Previous month:
April 2019
Next month:
July 2019

June 2019

IRS Audits 2018—Audit Credibility?

William R. Stromsem, CPA, J.D., Assistant Professor, George Washington University

 

While volunteering at a low-income taxpayer clinic, I observed a client whose prior-year return had been completed by a commercial preparer. When we refused to include her claim of 21,000 business miles for which she had no records and for a job that seemed unlikely to generate this mileage (occasional catering server working almost entirely in one city), she was indignant. She said she would go back to her old preparer who understood how the system works. When we cautioned her about penalties, she said that everyone does this and at low income levels, no one ever gets audited. Clients at all income levels can be tempted to play the audit lottery and with lower audit rates, the game is getting better for the players! 

Number of Audits Declines Again

On May 18, the IRS released its Data Book containing information about audits conducted in 2018 and again the IRS’ audit credibility has to be considered. Of the approximately 150 million individual returns filed in 2017, the IRS audited just under 900,000 in 2018 for an average of .6%. Or, looked at another way, the average individual filer should expect to be audited only once every 167 years. This does not include CP-2000 notices for math errors or matching problems. Most of the audits (74.6%) were correspondence audits, which generally cover a very limited set of issues. The Data Book does not include information about civil and criminal penalties resulting from audits, but these have always been statistically low and provide little deterrence from playing the lottery.

Individual Audits

For high-income individuals with adjusted gross income over $10 million, there is a 6.66% chance of being audited, and for those with income of under $25,000, it is .69%, raised somewhat by returns that claim an Earned Income Tax Credit (EITC), where the audit rate is 1.4% because of the complexity of the credit and IRS concern about fraud. In between the high and low, the audit coverage doesn’t exceed .53% until income rises to $500,000. It then goes to 1.1% for incomes from $500,000 and up to $1 million and jumps to 2.21% for incomes from $1 million to $5 million.  Depending on level of income, taxpayers who filed a Schedule C had between .9% and 2.4% rate of audit. There are a variety of other factors analyzed in the links below.

Business Returns

Audit rates are embarrassingly low. C corporations had an average audit rate of .9%, although corporations with assets of $5 million or more had a much higher audit rate, from 4.6% to 49.3% depending on level of income. Average S corporation and partnership audits plunged to .2% in 2018, meaning that an average S corporation or partnership might expect to be audited approximately once every 500 years! (Note: this rate will likely increase with the new partnership audit rules.)

Detailed Information

Tables in the Data Book cover specific issues:

·         Recommended and Average Recommended Additional Tax After Examination, by Type and Size of Return

·         Individual Income Tax Returns Examined, by Size of Adjusted Gross Income

·         Returns Examined with Unagreed Recommended Additional Tax After Examination, by Type and Size of Return

·         Returns Examined Involving Protection of Revenue Base, by Type and Size of Return

·         Returns Examined Resulting in Refunds, by Type and Size of Return

·         Returns of Tax-Exempt Organizations, Employee Retirement Plans, Government Entities, and Tax-Exempt Bonds Examined, by Type of Return

Conclusion

Late in 2018, the IRS published the Comprehensive Taxpayer Attitude Survey that showed the level of taxpayer concern about an IRS audit when deciding whether to report and pay taxes honestly. Fear of an audit did not at all influence 19% of taxpayers to be honest and it was of very little influence for another 16% of taxpayers. Applying these percentages to the 196 million tax returns filed in 2017, 37 million were filed by taxpayers with no concern about audits, and 31 million were filed by taxpayers with little concern about audits. Only 34% of taxpayers were greatly influenced to be honest by the fear of an audit. 

Most taxpayers are honest, and this is basic to our self-assessment system of taxation. The Comprehensive Taxpayer Attitude Survey showed that 85% of Americans continue to say that it is not at all acceptable to cheat on taxes. However, for those who might be tempted, the IRS needs to have a credible audit potential, and we see this being eroded year after year. CPAs have a great stake in maintaining a credible audit potential. To the extent that we ask our clients to follow the law, they may be paying a disproportionate share of taxes. If clients perceive us as requiring a higher level of compliance, they may at some point prefer to self-prepare or go to a return preparer who is less competent (or ethical). If audits are reduced, our representation and controversy work is also reduced.   


Charitable Contributions from a Required Minimum Distribution

With the increase in the standard deduction and the decrease in available itemized deductions ($10,000 limitation on state and local taxes and miscellaneous itemized deductions no longer available), many taxpayers are choosing to take the standard deduction. Choosing the standard deduction means taxpayers will not receive a deduction for charitable contributions. However, for taxpayers aged over 70 ½ and receiving a required minimum distribution (RMD) from their IRA, there is an alternative that is even more tax beneficial than taking an itemized deduction. These taxpayers can reduce their RMD by the amount of charitable contributions made from their IRA. This is known as a qualified charitable distribution (QCD). A QCD is particularly beneficial because it not only reduces the amount of tax paid regarding the RMD, but the deduction reduces adjusted gross income rather than just taxable income if the amount were to be claimed as an itemized deduction.

But there is a “catch” for many IRA beneficiaries. Unlike an itemized charitable contribution that is deductible in the year the charity receives the check, where the taxpayer has checks that they can use to make a QCD, the deduction from the RMD is only available for the year the charity cashes the check. Many taxpayers make their charitable contributions at the end of the calendar year and many charities will not be depositing the checks until the following year. This contrasts with the situation where the taxpayer authorizes the IRA custodian to send a charitable contribution check directly to the charity, in which case the deduction from the RMD is available on the date the custodian mails the check.

Taxpayers also need to ascertain the annual date when the RMDs are distributed by contacting their IRA custodian or checking their deposit records. Many, if not most, IRA custodians distribute the RMDs at a date during the year, rather than at calendar year end. So, for instance, if the distribution date for the taxpayer’s RMD is June 30, 2019, and the taxpayer arranges with the IRA custodian to make charitable contributions in December 2019, the 2019 RMD has already been transmitted and therefore the contributions cannot reduce the 2019 RMD. Furthermore, because the charitable contributions were made in 2019, it is unlikely that they would qualify for a reduction in the 2020 RMD. In such a circumstance, the contribution amounts will come out of the taxpayer’s IRA and will not be taxable to the taxpayer, but will not reduce the taxable amount of the RMD.

 


Transcript Faxing Service Ends June 28

Effective June 28, the IRS will end its faxing service for individual and business tax transcripts and, effective July 1, the IRS will end its third-party mailing options from the Form 4506 series. The IRS announced both changes last year, but the dates are now confirmed.

The IRS will be issuing a news release and updating IRS.gov pages shortly. The IRS also plans a webinar for tax professionals on June 19, 2 p.m. Eastern Time, to review alternatives to faxing and mailing. Practitioners can register for the webinar here.

Since the IRS last year announced numerous safeguards to protect taxpayer transcripts, it has worked with professional associations to assure that preparers still have access to the information needed for tax preparation.

These alternatives require preparers to register and have an e-Services account that is protected by two-factor authentication. Tax professionals also have several options to obtain tax transcripts necessary for tax preparation or representation as follows:

  • Use e-Services’ Transcript Delivery System (TDS) online to obtain individual transcripts and business transcripts, or
  • Call the IRS to obtain an individual transcript or a business transcript. If an authorization is not already on file, fax one to the IRS assistor and the assistor will place the transcript in the tax practitioner’s e-Services secure mailbox.

When needed for tax preparation purposes, tax practitioners may:

  • Obtain an unmasked wage and income transcript if authorization is already on file by using e-Services’ TDS.
  • Call the IRS to obtain an unmasked wage and income transcript. If an authorization is not already on file, fax one to the IRS assistor and the assistor will place the transcript in the tax practitioner’s e-Services secure mailbox.

The wage and income transcript is the only unmasked transcript that will be available to tax practitioners.

Reminder:

Attorneys, CPAs and enrolled agents (i.e., Circular 230 practitioners) can create an e-Services account and obtain access to the TDS and the e-Services secure mailbox. Unenrolled practitioners must either be responsible parties or delegated users on an e-File application.

The IRS urges tax professionals to register for e-Services or update existing e-File application information to ensure that all appropriate personnel have e-Services mailbox and TDS access.

The charts below indicate the types of individual and business transcripts available via TDS.

TDS: Individual transcripts

Tax Return Transcript

Record of Account Transcript

Account Transcript

Wage and Income Transcript

Verification of Non-Filing Letter

 

TDS: Business-related transcripts

CIVIL PENALTY

CT-1

11C

706GS(T)

720

730

940

940EZ

941

943

944

945

990

990C

990EZ

990PF

990T

1041

1041A

1041QFT

1042

1065

1065B

1066

1120

1120A

1120C

1120F

1120FSC

1120H

1120L

1120ND

1120PC

1120POL

1120REIT

1120RIC

1120S

1120SF

2290

4720

5227

8288

8752

8804

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

https://www.irs.gov/newsroom/irs-takes-additional-steps-to-protect-taxpayer-data-plans-to-end-faxing-and-third-party-mailings-of-certain-tax-transcripts