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IRS to increase audits of prior and subsequent year tax returns

In an August 27, 2013 report, the Treasury Inspector General for Tax Administration (TIGTA) found the IRS needs to strengthen its correspondence audit selection process by auditing more tax years of noncompliant tax filers.  Correspondence audits are the most economical type of IRS audit; of the 5.7 million correspondence audits conducted from 2008 to 2012, they returned an additional $40.4 billion in taxes.  Correspondence audits make up 76% of all IRS audits and account for 56% of the additional taxes collected.

A correspondence audit is used to examine taxpayers who are suspected of underreporting their tax liabilities.  Audits are triggered when the IRS detects a return falls outside of statistical norms.  Tax payers are sent a computer generated letter identifying one or more items on the return that are being questioned and require additional supporting documentation.  The taxpayer then sends in the additional information, it’s reviewed by the examiner and the case is either closed or additional taxes are assessed.

The TIGTA conducted a review of the effectiveness of filing checks made during the correspondence audits process of Small Business/Self – Employed Division.  The review was to determine if taxpayers who were found to underreport in one year had prior and subsequent years reviewed.  The TIGTA examined 102 of 7470 audits.  They found 43 of the 102 had similar issues on other tax returns, but only 11 of the 43 had prior and subsequent tax returns examined, thus resulting in thousands of dollars of uncollected taxes.

What does these mean for you?  If you are an individual taxpayer with a W-2 and some 1099’s – very little.  Your information is being matched to documents the IRS has on file.  You may be asked to provide missing information, but it’s unlikely to result in the examination of prior or subsequent tax years.  The greatest concern is to small businesses and self-employed individuals.  The IRS is using the correspondence audit to substantiate any expense you have claimed.  If the IRS finds you underreported your tax liability, it possible they will audit additional years, looking for the same issue.

In one correspondence audit we handled: the taxpayer was required to support their travel expense claim.  The taxpayer had never kept a mileage log and the expense was denied, resulting in an additional tax assessment.  In this case the taxpayer was lucky the IRS did not audit prior year’s tax returns.

What should small business and self-employed individuals do to protect themselves?   Keep and maintain the receipts necessary to document any expenses you claim.  Add notes to receipts that could be called into question.  Keep auto mileage and entertainment logs with details of the event.  Know what documentation the IRS requires and keep it with the receipt.  If you don’t know the regulations ask your CPA.  It’s always been important to keep proper tax records, but now not doing so could result in multiple year tax assessments.

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