The odds of not getting audited are more in your favor than they were a few years ago. But they're not zero. A tax expert's advice: "Be accurate; document your deductions and record your income." And be careful about home-office deductions.
WASHINGTON — Just because the Internal Revenue Service is auditing the fewest tax returns in years, and just because the IRS has thousands fewer enforcement agents to look into your finances — don’t take it as a green light to cheat.
“I always tell clients to understand the difference between tax avoidance and tax evasion,” said Jeff Carbone, managing partner at Cornerstone Wealth. “You know what the difference is? Ten years.”
The IRS has a lot less of everything compared with a decade ago. That might make the fast-and-loose crowd feel better, but it shouldn’t.
I don’t cheat, so I am not worried. I want the IRS to catch the no-goodniks (in the words of my favorite cartoon character, Boris Badenov) who do cheat, because the honest folks have to pay more taxes if they don’t. (The money has to come from somewhere.)
This is important stuff. Individual income taxes account for about 48 percent of the federal government’s revenue for fiscal year 2017 — about $1.6 trillion, according to the Joint Committee on Taxation. That’s the highest percentage of federal receipts in years, according to the committee.
I asked the IRS: If the number of revenue officers has gone down, why is the amount of revenue collected up?
“Not all of the revenue attributed to collection is the direct result of the efforts of revenue officers,” the IRS said in an email. “Collection revenue not only comes from the work of revenue officers, but also from automated collection programs and collection notices that are automatically generated and mailed to taxpayers. Also, the IRS website makes it easier for people who owe back taxes to pay them over time through payment plans, called installment agreements.”
The IRS today is living on about $1 billion less than it was living on nearly 10 years ago, down from $12.1 billion in 2010 to $11.2 billion now, according to recent figures released by the agency. That pays for a lot fewer agents, whose numbers have declined by one-third from 22,710 in 2010 to 15,357 today.
The agency has been trimmed back, even as the numbers of filers have grown. Americans filed 150 million individual tax returns in the fiscal year that ended in September, the most ever. Even as the number of returns have grown, the number of audits has dropped 40 percent from 2010 to 2017.
What does all this mean?
For one thing, it’s less likely the IRS is going to chase you. But the richer you are, the more likely it is that the IRS is looking over your shoulder.
That’s not surprising, because wealthy people generally have more investment assets and stuff like second homes, cars, boats, jets and family businesses.
“The wealthy have complicated tax situations,” said Jason Fleetwood, an accountant and partner at CohnReznick’s Tysons Corner, Virginia, office. “Those who earn significantly more would expect to have a higher chance of being audited because errors uncovered are more likely to bring in additional tax revenue.”
But the odds of not getting audited are more in your favor than they were a few years ago, and they are getting better and better every year.
Taxpayers with incomes of more than $1 million have a 1-in-25 chance of getting audited these days. That’s better odds than 2011, when their chances were 1 in 8.
The further down the income ladder, the less likely it is that the IRS will come snooping.
For example, if you earn $200,000 or more, your chances of getting audited are 1 in 80. Those odds are better than 2011, when the odds were 1 in 25.
Individuals, all totaled, had less than a 1-in-160 chance of being audited. That’s way down from 1 in 90 for 2011.
Accountants said the audits are down, but you get the sense the IRS is still watching.
“There may not be as many actual IRS audits, but notices seem to be more prevalent addressing specific issues, such as proof of mortgage interest deduction or charitable contributions,” Fleetwood said. He said his individual clients and business clients are seeing more communications from state revenue agencies as they look for money wherever they can get it.
Fleetwood has some simple advice: “Be accurate; document your deductions and record your income.”
That doesn’t mean you have to pass up legitimate tax shelters, such as retirement account contributions, education savings plans, charitable contributions, health-care savings accounts and pretax transit accounts, such as the Washington Metropolitan Area Transit Authority’s SmartBenefits program, which I use.
And you can do all that without raising red flags.
But if you want to send up a flare and tell the IRS you are playing fast-and-loose, you can do it. It’s the usual stuff: home office, car, expensing meals, travel, hotels. Just make sure you can back it all up.
“The immediate red flag is taking the home office as a write-off,” Carbone said. “It should be a true room set aside in your home for work.”
As Fleetwood bluntly put it, “Placing a computer in your bedroom next to your bed, or in your theater room where you and friends gather on weekends to watch football, doesn’t make either room an office.
“If you are claiming a home office deduction, and you’re not using the room, you may get caught.”
There are other tips from financial advisers for avoiding those deductions that trigger IRS scrutiny:
- Hobbies aren’t businesses. Claiming a horse you ride as a business is not a deduction. The Pony Express went out of business with the railroads in the 19th century.
- If you have one car and you claim it is used all for business, then how do you do your grocery shopping, take the kids to school and pick up the laundry?
- Same with a cellphone or landline. Is it really never used for personal calls?
- Travel expenses. Was that trip you took to Florida really all business? When you try to mix family with business, it can be a gray area, and get you in trouble,” Carbone said. “Taking your family to Disney World and carving out some time to do business is not a business trip.”
Then there’s something called variance analysis. It’s when you file something that jumps out of the IRS. Let’s say you’re making $100,000 a year off an investment, and all of a sudden it disappears after 10 years. Or a big charitable deduction comes out of nowhere when you claim little or no income. Or a big tax-deductible expense.
Call it a blip, a deviation, an anomaly, whatever.
“The IRS is looking at dramatic changes in your file,” Carbone said. “One I see a lot is investments on capital gains. When you don’t report them correctly, that usually leads to a paper audit.”
What is a paper audit? I ask.
“Paper audit is when the IRS sends you a letter that says, ‘Here is what you claim and here is what we think,’ ” Carbone said. “It’s less serious. You just correspond via mail.”
Less serious than what? I ask.
“When it gets beyond paper, and the IRS says, ‘We would like to set up a meeting.’ That’s definitely a ‘What did I do?’ moment. If you did everything from an avoidance standpoint and not an evasion standpoint, you don’t have anything to worry about.”
I guess that’s the difference between 10 years and none.