Audit Roulette; Lifestyle Audits; and IRS Cash Rewards

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, March 8, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Question: If I file an extension to August 15, 1998, am I less likely to be audited?

Answer: No. This is an urban myth about IRS, as is the belief that your risk of audit is greater if you do not use computer software or a professional tax preparer because IRS scrutinizes the type style of your return.

Actually, your chances of an IRS audit is approximately 1%. Returns are selected for several reasons; however, when you filed and whether your return was prepared in ink or by computer is irrelevant. Most returns are audited because of their Discriminant Function (DIF) score, a technique that compares your return’s income and deductions, against national averages.

The DIF identifies returns with potential for additional taxes. Once the computer selects a return, it is manually reviewed for examination potential. The self-employed individual and those with sizable itemized deductions (large cash charitable donations or employee business expenses) are often victims of a DIF-based examination.

Your return could be selected at random or, if you are part of an industry that has been targeted for audit (restaurants and bars), then you could be audited in an industry project. Finally, if you have a questionable tax-shelter or abusive trust arrangement, your chances of audit, along with others who participated, are significantly higher.

Question: Does IRS audit someone because he has an expensive house or car?

Answer: No. If, however, you are under audit and your income does not match your financial status (lifestyle), IRS may require an explanation of how you acquired your assets. IRS, however, cannot snoop into your financial affairs just because you own property, drive a nice car or have a large investment portfolio, since those assets may have been acquired by gift, inheritance or with savings or investments in prior tax years. If you are under audit for a specific year and IRS asks about the source of your income for assets purchased in a prior year, stop the audit and retain a tax professional to represent you.

Lifestyle audits are intrusive and Congress has pending legislation (Taxpayer’s Bill of Rights III) that would outlaw the practice, except in those circumstances where IRS has a reasonable indication of unreported income. IRS views this legislation as consistent with its past and current policies regarding financial status examination techniques.

Question: Does IRS pay a reward if someone I report is guilty of tax evasion?

Answer: Yes, but it has been stingy with its payouts, often claiming that the leads supplied were not material. Rewards are available for information involving civil and criminal tax law violations. The reward amount is within IRS’s discretion, but can be as high as 15% of the amount recovered in taxes, penalties and fines (but not interest) from the delinquent taxpayer, to a maximum of $2 million. The 15% rate applies to specific information responsible for the investigation and a direct factor in the recovery. A 10% reward is available for information that causes an investigation and was of general value in determining tax liability. A 1% rate applies if you supply merely a name. In conclusion, the more specific and detailed your information is to the investigation and recovery of tax, penalties and fines, the higher your reward.

All names remain confidential. Remember, it may take two-plus years to complete an investigation. Even then, IRS will not disclose the specific action taken regarding the investigation.

Protect yourself with a clear understanding regarding your rights to an IRS reward. For more information, call the IRS Criminal Hotline (800-829-1040). Supply your information in writing, using Form 211 (not available on-line: 800-829-3676 to order).


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**