Dear Friends-

Your tax return just got selected for audit?!

Try not to take it personally. Ian Comisky, a Philadelphia tax attorney who once prosecuted tax fraud cases for the government, says the Internal Revenue Service is in the process of updating the sophisticated computer program it uses to sniff out potential fraud. If you’re lucky, the computer simply selected your return at random because you happen to be married with three kids and the IRS wants to know what deductions are typical for taxpayers with this profile.

This is not to suggest that an audit letter should be taken lightly. It’s certainly more serious than a “correction notice,” which I wrote about last week.

In a so-called “audit notice” the IRS is informing you it is questioning something about your return and wants additional information. The letter should specify exactly what documentation you need to provide and also include a statement about the rights you have as a taxpayer.

If you’re comfortable your return is accurate- i.e. you weren’t too “creative” with the math--either you or the individual who prepared your tax return can respond. However, be very careful to provide exactly what the IRS asks for: Don’t volunteer anything more or you could open the proverbial can-of-worms. Comisky calls this an “eggshell audit.”  In his words, it should be “handled with care because if it breaks, it can lead to criminal charges.” 

During the government’s 2007 fiscal year, the IRS hit nearly 3.8 million taxpayers (individuals and businesses) with levies for additional taxes and penalties. It filed almost 700,000 liens and more than 4,200 cases were turned over to the Justice Department for criminal investigation. The average sentence handed down for tax and tax-related cases was 22 months.

Small Business owners are favorite IRS audit target, and for good reason: They have more opportunities to “massage” their declared income and expenses. Many small business owners deal in cash, which is easy to hide. Honestly now, did you get a little conservative when you reported that your landscaping business only earned $60,000? That $35,000 mortgage deduction you claimed was the tip-off. The IRS computer spit out your return faster than a Sydney Crosby slap shot.

However, the IRS doesn’t just rely on technology to point out potential tax cheats. “A lot of audits start the old-fashioned way,” says Comisky. “Somebody turns you in. Maybe you fired them. Or the girlfriend turns the boyfriend in. Or the mistress turns in the husband.”

In addition to an audit notice, there are several other ways you could learn the IRS has “issues” with your return.  In escalating levels of seriousness, these include:

• An IRS agent makes an unexpected appearance at your front door and asks to come in to “just discuss a few things.”
  

According to Comisky, who co-authored Tax Fraud and Evasion, “The first thing they do is try to get an interview when you don’t have counsel with you usually at night or in the morning.” Don’t be fooled by the agent’s casual tone. Comisky says the agent has generally spent months preparing for this friendly get-together and you’re probably facing a criminal investigation.

• You receive a phone call or letter from the U.S. Attorney’s Office.
  

This means the IRS thinks its case against you is so strong it’s been sent to the grand jury. The next communication you receive may be a subpoena or “target letter.”

• Your bank, brokerage, and IRA accounts are frozen.   
  

This is known as a “jeopardy assessment.” The IRS simply starts seizing assets. “You can go to court,” says Comisky, “but they grab the stuff first.” 

I hope you never find yourself in any of the above situations. In reality, however, the thought of getting away with paying less in taxes is so alluring it can make very smart people, who can afford very expensive and presumably sophisticated accountants, push the envelope.

Out of your league? Then I invite you to peruse the list of tax court cases involving “small fish” like you and me. There are numerous examples of “regular folks” falling prey to some hair-brained scheme that promises to save them a few hundred bucks. In the end, it costs them far more than in taxes, penalties, and legal fees. Often, the individual who promoted the scheme does jail time.   

Although we’ve all heard it numerous times, the following is worth repeating: If it sounds too good to be true, it probably is.

Gail’s corollary: If you decide to go for it anyway, line up a good tax attorney. Oh, and buy a half dozen bottles of Maalox. Just in case.

Hope this helps,

Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.