Your Money : SPOTLIGHT ON TAXES : Uncle Sam Has Made Room for a Few More on the Audit Hot Seat : Scrutiny: New programs target industries likely to shun employment taxes, those heavy on cash.
Architects, art dealers, beauticians, bail bondsmen, morticians and ministers beware. You are now among about 80 industry groups targeted in the Internal Revenue Service’s most feared audit program: the Market Segment Specialization Program, for which specially trained IRS agents scrutinize every line of your tax return to ferret out gaffes.
To make matters worse, the agency also just launched an auditing initiative called economic reality, an expanded and improved method of nabbing people who understate their incomes.
Both the MSSP and economic reality programs focus on groups that can receive a large portion of their income in cash or trade, as well as industries that may be failing to pay employment taxes for their workers. That’s because the agency suspects that a large portion of the nation’s “tax gap”--a yawning $100-billion difference between what the IRS believes is owed and what’s actually paid each year--can be attributed to people who are hiding income or misstating employment arrangements in an effort to escape federal and state income taxes.
Who is in the hot seat?
People who receive tips, such as those who wash and detail cars; barbers and beauticians; pizza drivers, and waiters and waitresses. Companies that do a large portion of their business in cash, such as grocery stores, liquor stores, gas stations, pizza parlors, parking lots, pawn shops, cart vendors and coin-operated laundries are also being scrutinized for non-reported income. And industries that use large numbers of independent contractors, ranging from garment manufacturers to rest homes to building contractors, are facing careful review of their employment arrangements.
The IRS is also checking to see if employees are being mis-categorized as “independent contractors” so companies can avoid paying Social Security, Medicare and unemployment taxes.
When these folks get audited, they’ll also find that the IRS is not focusing completely on their tax returns. Through the wonders of computer matching, IRS agents can find out if you own a boat, a plane or a luxury car. They can determine the size of your mortgage. And they can subpoena your bank records to find out just how much money is going in and out of your accounts, says Bob Kamman, a Phoenix tax accountant.
If your lifestyle appears pricey given your means, the agent will ask you how you’re coming up with all that money. Unless you’ve received an inheritance, life insurance payout or are getting regular gifts from well-heeled relatives, you’re in trouble.
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In some cases, the agent will actually calculate new income figures for you that are based on your lifestyle rather than what you’re reporting. And the IRS will bill you for unpaid tax on the difference between its income projections and yours.
Taxpayers who are found to have large amounts of unreported income are also subject to civil and criminal penalties.
On the bright side, the IRS is now so focused on taxpayers it considers likely to cheat that the chances of anyone else getting audited become slimmer every day. Currently, the IRS audits a mere 0.7% of the nation’s taxpayers, says Martin J. Horwitz, a Cincinnati attorney and author of “Survive Your IRS Crisis.”
Still, even innocent and unremarkable taxpayers can get caught up in an IRS exam, if they load their return with so-called audit triggers. While the IRS keeps its list of triggers close to the vest, tax professionals say they boil down to a handful of unusual itemized deductions, including casualty losses, home office deductions, exceptionally large charitable contributions and contributions of property rather than cash.
Small-business owners are also prime targets for audits because the IRS suspects that some entrepreneurs run their personal expenses through the company and put company income in their pockets.
While you’re certainly not going to shutter your business just to avoid an IRS audit, tax professionals suggest that you take some steps to protect yourself if you’re in a high-risk category or if you are claiming targeted deductions.
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For example, keep meticulous records of your charitable contributions. If you give anything of great value, make sure you get a receipt or acknowledgment from the charity.
Anyone who claims casualty losses should be prepared to present the IRS with pictures, videos or detailed listings--preferably with purchase receipts--of all the items they lost. You’ll also need to present insurance estimates of the damage, receipts for completed work and documentation for any reimbursements you may have received.
If you are claiming home office deductions, you should know that the IRS won a Supreme Court case last year that severely narrowed the criteria for claiming these deductions. In addition, the value of these deductions are frequently so small that many tax accountants suggest you think twice before bothering to claim them. The value of the deduction is often not worth the time and cost of trying to defend it in an audit, says Philip J. Holthouse, partner at Holthouse Carlin & Van Trigt in Los Angeles.
