The IRS has recently made several changes which set the stage for more aggressive enforcement of our ‘voluntary’ tax system.  One step has been to extend the Voluntary reporting and compliance ‘catch up’ program for US taxpayers who have hidden funds in foreign accounts and avoided the tax thereon.  Surprisingly, 000’s of people have/are applying for the reduced penalties that are offered under the program!  Second, IRS has begun hiring 00’s of additional auditors and has also begun regulating professional tax preparers. The intention is to crack down on the bad ones and provide additional oversight of the good ones.  Ultimately, the oversight program will likely result in the preparer community doing the legwork for the IRS by limiting the amount of creative assistance preparers can provide! But for peace of mind, so long as documents exist to support all amounts reported in filed returns, ‘bring ‘em on.’  The government is under budgetary pressure to increase revenues, and taxes are one of its main sources. So the IRS is seeking cooperation from states in their efforts to identify nonfilers and under reporters. While there have long been file sharing arrangements following completion of audits, now the sharing is occurring on a more current basis to allow IRS to compare state records with federal returns filed. And file sharing is not limited to just state income tax files!!

Based on internal studies and estimates, IRS is working on a major compliance initiative to identify gift tax cheats. Apparently about ¾ of inter-family transfers of real estate never get reported on a gift tax return!  The potential for underpaid gift tax is significant with that kind of volume.  So, not all those new auditors will be looking at income tax filings.  Considering the vast amount of wealth that is set to be transferred to the next generation within the next few years, IRS seems to be positioning itself to ensure that the $1million lifetime gift tax exclusion amount has been exhausted before the estate tax return has to be filed!

A word of advice – consult with a professional on any tax authority correspondence, and definitely in the event you are selected for an audit. Someone familiar with auditing procedures can make a big difference.

Congratulations to the US Treasury Department for improving the speed of processing our income tax returns.  Initial results of last year filings have already been summarized and are being used in decision-making—MUCH faster than ever before!  E-filing must be working!

IRS just recently released the statistical results from last year’s return processing. You may find the following information useful as you gather your 2010 data and documents.

• Approximately 139 million individual returns were filed last year.

• IRS completed almost 1.5 million audits, just about the same number as in ’09, so you can estimate your chance of being audited—just about 1%. But a larger percentage for high income filers –6.4% for individuals with more than $1 million income, so for most normal, middle class folks, our chance of being audited is even less than 1%.

• For those who operate business as corporations, know that the audit rate for corporations was 1.3%, again with a focus on the larger ones—up to 15% of those with assets exceeding 10 million.  So the big guys get the attention!

• There is a definite trend toward ‘correspondence’ audits, conducted entirely by mail. Seems that almost 75% of individual audits were conducted in this manner (much less confrontational, but still requiring the same level of documentary support).

All tax filers should be alert to the fact that IRS spends a lot of money every year on enhancements to their computer systems.  They used to be the largest purchaser of artificial intelligence software in the world.  And it works for them.  Recent experience revealed a new tactic being implemented as a standard part of every examination, whether conducted in their office or on-site (which is their preference for businesses). A number of questions are posed early in the interview, in a focused effort to identify underreported income. The questions are the result of a computer evaluation of the likelihood of same, based on statistically-derived living costs in the general geographic area where the taxpayer resides.  The unique focus on income is new!  Conclusion: anyone reporting a negative or very low amount of taxable income should be prepared to defend their reported low income amounts. Better have the information on loans, inheritance, etc. that must have provided the resources to pay all the bills showing on the return, plus all the (IRS derived) personal costs of living that never show up on returns!

Other statistics are available on IRS website. Search for ‘statistics of income’ for useful benchmark data which could help identify areas that might attract IRS attention in your return!