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IRS AUDIT RISK - DESTINY OR BLIND FATE?

Posted on 10/12/2010

DESTINY OR BLIND FATE?

WHAT TRIGGERS AN IRS AUDIT?

By Robert S. Steinberg, Attorney, CPA, CVA  

October 12, 2010

In earlier articles I have discussed how impossible it is to predict the future, whether in life as a general proposition, or for what the tax laws may become.  In this issue I shall explore the question: is the future predetermined, for our free will to decide, or, subject to the whims of chance and blind fate?  Why do some get into trouble with the IRS yet others completely avoid contact with that dreaded agency?

OPENING DOORS: WHAT HAPPENS TO US?

Not only is our death predetermined, but many believe our life in a broad sense is predetermined by unfinished business of the soul.  Some call it Karma.  We assume physical form and life presents us with needed learning opportunities.  During life’s passage, we come upon many doors that can be entered or not. Our destiny is in our hands to the extent we may choose among these doorways. The choices determine what happens thereafter and for many in the hereafter.

Others believe in fatalism, that it is pure chance or blind fate which determines life’s direction, or, as Daniel Defoe said, “The best of men cannot suspend their fate.  The good die early and the bad die late.” The epic poem Beowulf is steeped in the notion that life is uncontrollable and death randomly picks its victims. Sophocles’ “Oedipus Rex” could not escape his inevitable destiny.  Others like William Jennings Bryan argued that “Destiny is not a matter of chance, it is a matter of choice; it is not a thing to be waited for, it is a thing to be achieved.”

In Thornton Wilder’s classic novel “The Bridge of San Luis Rey” a friar witnesses the collapse of an Inca woven rope bridge traversed by hundreds every day, flinging five people to their deaths.  “Why did this happen to those five?” The friar decides to investigate whether something in each lost life had predetermined his or her fate.  Did the victims die from God’s retribution for some committed wrong or was blind fate at work?  He thinks, “If there were any plan in the universe at all, if there were any pattern in a human life, surely it could be discovered mysteriously latent in those lives so suddenly cut off.  Either we live by accident and die by accident or we live by plan and die by plan.” He investigates their lives, gives each a score for goodness, piety and usefulness.  In the end “He added up the total for the victims and compared it with the total for survivors, to discover that the dead were five times more worth saving.”  What did he do, a man of faith, he tore up the findings.  He goes on resigned to the fact that man’s reason cannot explain God’s plan; it is the beauty of the world, its great oceans and “clouds of pearl that hang forever upon the horizon of the sea,” that sustain his committed belief.  

DO BAD THINGS RANDOMLY HAPPEN TO GOOD PEOPLE OR DO WE UNKNOWINGLY INVITE THE CALAMITOUS TAX AUDIT?

 WHY DO SOME GET AUDITED WHILE OTHERS DO NOT?

 

1.     Your income level:  It should be no surprise that the more you earn the more likely you are to be audited.  On average less than 1 percent of those earning less than $25,000 are audited while 1.66% of those earning above $100,000 receive the honor.

2.  Some other factors that, in my experience, increase your audit risk are:

a.    Being a partner in an audited partnership or shareholder of an audited S Corp.  Now, service S Corps paying little salary to avoid employment taxes face special scrutiny.

b.     Claiming substantial cash contributions disproportionate to your income level or not attaching adequate descriptions for non-cash donations.

c.     Claiming losses that IRS has designated as tax shelter loses or even if not so designated, reporting loses disproportionate to your at risk investment.

d.    Reporting an array of complex investments and / or business activities.

e.    Claiming large itemized deductions as determined by IRS tabulated averages.

f.      Claiming business expenses high in relation to your business income or unusual expenses for that particular business.

g.    Deducting rental expenses as a real estate professional.

h.    Deducting depreciation of your personal residence as a home office. This bifurcation of your home has other negative tax consequences as well.

i.       Claiming automobile expenses when your business activity appears to require no automobile usage.

j.      Having been previously audited with resultant adjustments.

k.    Reporting complex, unusual or what IRS considers important litigation items, without an explanation.

l.       Having a disgruntled employee, former spouse or angry relative who decides to file Form 3949A or Form 211 to inform IRS about tax fraud or claim an informant’s reward.

m. As a result of some of the above and other factors, receiving a high DIF (Discriminate Information Function) score by IRS computers resulting in your return being manually reviewed by IRS personnel who make decisions about audit selection based on adjustment potential.

n.    Failing to report income reported to IRS by third party payers like stock brokers, banks, mutual funds or companies you did work for as an independent contractor

o. Filing a Schedule C as a self employed person.  Many who use the LLC format don’t realize they are increasing their audit profile by not electing corporate status.

p.  Having a high audit profile occupation such as a lawyer or doctor.

q.  Engaging in offshore activities that require special and complicated additional reporting.

r.  Filing delinquent or amended returns without adequate explanatory statements being attached to the return.

s.  Having the misfortune to be among those randomly selected to keep the system honest or for statistical purposes.

Why me? Why do some become the target of a criminal tax investigation?

Civil tax consequences versus criminal charges filed often turns on what the government can prove.  Can the government prove beyond a reasonable doubt that the taxpayer intentionally violated a known legal duty?  For tax evasion the government must prove, in part, that the taxpayer committed at least one overt act in the attempt to evade a tax liability or knew that the statement in a return was false.  The overt acts also often prove that the taxpayer’s conduct was willful or intentional as described above.  But, these acts do not require an evil motive and may seem innocuous to the uninformed.  An indictment or information might charge, for example, that the taxpayer emailed false information to his or her return preparer after having been informed of an unappealing tax rule, or, solicited another to do so, or, attended a meeting where evading the tax liability was discussed, or, altered a document supposedly supporting a deduction.    These overt acts distinguish the act of evasion from a mere mistake.  They indicate that the misstatement in the return or underpayment of tax was knowingly false or intentional.  As in the UBS case they are often damning. Deciphering these indicia of fraud is a job for a lawyer versed in criminal tax matters.  Often,  good people employ poor judgment unaware that the circumstances surrounding their injudicious decisions expose them to serious criminal consequences.  That is not to say that in every case a criminal prosecution will ensue. Quite the contrary, the government is very selective about suspected tax crimes it chooses to investigate, opening on average only 4,000 cases each year, and prosecuting only about 2,500.  The conviction- rate, however, is about 85%.  So, ask yourself do you like to play Russian roulette with a 1,000 chamber gun?  The likelihood of getting caught may be remote but the consequences will be catastrophic and clearly not worth the risk. 

CONCLUSION

In the tax world, most bad things happen to careless or foolish people; sometimes, bad things happen to bad people and sometimes blind fate traps a poor undeserving soul in what feels like an inescapable tax beurocracy.  Whatever the cause, it is not fun to be audited and not funny to become the target of a criminal tax investigation.  Perhaps the best one can do is adopt the wide credo of Roman Emperor and philosopher Marcus Aurelius, “Accept the things to which fate binds you, and love the people with whom fate brings you together, but do so with all your heart.” 

© 2010 By Robert S. Steinberg.  All rights reserved.

 This article originally was published in Steinberg Talks Tax Vol. 4, No. 8

 

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