1099-Div)
Banks/Interest (Form 1099-INT)
State Unemployment and State Income Tax Refunds (Form 1099-G)
Mortgage Interest (Form 1098)
Partnership (Schedule K-1)
Student Loans (Form 1098-E)

The IRS reviews each information return and compares it to the return you submitted. Any discrepancy in what was reported to the IRS versus what you submitted will be automatically adjusted by the IRS computer system.

Market Segment Specialization Program

The IRS selects various industries or professionals to audit which is known as the Market Segment Specialization Program (MSSP). For example, there was an MSSP on the tobacco, wine, veterinary, aerospace, farming, tanning and a myriad of other industries. The program enables the IRS to create guides that help tax examiners audit a particular industry.

Informants and Random Audits

The IRS may receive tips from informants, gather information from federal, state, and local enforcement of evidence of criminal activity, or pick a return to audit at random.

The IRS announced that it plans to begin random audits for its National Research Program (NRP). These audits will be more intrusive than a traditional audit and the data gathered will be used to update the computer system for DIF. The NRP project will focus on worker classification (employee vs. independent contractor status), fringe benefits, executive compensation, and reimbursed expenses. The IRS is randomly selecting 2,000 employers to audit for each year over the next few years.

Some Good News

Despite the increase in audits, the Treasury Inspector General for Tax Administration Report indicated that the rate for no change, meaning the taxpayer substantiated all items under review, increased for individual income tax returns.

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