The IRS is stepping up its audit game. It's focusing on returns of the wealthy and the self-employed, where it hopes to find larger amounts of hidden cash. And, according to some reports, it is trolling Web sites like Google maps and Facebook in an effort to find tax cheats.
"The IRS is doing a better job of identifying where there are differences in tax returns that will lead to an audit," says David Gannaway, a tax litigation consultant at the New York accounting firm of Marks Paneth & Shron.
Focus on the accuracy of tax returns is heightened because of the weak economy. Roughly 13 percent of taxpayers now say it's OK to cheat on your taxes, compared with 9 percent in 2008, according to a survey by the IRS Oversight Board, a White House-appointed group that oversees the IRS.
Analysts hypothesize that taxpayers in financial trouble will do more to fudge their tax returns. Their angry neighbors and colleagues will be more inclined to tip off the IRS to the cheater next door. And the IRS is under increasing pressure to make its audit practices more effective.
None of that is particularly bad news for the vast majority of taxpayers who don't cheat on their taxes. So, the first obvious bit of advice is: Don't cheat. But even those on the straight and narrow worry about getting audited. Being pulled under the agency's microscope can be stressful and expensive.
Here's what you need to know this year about avoiding — or acing — the audit.
— Don't forget to include all of your income. The IRS compares your tax return to the W-2s and 1099 forms you receive from the people who pay you. Taking deductions that aren't legal can be easily construed as a mistake, but hiding income that you know you received is more likely to be seen as straight-up fraud.
— Document unusual deductions. The IRS does pluck returns out of its pile if the deductions they claim seem out of whack with the average for their income level, says Gannaway. For example, taxpayers earning between $50,000 and $100,000 deducted $6,690 in medical expenses, $5,822 in taxes, $10,557 in interest and $2,612 in charitable contributions in 2007, according to CCH, a tax research firm. Obviously, a taxpayer facing a serious medical emergency or living in a high-tax state may legitimately claim deductions far above those averages. But if they do, it's good to have the paperwork to back it up.
— Don't cry poverty to the IRS and then brag about your new wheels on Facebook. The IRS does give its agents leeway to troll sites like Twitter and Facebook to find inconsistencies, but it does not allow them to fake identifications to do so, according to agency documents uncovered by the Electronic Frontier Foundation, a sort of American Civil Liberties Union for the tech crowd.
— If you're self-employed, be careful but not cowed. Many people have become self-employed in the current recession. Some are running side businesses. Others have been driven into (or chose) consultancy when they couldn't find full-time work. IRS investigators know that it is easy to hide expenses in a business, so they tend to audit those small sideline businesses at a higher rate than they audit returns backed solely by paycheck jobs. But, if you do run a side business, it is your legal right to deduct all of the money you spend in that business — including trips to the copy shop, lunches with potential clients, postage, printing, office equipment and furniture. So, capture every expense with good record-keeping and receipt-filing. Take what's coming to you. But be prepared to defend those deductions. And don't get silly and go overboard with deductions that aren't kosher. You know what they are.
— If you do get audited, take each step at a time. Usually, the first step of an audit is a letter questioning one single aspect of your return. You can gather the supporting information about that aspect and send copies of it back to the IRS. If the IRS asks for a meeting or a review of your total tax return, hire help to represent you. That could be a tax attorney, a certified public accountant, or an enrolled agent. They are all accustomed to appearing before the tax agency and know how to present your case in the best light.
