Random audits should not be feared

I have to admit I became uneasy when I read that beginning in October, the Internal Revenue Service…

I have to admit I became uneasy when I read that beginning in October, the Internal Revenue Service will revive its practice of randomly targeting taxpayers for audits.
I know that the chances of the IRS’ auditing my tax returns are slim, and I also believe there’s no reason to sweat stuff beyond your control.
But here’s the thing: Journalists are suspicious and a bit pessimistic by nature. Therefore, the very idea of the IRS’ doing random audits makes me nervous.
It’s the same way an adviser must feel about the Securities and Exchange Commission’s paying a visit. You know you have done nothing wrong, but you are convinced that if they showed up, they would find something.
Although the number of taxpayers affected by the planned random audits represents a small percentage of tax returns, many of those audits will be much more thorough and cover more ground than a regular IRS audit, according to IRS officials.
Previous random IRS audits were controversial. In the early 1990s, they were criticized for being overly intrusive and time-consuming for taxpayers. Back in the day, tax experts say, the IRS often challenged each little item on a tax return and ordered taxpa0ers to produce large amounts of documentation.
Help, please
Worried about what might happen, I decided to call my financial adviser.
Assuring me that everything was going to be fine, my trusted adviser hooked me up with a tax expert just to be on the safe side.
The guy was good.
It’s a known fact, the tax expert said, that the IRS looks to instill the fear of being audited in all taxpayers to encourage compliance with the income tax laws. The U.S. tax system depends on voluntary compliance.
Percentagewise, according to the tax guru, the IRS audits very few tax returns, and that includes the random audits.
In fact, most tax returns singled out by the IRS for audit contain tax deductions that seem too high in relation to the person’s income, or tax items that are erroneous, require proof or explanation, or are on a list of hot tax issues.
The tax expert went on to say that the IRS doesn’t have sufficient personnel or resources to examine every tax return. As a result, it selects only those tax returns that, upon preliminary inspection, are most likely to result in a substantial tax deficiency. In recent years, less than 2% of all individual income tax returns have been audited.
However, the tax guy said, the chances for an IRS audit are higher depending upon certain types of income, certain amounts of income, profession, types of transactions and types of tax deductions claimed on a specific tax return.
What are the red flags? My tax guru directed me to several websites, where I gathered data you can share with clients. Here are some circumstances that are likely to increase the odds of an IRS audit:
• Your tax return contains large numbers of itemized deductions that exceed IRS targets.
• You claim tax shelter investment losses.
• Your return includes complex investment or business expenses.
• You own or work in a business that receives cash or tips in the ordinary course of business.
• Your business expenses are large in relation to the income claimed on the tax return.
• You have rental expenses.
• A prior IRS audit resulted in a tax deficiency.
• Your return includes complex tax transactions without explanations.
• You are a shareholder or a partner in an audited partnership or corporation.
• You claim cash contributions to charities that are large in relation to your income.
• An informant has given information to the IRS.
The tax expert told me to use common sense and to take every tax deduction to which I feel I am entitled. He calmed my fears of an IRS audit and reminded me that it doesn’t make sense to risk an audit by taking deductions that have minimal tax benefits.
The best way to avoid an audit, the tax guru said, is to file a complete and accurate tax return.
That sounded like some solid advice.