The Internal Revenue Service relaunched its program of random audits this month in an effort to hone its ability to estimate compliance rates and crack down on tax fraud. Unlike its usual audits, which are more targeted and so not representative of all taxpayers, the program will randomly select about 13,000 individuals for a closer examination of their 2006 returns. The goal is to gather information that will help reduce the $290 billion "tax gap," the estimated difference between taxes paid and taxes owed. (In 2006, the IRS audited about 1.3 million taxpayers as part of its routine auditing process.)
To help sort out what happens during an audit, and how to minimize the chances of undergoing that unhappy process, U.S. News spoke with Ian Comisky, a partner at Blank Rome and coauthor of the reference book Tax Fraud and Evasion.
What happens during a random audit?
No one knows for sure what will occur during this latest round of random audits. The IRS has stated that a lot of the audits won't be that intrusive. They're going to use their computer matching program to verify some things. [But for some] it looks like there will be an intensive audit, which can include verification of every item on the return. That means you have to prove you're a citizen, date of birth, dependents, income and expenses, etc. (i.e., that they really exist). In terms of how intrusive each audit will be, we won't know until people start getting audit notices.
What should you do if you get an audit notice?
If it is a computer-matching notice of audit or for verification, you may be able to handle it yourself. Otherwise, call for help. Call your accountant. My general view is, unless you have a very simple return, you're going to need help if it's a "complete" audit. It may be very time-consuming. You'll want a professional to help you.
How expensive is that?
It depends how intrusive [the audit] is. It can be a couple of hundred dollars to $500 to much more. It depends how long it takes and whether in addition to the time-consuming nature of the review, the IRS is finding anything. If the return is immaculate, it should not be very expensive. Otherwise, it will take longer and longer, if, for example, you have to start explaining income not reported.
If you don't have problems, just get someone competent who can help you. If you have problems, you may want to call someone like me.
Could you go to prison as the result of an audit?
If it's a big enough problem—that is, there are firm indications of fraud—they can refer any audit to a criminal investigation unit. It depends how much unreported income you have and how flagrant it is. For example, if a taxpayer is making $100,000 and reported $30,000 a year, and this continued over several years, they may seek to refer the case.
How can you reduce your chances of getting audited?
You can't reduce your chances of a random audit. But for audits in general, there's a lot of stuff you can do.
For a normal tax return, file an accurate return, and most of the time you won't get audited. Get a reputable return preparer. If someone says, "Don't worry, you won't get audited if your expenses are below this amount," that is probably not someone you want to work with. Keep records. If you have any cash transactions, keep records. If you make a mistake, and you discover it, you can file an amended return before any audit starts. If you make a mistake, it is just that most of the time. But if you go into a return thinking, "Maybe the IRS won't catch me," and you don't report 10 or 20 percent [of your income], that's not the way to do it if you want to avoid an audit or more than an audit later.
In general, small-business owners and self-employed people have a much larger likelihood of getting audited, because W-2 wage earners have taxes withheld from their returns.
Other "stuff" that may pop you out of a computer and trigger an audit includes a situation where you have $50,000 in income and have reported losses of $100,000, wiping out all the income reported. Or, a taxpayer showing $60,000 in income with a $45,000 mortgage [deduction] may get you an audit.
What if you're a waiter and most of your income is in tips? Does that mean you have a better chance of getting audited?
[The IRS] has nationwide statistics on what they expect waiters to report. If it's dramatically below that amount, they may get audited. If you're in the general parameters, you're probably OK. You're supposed to report everything. And as attorneys, we have an obligation to tell people to report everything.