A stiff IRS `research' audit requires v-e-r-y c-a-r-e-f-u-l records
Boston — Even people who are used to dealing with the IRS have some strong words for this program. ``It's a nightmare,'' says Edward H. Pendergast, an accountant with Tonneson Kennedy & Lehan in North Quincy, Mass. ``It's cost some clients an extra $5,000.''
``It's a real mess,'' agrees Francis M. Gaffney, national director of tax services at KMG Main Hurdman, an accounting firm. ``It can get very expensive and take a great deal of time if it's a significant return.''
The object of these unkind sentiments is an Internal Revenue Service program known as the Taxpayer Compliance Management Program (TCMP). It provides the best reason yet for keeping accurate and complete records to back up every statement on your tax return.
Technically, the TCMP is an audit. But the IRS conducts most audits because it sees a reason to do so: A taxpayer may be heavily involved in an investment where there has been a record of excessive deductions; the overall deductions on a return may be out of line compared with income; or there may be just one item on the return which the IRS would like to see supported. This last one is an audit, too, even though it does not involve a review of the whole return.
The TCMP, however, is quite different. Every three years, the IRS picks some 50,000 returns at random and asks the taxpayers to supply complete documentation for every statement on them. Every tax credit, every deduction, and every source of income must be reviewed and backed up.
The 50,000 people reviewed are not limited to high-income taxpayers; they range from those who file the very simple 1040EZ to people in very complicated tax and investment groups.
The purpose of the TCMP is ``not to ferret out more taxes,'' an IRS spokesman says. ``But if we find out more taxes that need ferreting out, we'll take 'em.''
TCMP's primary purpose, the spokesman says, is to find what areas are most likely to cause problems for taxpayers, as well as the most likely areas of abuse. If several taxpayers make a similar mistake because they don't understand the instructions, then perhaps the instructions can be rewritten.
``It's a research program to tell the IRS where they are likely to find changes,'' says Larry Goldstein, a tax manager at Arthur Young & Co. ``They can see what kinds of adjustments are likely to come up in audits.''
The TCMP also plays a role in creating another IRS term, the DIF, or discriminant function system. This is the highly secret formula the IRS uses to select returns for ordinary audits.
``It's a computer program used by the service to classify returns according to their tax-change potential,'' Mr. Goldstein said.
A well-constructed DIF picks out the most likely revenue-producing audits and indicates what particular parts of a tax return are more likely to have errors. Each return is scored on the basis of income, size and type of deductions, tax credits, types of investments, and a variety of other things.
Since the IRS started using DIF in 1969, the extra revenue taken in by the average audit has increased from $146 to $1,592, and the number of audits producing no change has decreased from 46 to 16 percent.
The last TCMP program for individuals took place in 1984, so the next one will come around next year. But the IRS can ask for documents to support returns from any of the last five years.
Even though only 50,000 individual returns go through the TCMP every three years, the program should serve as one more incentive to keep complete tax records. If you haven't already, Mr. Gaffney says, get yourself a folder, envelope, or something else to keep 1986 records in.
``As you pay your bills, put the receipts in the folder,'' he suggests. He would also include canceled checks, store receipts for anything that might be deductible, and travel and entertainment receipts and records.
If you don't have a similar folder for last year, you'll have to pull your records together as best you can to file your 1985 taxes. You can, for example, still deduct expenses for using your car in business or charitable work. But unlike past years, you'll have to have fairly complete mileage and expense records.
Of course, having a good record-keeping system will be very useful if you're called in for an ordinary audit. Having a tax professional in your corner won't hurt, either.
Even if you do your own taxes and are called in for an audit, it might be worthwhile to have a accountant or tax attorney go over your return first. Then, most experts advise, let the professional meet with the IRS agent, while you stay home. But if the audit is nothing more than a question about a couple of deductions or something, you can probably handle it yourself.
``Clients can get very upset,'' Gaffney says. ``They may see the discussion moving out of the realm of an objection to one person accusing the other of not filing a correct return. If the adviser is there, he can handle it. He's been in these situations many times before.''
Sometimes, Mr. Pendergast says, the call for an audit is not from an ordinary IRS agent. ``If they come from the intelligence division, call a lawyer,'' he states. ``You know you're in for fraud.''