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Tax Newsletter
October 2002

IRS Audit Priorities and Programs

The IRS reports that efforts are underway to focus audit resources on key areas of non-compliance, such as off-shore credit card users; high-risk, high-income taxpayers; abusive schemes and promoter investigations; and non-filing by higher-income taxpayers.

A few years ago the IRS shifted resources away from audit enforcement to increase their customer services, and are now shifting resources back to the audit enforcement area to deal with the non-compliance issues identified above.

“High-Risk, High-Income” Returns

IRS Commissioner, Charles Rossotti, has stated, “that since individuals who make more than $100,000 pay more than 60% of taxes, the focus needs to be on them”.

High-income returns are often more complex and, generally, upper income taxpayers have resources to engage in pass-through entities such as partnerships, trusts and corporations. Even utilizing IRS's various matching programs, income and deductions from such activities are more difficult to verify.

While the IRS has begun to match K-1 forms from pass-through entities, the technique does not provide any verification of income reported by the entity itself. Verifying the income on these returns requires an examination. The returns selected for examination will be those most likely to have unreported income or “structured transactions”.

A structured transaction is one with limited economic benefit, whose primary purpose is to reduce or eliminate a tax liability. Structured transactions are generally done through one or more pass-through returns, such as Partnership or S Corporation. The pass-through returns create paper losses that flow back to individual income tax returns offsetting income from other sources.

Abusive Schemes and Offshore Accounts

Tax shelters and abusive transactions have been a major focus of the Service for the past couple of years, and will continue, with special emphasis on the promoters of these abusive transactions. Schemes and scams on the rise include:

  • Schemes - reducing a person's tax liability by claiming inflated expenses, false deductions, unallowable credits or excessive exemptions.
  • Frivolous return arguments – such as "compliance is voluntary" or the "U.S. Constitution does not provide for tax collection".
  • Promotion of slavery reparation claims.
  • Abusive shelters and trusts – i.e. investments established for the purpose of hiding income from taxation.
  • Employment tax schemes - including employee leasing, paying in cash and filing false payroll tax returns.

The IRS estimates that many taxpayers have opened offshore accounts to evade US taxes; therefore, offshore credit card accounts have become a target of the IRS. Although it is not illegal to have an offshore credit card, credit cards 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. The IRS is currently investigating the identities of cardholders, as well as reviewing records of many large businesses to identify offshore bank credit cards being used by consumers to confirm that offshore income is being reported for U.S. tax purposes.

How Might This Affect You

National Research Program (NRP) examinations, which begin this fall, will measure reporting compliance and identify compliance issues. NRP will enable the IRS to improve the examination selection process. NRP no longer relies heavily on time-intensive, "line-by-line" audits for establishing a baseline measure of reporting compliance.

The NRP effort will review a small, statistically valid sample of individual returns for tax year 2001, less than 50,000 returns out of 132 million individual returns filed. The new NRP process will have four main categories:

No IRS contact. About 8,000 returns will be checked relying solely on information already available to IRS.

Correspondence. These will be less intrusive correspondence exchanges with taxpayers--rather than the old standard of sit-down audits. About 9,000 returns will be included in this process.

Less intrusive audits. Instead of the old "line-by-line" examination approach, the IRS will gather more information beforehand from agency records and focus only on selected parts of approximately 30,000 returns.

Calibration audits. These will consist of about 2,000 examinations that will check each line of the return. But, in a major change from earlier programs, taxpayers will not be required to provide line-by-line substantiation.

Please feel free to contact us should you have any questions regarding the foregoing.

The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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