Michael Whiteman has been involved with income taxes for more than two decades. In one of his former professions, he was an agent with the Internal Revenue Service, one of those people who audit tax returns. He isn't doing that anymore, but the tax attorney and professor of accounting at the University of Massachusetts at Amherst still believes in the collection power of income tax audits, and the need for honest taxpayers to keep good records so they need not tremble when a letter asking for an audit arrives.
Based on the most recent numbers from the IRS, Mr. Whiteman says, the Treasury could collect about $80 billion more than it is taking in, which could be used to help cut the deficit, fight drugs, or pay for child care, to name just a few of this year's foremost campaign issues.
Raising that much revenue through audits would require a tenfold increase in the enforcement budget for the IRS, Whiteman says. But depending on who is elected president in November, such an increase may be possible.
Gov. Michael Dukakis, Whiteman notes, has already mentioned the possibility of a tax amnesty such as he used in Massachusetts in 1983 and early '84, and the probability of increased enforcement, if he is elected president. The 1983-84 amnesty program allowed people to pay all their back taxes, without fear of penalty or prosecution by the state. It has since been followed by much tougher collection and enforcement. If something like this happens nationally, taxpayers who play the ``audit lottery'' and those who simply keep poor records will have to clean up their acts.
``The vast majority of Americans are honest taxpayers,'' Whiteman says. ``And a lot of them are terribly disgruntled that they know people who are cheating on their taxes. They figure that `I pay mine, why shouldn't everybody pay theirs.'''
The audit lottery, Whiteman explains, is based on the knowledge that just over 1 percent of the individual income tax returns are audited, so a taxpayer's likelihood of being audited is fairly small. Out of 101.8 million individual returns, the IRS audited about 1.1 million in 1987.
So even many people who deliberately leave some items off their tax returns, like extra income, may only have to answer to their conscience.
Of course, that 1 percent represents a share of all returns, including those using the simple 1040EZ form, with which the taxpayer simply includes a W-2 statement and might report a little interest on a bank account. Although almost none of these returns are audited, people with higher incomes tend to get audited more often. Last year, 0.53 percent of returns from those making less than $10,000 were audited, while 2.24 percent of the returns from people making more than $50,000 received the extra IRS scrutiny: For those at higher income levels, the chances of an audit are greater.
And people in some cities were audited more than in others. Anchorage, Alaska, for example, had an audit rate of 2.56 percent in 1987, while the folks in Manhattan were examined at a 1.31 percent rate. In San Francisco, the rate was 1.77 percent, while it was 1.22 percent in Dallas and 0.56 percent in Boston.
Even the highest of these numbers is too low, Whiteman believes, and should be increased for two reasons:
``If they increase the audit activity, it would have a twofold effect,'' he says. ``The immediate effect would be increased tax money; the second would be greater tax compliance, because people would be less likely to play the audit lottery if they knew the likelihood of their getting audited was going to substantially increase.''
Whiteman understands that in the current political climate, the money needed to collect an additional $80 billion probably won't be appropriated, since recent actions on Capitol Hill have indicated that less money will be spent on IRS enforcement, not more. But most taxpayers have nothing to fear from more audits, he adds, especially if they keep good records.
The best way to be prepared for an audit, Whiteman says, is for taxpayers to have all their books and records ready. ``If there are some questionable items, technically, where they've gone out on a limb - where there might be some justification for a claim, but it could go either way - they'd be well advised to be represented by an attorney or a CPA,'' he says, referring to certified public accountants.
``And if you've been cheating on your taxes,'' Whiteman cautions, ``you'd be best advised to have an attorney with you.''
The simplest kind of audit is a correspondence audit. Here, you just send in copies (never send originals) of one or a few documents to support a claim or deduction.
A more common audit is in an IRS office, where you bring records and perhaps your accountant or attorney. If you do bring a professional along, it's usually best to let that person do most of the talking, since they've dealt with auditors before and know what to say - and when to keep their mouths shut. Depending on how complicated your return is - or how uneasy you are in this type of situation - you may even want to send this person to the IRS office in your place, if this professional prepared the return.
The field audit takes place at your home or office and will probably look more closely at your financial affairs. As with the IRS office audit, you have a right to have an accountant or attorney represent you.
Most of the individual taxpayers Whiteman has audited kept fairly good records, he says. Owners of small businesses were another matter.
``The newly started small business with people embarking on a new endeavor, and being so busy making the business go, often don't comprehend the necessity of maintaining records,'' Whiteman says. ``That's usually when it gets messy.''
Generally, every piece of paper relating to a taxable item or tax deduction should be kept for the amount of time the return may be audited. The IRS usually has three years from the filing deadline in which to audit your return, although state laws vary. If fraud is suspected, there is no time limit.
After that, you should still keep copies of old tax returns and items that might be taxable over a long time, like records of stock trades. If home improvements have been made, you may need those records to reduce the capital-gains tax when the house is sold.
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