Our “voluntary compliance” tax system has historically relied upon a certain level of enforcement (both civil and criminal) to strongly encourage that cooperation. Has the level of enforcement diminished to the point that the “audit lottery” favors the non-compliant taxpayer? We think not…
1. IRS Audit Rates are Declining - The Internal Revenue Service is doing little to hide the fact that its power to audit taxpayers has diminished over the past decade. Budget and personnel cuts have strapped the IRS’s audit resources and taxpayers are seeing significantly fewer tax audits as a result. In fact, taxpayers had just a half a percent chance of being audited in 2018 with only a million or so audits taking place that year.
What does this mean for taxpayers? While your chance of audit may be lower, don’t press your luck. Because about 75% of IRS audits are conducted via mail, a prompt response is crucial and may significantly reduce the amount of interest and penalties owed.
2. Using Technology to Identify Tax Fraud - What the IRS is lacking in manpower, it is making up with technology. The IRS uses a computer system called Discriminant Information Function (DIF) to identify any inconsistencies or abnormalities on tax returns. It scans all returns for information that just doesn’t make sense such as business deductions that fall outside a “normal” range, multiple people claiming one dependent, 1099s that have gone unreported, etc. With the amount of digital information out there these days, it’s easier now more than ever to compare data on the tax return to that in cyberspace and all filed returns.
What does this mean for taxpayers? Four-leaf clovers are very rare. Unfortunately, overstated expenses or understated income aren’t! Is it realistic for a business that reported $1,000 in income to spend $10,000 on client gifts? Is it reasonable for a person who made $50,000 to donate $45,000 to charity? Can you claim 100% of your mileage for business, even if you only own one car? Maybe - but be sure that you can substantiate all of your deductions with receipts and records, especially if you paid in cash. And no, you can’t claim your dog as your dependent, even if you pay way more than half his support for the year!
3. State Tax Audits are on the Rise - While federal tax audits are at historic lows, taxpayers aren’t completely out of the woods. Sweeping changes in tax law have resulted in some low hanging fruit for state tax auditors. This is especially true for individual taxpayers looking to “relocate” to low tax jurisdictions and businesses that have failed to remit taxes they collected.
What does this mean for taxpayers? For individuals, states have fact-intensive tests to determine residency that review all aspects of life and go way beyond the address of your vacation home. Auditors will consider where you go to church, where you keep your family photos, where your doctor or attorney is located and where you keep your favorite shirt. Thinking of relocating to Florida, think again before you file your taxes! Sales tax audits are also on the rise. Business owners are finding it harder and harder to escape the world of eCommerce and digital transactions are easy to track. If sales tax was collected, was it remitted to the state? States are becoming more aggressive in this area as businesses struggle to comply with the standards imposed by the decision in South Dakota v. Wayfair, Inc., 504 U.S. 298 (2018).
A wise man once said, “The only sure thing about luck is that it will change.” This is especially true when we’re talking taxes. While it is not inappropriate to be aggressive, there is a fine line in the eyes of the IRS between tax “avoidance” and tax “evasion”. As parents often tell their children not to press their luck after the parents give in to one special request and the children ask for another, in short, it is safer to simply not push it.