Where the IRS is looking

by Steve Beeler and Charles Nelson

Tax planning should have started early for your 2007 individual income tax return, but in case it hasn’t your "tax defense team" draws upon its experience and contacts with the IRS to provide some preventative medicine.

Two years ago, the IRS started hiring large numbers of revenue agents and began adjusting procedures so that more returns could be examined. Their inside joke is "... we are no longer the kinder and gentler IRS." The IRS believes a taxpayer will complain to an average of seven peers when he or she is notified of an audit. Emotional terrorism by proxy is now IRS policy. Preparation is always the most effective defense and the numbers are on our side since fewer than two percent of all returns can be audited. However, the IRS is looking to cherry-pick the returns most likely to yield the greatest additional revenue.

Never hesitate to take a legitimate deduction for which you can provide independent documentation. When appropriate, take every deduction because a deduction not taken is money lost forever. Be aggressive, but be smart regarding those deductions and if a tax preparer gives you a story that is too good to be true, it probably is. Remember, using a paid preparer will not protect you from the IRS. You are the responsible party—you sign the return.

If it is legitimate and can be documented, always take the deduction. The IRS has trained its agents to probe several areas that are more likely to involve improper tax benefits, and using them could make it more likely that your return will be audited.

If you submit an amended return, which will generate a refund or a refund larger than the original return, expect an audit. If you receive a Form W-2 or a Form 1099, report the income on Form 1040; if this income is not reported, the IRS’ computers will automatically catch it. If records are lost, and an audit occurs, you could be denied your deductions. Therefore, records should be retained for at least four years.

However, there are areas where you can be aggressive. Most taxpayers who itemize do not realize how many minor donations are deductible. New rules make it possible to pay all contributions by check. Not only does this form of payment provide you with a receipt, it significantly reduces the chances of the charity being defrauded. It is important to request a receipt whenever possible since most purchases from charities are tax deductible. For instance, if you buy Girl Scout cookies, the non-deductible portion is $0.73 per box. If you pay by check or credit card and keep the receipt, the amount you pay beyond that is deductible. This rule applies for virtually any other product purchased in a fundraising effort. Raffle tickets are never deductible as charitable donations, so do not put “raffle” or any related terms on the memo portion of your check. The typical middle-income household contributes 4 percent to 5 percent to charity; therefore, contributions at this level will not trigger an examination.

If you volunteer for a charity, expenses can be deducted as charitable donations. Mileage incurred is deductible at the rate of $0.14 per mile. As such, it is important to keep detailed records of your mileage. Also, if you start a part-time business and lose money, generally, the loss can be claimed for one year. However, it is important that records are kept in order to prove that an attempt to make a profit was made.

Substantial amounts of taxes can be deferred by taking advantage of IPA’s 401(k) plan. A portion of your earnings can be invested before you have to pay taxes and you can retrieve the money at a lower tax rate after you retire. Next to home ownership, this is the most popular wealth creation tactic utilized today.

Filing your returns on paper, as opposed to filing them electronically, is vital when trying to avoid an audit. Comparisons can be more effectively run on electronic returns. Additionally, electronic returns are easier to retrieve and bypass several steps in the bureaucracy. The number of employees handling paper returns has been substantially reduced, and this area is now overwhelmed. Filing the traditional paper returns slows the refund; however, if you are filing an aggressive return, this process can help to avoid an audit.

Many taxpayers take chances by not reporting income received or taking deductions that cannot be documented. Many succeed in their efforts. Generally, the IRS will not audit a return more than three years after its due date. However, by increasing the risks, you increase the likelihood of being chosen for an audit. If you deduct an expense, be prepared to provide some documentation to support that deduction. The goal of the process is to take all you can without making it worth the IRS’ trouble to try and take it back.