Washington — For most taxpayers, the chances of being audited for 2002 are low. But for those who use offshore credit cards, tax shelters or trusts to hide income, or for wealthy taxpayers who understate income, the odds may be considerably greater.
Last year the Internal Revenue Service shifted its audit priorities to focus on promoters of abusive tax shelters, schemes and trusts, as well as participants in such tax-evasion schemes.
IRS estimates the nation's "tax gap," the difference between income taxes that should be paid and what is actually collected, to be about $207 billion a year. Not all lost revenue is due to cheating, but evaders do make up a significant portion.
Traditional audit "flags" include large itemized deductions -- especially for charitable contributions -- and meals, travel and entertainment expenses for taxpayers who are self-employed. IRS is also targeting promoters of nonexistent slavery reparations, those who make frivolous arguments to avoid filing returns, and employment schemes such as paying in cash and filing false payroll tax returns.
People who have credit cards from non-U.S. banks or financial institutions also may find themselves audited. While it's not illegal to have such cards, they can provide easy access to offshore funds and accounts in tax-haven countries that allow income to be hidden. (U.S. citizens must pay tax on their worldwide income.)
In recent years, the odds of being audited have been very low -- 1 in 202 for 1998 returns, 1 in 174 for 1999 returns. IRS hasn't yet released audit figures for 2000 or 2001 tax returns. The agency is increasing its tax-enforcement budget, though it's still less than what former IRS Commissioner Charles Rossotti said was needed to catch tax cheats.
Three-fourths of audits -- "examinations" in IRS parlance -- are done by mail. The agency sends a letter to a taxpayer inquiring about a return, a possible error or documentation for certain deductions or items. Often, the taxpayer simply sends in the requested documentation or explanation and, if tax is owed, sends IRS a check.
If the agency requests an interview, a taxpayer has the right to have a tax preparer or attorney present during the interview. If the tax return is for a taxpayer's business, IRS agents may visit the company's office.
Denise Sposato, a spokeswoman for tax preparation giant H&R Block, said that most tax errors are unintentional, not efforts to evade taxes. Even so, taxpayers who underpay taxes must, besides paying the owed tax, pay interest on the unpaid amount. Penalties also may be assessed.
Like many preparers, Block will pay a tax penalty or interest owed if the preparer caused the error. For $27, clients can also purchase a "Peace of Mind" warranty guaranteeing that Block will pay up to $5,000 in back taxes owed as a result of Block's error.
During an IRS interview taxpayers should, while being honest, answer only questions that are asked and "don't volunteer more," Sposato said.
According to Block, taxpayers facing an audit make these common mistakes:
- Ignoring an IRS letter.
- Not responding to the letter quickly.
- Answering an IRS inquiry without addressing all the issues IRS raised.
- Signing an IRS agreement without consulting a tax professional
- Going to an audit unprepared
- Failing to double-check IRS' figures or conclusion.
Generally, IRS may audit your tax return anytime within three years of the due date of the return. In cases where IRS believes income has been underreported by 25 percent or more, the agency can examine returns up to six years old.