IRS Trends in Tax Auditing
Are you aware of the significant changes in the way the IRS targets taxpayers for audits and how it conducts the exams?
Whether you have read statistics about the percentage of returns that are audited or heard about the recent cuts to the IRS's budget, you might feel justified in playing the odds that you or your business won't be among those selected by the IRS for examination. But the numbers are very misleading, because the IRS is getting a lot smarter about how it chooses returns for audit and how its examiners conduct their audits.
Over the past few years, the IRS has dramatically stepped up its efforts to study specific industries, and to educate its examiners about business practices, terminology, accounting methods, and common industry practices. It has also identified areas of inquiry that produce audit results. Examiners are told specifically to look out for certain red flags to get at what is really going on in a business or transaction. The IRS has also updated its tax gap figures (the estimated $450 billion difference between what taxpayers owe and what they pay). Several research studies are underway into various segments of the taxpayer population. That, in conjunction with Treasury reports on IRS audit performance means that examinations are increasingly focused on business areas and issues that are likeliest to generate increased taxes, penalties, and interest.
In March 2012, the IRS released audit rates for fiscal year (FY) 2011, which show a general show an uptick in audits, especially of higher income taxpayers. Individual taxpayers were collectively audited as a 1.1 percent rate over the FY 2011 period. The audit rate for individuals with adjusted gross incomes (AGI) between $200,000 and $500,000 was 2.66 percent in FY 2011 compared to 1.92 percent in FY 2010. The audit rate for individuals with AGI between $500,000 and $1 million was 5.38 percent in FY 2011 compared to 3.37 percent in FY 2010. For individuals with AGI between $1 million and $5 million, the audit rate increased from 6.67 percent in FY 2010 to 11.80 percent in FY 2011.
Another IRS initiative is to improve compliance by fostering greater communication between the IRS and representatives of various industries. This interplay is intended to clarify treatment of specific tax problems far in advance of an audit. For example, the IRS and the food service industry have come to an understanding about properly determining and reporting employee tips. Employers that comply will face reduced IRS scrutiny on this issue. Additionally, the IRS has established the Voluntary Classification Settlement Program (VCSP) where employers who have misclassified their employees as independent contractors may come forward before the IRS initiates an audit and voluntarily reclassify the workers in exchange for reduced penalties.
Written by: By Adam Smetzer, CPA, Chornyak & Associates
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