If IRS Knocks, Audit Is Tougher Than Ever

The Internal Revenue Service is getting better at targeting its field visits

IT may be downsized, but the Internal Revenue Service probably knows more about American taxpayers than ever before, given the agency's increased ability to electronically cross-check available tax documents. And IRS audits may be tougher than ever, thanks to research work undertaken in recent years involving the agency's compliance programs.

So even though the taxman won't be visiting as many people this year, experts say be prepared.

"We expect that there will be slightly fewer audits than occurred last year" as a result of federal budget cuts and a slightly smaller work force, says IRS spokesman Anthony Burke. "But there will still be more than took place back in the early 1990s."

Estimates as to the exact number of returns to be audited varies, according to how the IRS measures its various compliance programs. Thus, for fiscal year 1995, which ended in September of last year, the agency examined 1.67 percent of all individual tax returns, compared with 1.08 percent for 1994. This calender year, according to one agency reckoning, the audit rate will be around 1.4 percent of all returns. That translates into well over 1 million returns for each year.

"The main difference this year is that there will be fewer correspondence audits, that is, simple questions put to taxpayers through the mail," says Frederick Daily, a tax attorney based in San Francisco, and author of "Stand Up to The IRS." Part of the reason is electronic, Mr. Daily says. The agency can now better correlate tax documents.

Field audits may hold steady

"Actual field audits, where you visit an IRS office, will probably remain about the same as last year," says Mr. Daily.

"Taxpayers shouldn't be looking for fewer or easier field audits this year," agrees Edward Wallower, who heads the tax-appeals program for H & R Block Inc., a national tax-preparation firm based in Kansas City, Mo.

"In an audit, the IRS is now looking for everything about you," says Amir Aczel, a statistician at Bentley College in Waltham, Mass. "The IRS is using tougher methods now," says the professor, who underwent an intense audit that prompted him to write a book, "How to Beat The IRS At It's Own Game.".

Last year's higher auditing rate stemmed partly from a special multimillion dollar appropriation by Congress. The supplemental appropriation was supposed to continue for several more years, but the new Republican-majority scuttled the provision. Congress also cut the IRS budget to $7.4 billion for 1996, down from around $7.5 billion in 1995.

'Economic reality'

Whatever the actual number of audits this year, Mr. Wallower says he is troubled by some of the agency's inspection methods, especially what the IRS calls "economic reality." Economic reality is a sort of means test that the agency uses to determine whether an individual's tax return matches his or her lifestyle. The process can invite abuses, Wallower says. In one recent case, he says, an agency auditor used statistics on living standards in Philadelphia to gauge the lifestyle of a person living in rural Pennsylvania.

"The service [IRS] is clearly trying to say, 'Hey, if we're doing an audit, let's do a complete audit, let's get it right,' " says Cornelius Coleman, who directs national tax services at Coopers & Lybrand, an accounting firm. "The nonreporting of income is a serious tax-evasion," he says.

Taxpayers likely to be audited, experts say, are ones who file returns with sloppy forms, numbers that don't add up, or line items unanswered, such as nonwage income. Other audit candidates are those who file special claims, such as an undocumented flood loss, or who file Schedule C as a sole business proprietor.

If you are called in for an audit, Mr. Aczel says, "don't volunteer too much information." Try to "limit the scope of the inquiry" to the area initially examined by the agent. Avoid looking into other tax years. One way to do this: Delay inquiries into prior returns. Such delays sometimes cause the investigator to back off, he says. "Remember, the resources the IRS uses for examining one tax year can be inexpensively expanded into looking at another tax year. Make certain you keep the inquiry focused," he says.

The IRS, for its part, points out that unpaid taxes run over $150 billion annually - money that could be used to quickly wipe out the federal budget deficit.

Moreover, the IRS has a multi-layered appeals process that offers taxpayers alternative methods of redress, including petitioning the tax court. The agency has expanded the duties of the Tax Ombudsman office to better aid individuals who believe they have a legitimate tax grievance.