The United States operates a quasi voluntary income tax reporting system. There are an ever-growing set of involuntary reports of income, such as W-2s, 1099s, K-1s, etc. and the IRS has become very proficient at automatically matching such reports against tax returns filed by the recipients. It takes almost no effort by the IRS to initiate a “correspondence audit” when its computers detect mismatches, especially ones involving under-reporting of income by the taxpayer.
Of course, besides under-reporting of income, many taxpayers mistakenly report deductions and credits for which they may not by law be entitled, resulting in under-reporting of taxable income. The IRS has developed a number of artificial intelligence algorithms to attempt to detect such errors, again, with an eye towards those which tend to cause an under-payment of tax.
Certified Public Accountants (“CPAs”) focus not only on ensuring that income, deductions and credits are properly reported, but also look for other possible reductions to tax liabilities and other economically beneficial activities for their clients. Our duty as CPAs is to bring expertise in financial matters, including tax effects, to enable our clients to both comply with the tax codes and to maximize their wealth making capabilities.
Interestingly, some taxpayers take substantial risks when preparing and filing their tax returns, despite the ethical guidance regularly provided by CPAs. Sometimes, taxpayers take a ‘do it yourself’ approach or may turn to non-professional, seasonal temporary workers, a friend, a family member or a computerized tax preparation software program to assist them with preparing tax returns. Of course, it’s self-serving for our CPA firm to advise against taking such risks, but we do so advise nonetheless. Why?
CPAs must have a minimum of a bachelors degree in accounting, and in most states, must possess a masters degree to even be permitted to take the 3-day long CPA exam. Only 12% pass the CPA exam in their first attempt. In addition to the education and examination requirements, states require an additional period of professional experience to qualify for the professional credential of Certified Public Accountant. Additionally, the AICPA and most state societies of CPAs, require an average of at least 40 hours of continuing professional education every year throughout a CPA’s career to maintain eligibility for membership. The state Boards of Accountancy and the AICPA require ethical conduct by CPAs and maintain review boards which take disciplinary action against CPAs who fail to maintain these high standards.
If the errors are in the taxpayer’s favor, it’s very unlikely that the IRS will take any action. However, as Al Capone and many others learned the hard way, in the extreme cases where tax evasion is proven, heavy fines and prison sentences are real possibilities. For the more routine under-reporting or late filing, stiff penalties and interest can quickly pile up debt on the unfortunate taxpayer, and the IRS is a very proficient debt collector.
Typically, there is a 3-year window from the date of filing during which the IRS can audit your tax return for any reason it chooses. However, if the IRS has probable cause for believing that fraud may exist, the window is wide open for all previous years. There is good reason to follow the axiom “don’t mess with the IRS.” That said, the IRS actually audits a very small percentage of tax returns beyond the correspondence audits for the computerized mismatches mentioned above. Here’s the approximate percentages audited by type of return for a recent year (IRS statistics):
Small C corporations
Large C corporations
S corporations & partnerships
Small Sole Proprietors & single-member LLCs
Mid-sized Sole Proprietors & single-member LLCs
Large Sole Proprietors & single-member LLCs
The IRS regularly sets its sites on certain classes of taxpayers and recently indicated an increased focus on individual returns and returns of sole proprietors/LLCs (Schedule C filers). The audit percentages for these classes of taxpayers are very likely to increase significantly in the upcoming year and beyond as the IRS attempts to close the gap between what taxpayers should be paying and what they actually pay for their income tax liabilities. We encourage our clients to NOT play “audit roulette” and bet their fortune and their freedom that the IRS will never come to call.
Of course, we can help you avoid being snared in the unfortunate net of a full-blown IRS audit by properly preparing your income tax returns. If you are contacted by the IRS, for ANY reason, please call on our assistance immediately. We have the necessary experience to calmly resolve their inquiry and make sense of their often perplexing correspondence. If you are one of the taxpayers selected for any kind of audit by the IRS, we are authorized to represent you. Our hourly fees for this service are reasonable and you’ll find it money very well spent. If the situation requires attorneys, we will arrange for competent counsel to meet with you.
We provide you with high-quality, low cost tax planning and tax return preparation services. However, more than any other time, if you receive IRS correspondence, you should call us! (262) 421-1170. Do not delay. The IRS takes a very dim view of being ignored or when taxpayers fail to answer their correspondence timely. It can also make resolving the issue much more time consuming and difficult.
Copyright©, 2009 by Kenneth S. Folberg, CPA, KSF CPA Services LLC. All rights reserved.