IRS Revives Random Audit Program

NEW YORK (Sept. 27) -- Starting in October, hundreds of Americans will be getting "Dear Taxpayer" letters telling them they've been selected for a special audit by the Internal Revenue Service.

The 13,000 chosen at random this year -- and similar numbers in subsequent years -- are part of the tax agency's National Research Program, which is designed to give the IRS a better understanding of how accurately income and deductions are reported and to reduce the so-called tax gap.

The tax gap, which is the difference between what taxpayers should have paid and what they actually did pay, is of growing concern because it's so big.

Earlier IRS research, which looked at some 46,000 individual tax returns for tax year 2001, found a $345 billion shortfall in tax monies. After enforcement actions and late payments, that was reduced to about $290 billion -- a still-worrisome number.

The special audits will be used to help the IRS update the criteria for selecting tax returns for annual compliance audits, said Mark Mazur, the IRS director for research, analysis and statistics in Washington, D.C. Last year, some 1.2 million taxpayers were audited, the IRS said.

"That will allow the IRS to do a better job of choosing taxpayers for audit who have a higher probability of errors on their returns," he said.

This will help the agency function more efficiently and reduce the odds of burdening law-abiding citizens, he said.

"The data also can help us determine if there's a need to change the law, outreach programs or enforcement practices," Mazur added.

Mazur said that some of the noncompliance stems from taxpayers failing to pay what they actually calculated that they owed in taxes or failing to file at all. But the greatest problem, responsible for about 80 percent of the tax gap, comes from underreporting.

"That's where taxpayers put the wrong numbers down for tax liability compared to what they owe under the tax code," he said. People who work in restaurants might underreport tip income, for example, or sole proprietors might take business deductions for personal expenses.

Sometimes mistakes are accidental, Mazur said, noting that "not everyone is good at math, and some of the tax code can be complicated." At the same time, he added, the agency has to watch out for "things that look like they're not unintentional and where, at the extreme, you have criminal activity."

Mark Luscombe, principal tax analyst at CCH Inc. of Riverwoods, Illinois, said the new IRS research program was designed to help officials at the IRS walk a fine line in updating statistics without upsetting taxpayers. The company, a division of Wolters Kluwer, provides tax information and services to tax professionals.

"They don't want to go back to the late 1990s, when Congress complained that the IRS was ruining peoples' lives with intrusive audits ... but they also need to improve its statistics," he said. "So they're doing fewer (special audits) but on a more frequent basis -- about 13,000 a year."

In some cases, taxpayers selected for special audit won't know about them because their income and deductions can be verified by the IRS from third-party documents, such as W-2 wage statements and Form 1099 interest payment statements.

In other cases, they may be asked by the IRS for information to support their income and deduction claims, such as receipts for charitable contributions, Luscombe said.

In still others, they'll be called in to sit down with IRS examiners and go over the tax forms line by line.

"If you're one of the unlucky ones called for an in-person audit, you might want to get in touch with a tax professional who has experience in dealing with the IRS," he said.

Luscombe noted that compliance is best when income is subject to withholding by employers or confirmed by third-party reports, such as the tax forms supplied by banks and brokers to taxpayers and the IRS that detail interest payments and capital gains.

"What they find in the audits could lead to requests for more" third-party verification, he said.

Should taxpayers be worried?

"In most cases, no," Luscombe said. "But, let's face it. The IRS doesn't mind if people are a little nervous."

Unfortunately, if the IRS finds a mistake on a tax form during the course of a special audit, the taxpayer will be liable for increased tax payment and penalties, the IRS said.