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IRS lets rich off audit hook!

That's the assessment of the Transactional Record Access Clearinghouse (TRAC). Using IRS data, the Syracuse, N.Y.-based group calculated a drop of at least 19 percent in the audit rate of people with incomes of $1 million or more between 2008 and 2007.

The IRS says TRAC is wrong.

It's not the numbers that the IRS has an issue with; they are, after all, from the agency itself. But the IRS says that TRAC misinterpreted them.

Let's go to the "he said/she said."

TRAC's tracking: In the face of growing federal deficits and public calls to lower the tax gap (the amount of taxes due but not reported and paid), the drop in millionaire audits is surprising, says report author Susan Long.

TRAC notes that in January 2008, the IRS "was boasting that its drive to focus increased attention on those reporting at least a million dollars in income was in high gear." But when the agency's Data Book was recently released, its figures confirmed that both 2006 and 2007 IRS audit numbers had to be revised sharply downward because of "misreporting" discovered in the agency's books.

"As it turns out, it now appears that the 2006 audit numbers had been inflated by 20 percent while the 2007 audit number that the IRS had boasted about had been inflated by 35 percent over actual levels," says TRAC, referring to the "millionaire audits" table (below) that it created to compare the examination numbers from 2004 through 2008.

Millionaire_audits_trac032309 (2)

IRS explanations: OK, maybe the 2008 numbers are down a little. But there are good reasons for that says the IRS, such as the fact that the agency spent much of last year focusing on the issuance of stimulus rebate checks. Then there was the matter of a reduced budget, which led to staffing issues.

Plus, contends the IRS, TRAC's finding was "misleading" because it compares the statistical equivalent of "apples to oranges."

IRS spokesman Bruce Friedland told Tax Analysts that the data from 2007 that TRAC used to show 2008's decline in audits of wealthy taxpayers are based on returns reporting $1 million or more from so-called positive income. These returns do not not include losses.

"It's a slightly different slice, but they are not really comparable because of the underlying definitions," Friedland said. He also pointed out that 2008 was the first year the IRS began collecting data based on adjusted gross income.

As for the revisions indicated in the Data Book, the IRS said the 2006 and 2007 audit figure adjustments were the result of a "regrettable" coding error that affected its published reports but not its operations. The agency maintains it still holds the scrutiny of millionaire tax returns as a high priority.

What catches the IRS' eye? Regardless of whose side you take in the "rich aren't getting audited enough" argument, when push comes to shove all most of us care about is whether we personally will have to answer IRS examiner questions.

There are some things that do cause the IRS to take a closer look at returns.

"There are several ways a return can be selected for audit, and the first way is what we call computer-scoring-termed DIF, or Discriminate Information Function," says Nancy Como, small-business/self-employed examination policy senior program manager for the IRS, during the March 10 IRS Tax Talk Today program. "It's sort of a random selection. The IRS evaluates tax returns based on IRS formulas, and this is based on deductions, credits, exemptions with norms for taxpayers in each of the income brackets."

Tax publisher CCH has put together some DIF data and has produced this table of average itemized deductions of which Como spoke:

Average Itemized Deductions
(based on preliminary 2006 IRS statistics)
Gross Income
Medical Expenses
Taxes Paid
Interest Paid
Charitable Contributions
$15,000 to $30,000
$30,000 to $50,000
$50,000 to $100,000
$100,000 to $200,000
$200,000 or more

These figures are, of course, for illustration (and entertainment!) purposes only. Do not think for a minute that just because your deduction amounts are similar to or less than these figures that you won't be audited.

But, as CCH notes, you can use them as a guideline and if your amounts are grossly over these amounts, be sure you can document and otherwise justify the claim to an IRS examiner.

And remember: Don't let the fear of an audit ever stop you from taking a legitimate tax break to which you are entitled.

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Neil "The Tax Dude®" Johnson

A note about DIF scores...they are also separated by zip codes. The concept being people living in the same zip code are of similar economic statuses.


Those deductions numbers are surprising, especially for low incomes. Do people with an AGI of $30K really spend more than half of it on medical expenses and interest?

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