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Alan J. Lyon: Items that will interest the IRS

It's Your Money

Posted: July 15, 2009 3:59 p.m.
Updated: July 16, 2009 4:55 a.m.
The IRS uses “audit anxiety” to help taxpayers be honest on their tax returns. Some people don’t even claim all of their deductions out of fear of audit. We have an obligation to pay our fair share of taxes but we don’t need to tip the government by not claiming all appropriate deductions. With the government hurting for money, they are trying to collect every penny they can. Here are some things that interest the IRS.

The IRS evaluates tax returns based on their “DIF” scores, a set of IRS formulas known as the “Discriminate Function System.” About three-quarters of all returns audited are selected by the DIF computer, which compares deductions, credits and exemptions with the norms for taxpayers in each income bracket.

While these formulas are kept very secret by the IRS, you can count on having a higher audit probability if you fall into certain categories or report certain things on your tax return.

The kinder, gentler IRS of the past 10 years is changing rapidly. The IRS hired a lot more auditors over the past few years, trained them and are now putting them to work. The IRS is also charging every penalty they can get away with.

The higher risk areas include the following:

1. Certain deductions. The IRS has found it profitable to audit returns that claim office-in-the-home deductions, travel and entertainment deductions, and certain other write-offs where they feel taxpayers stretch the truth. Be sure to keep detailed records of these deductions. Is that car really used for business 100 percent of the time? Car expenses are another risk area. Keep good records and some type of mileage log.

2. High income. Because auditing higher-income taxpayers is likely to produce more additional tax revenue than auditing lower-income taxpayers, this category is targeted by the IRS. The IRS has stated that it is targeting taxpayers with income over $100,000.

3. Certain occupations. Taxpayers whose occupations produce cash income, such as taxi drivers and waiters, run a higher risk of being audited. Self-employed individuals, particularly independent contractors, are IRS targets for the same reason; they are more likely to have unreported cash income.

4. No paid preparer or a problem preparer. If you have a complex return and prepared it yourself, or if your return was prepared by someone on the IRS’s problem-preparer list, you are more likely to be audited.

5. Related party transactions. Taxpayers who involve family members in their financial operations are more likely to be scrutinized by the IRS. Paying wages to your children, lending money to relatives, splitting income among family members, or running a family business will make the IRS more interested in your returns.

6. Foreign accounts. In the last few years, the Internal Revenue Service has detected a proliferation of abusive trust tax evasion schemes. It also believes some people are using offshore credit cards to evade paying U.S. income taxes. The IRS has expanded its efforts to crack down on abuses in these areas. There are requirements to report foreign bank accounts in your tax return and to the Treasury. The penalties for not reporting can exceed $10,000.

As a U.S. citizen or resident, the IRS taxes you on your worldwide income. The interest on that bank account in Switzerland may be taxed in the U.S.

7. S Corporations. The IRS is specifically targeting S corporations making sure that a reasonable salary was paid to the owners and that personal expenses are not being deducted.

Your best audit defense
The IRS has three years from the due date of your return to initiate an audit and California has four years. Typically, most returns are selected within two years of their filing date.

Have supporting documentation for all deductions. Keep records and receipts for at least four years from when the tax return was filed.

See your accountant immediately  if you receive an audit.

A professional can put your mind at ease, find the information that the IRS wants more quickly than you can, and will likely save you money in the long run by getting a faster and more favorable conclusion to the audit.

Alan J. Lyon CPA specializes in tax planning, tax preparation and consulting for individuals and businesses in Santa Clarita. He can be reached at 775-9399 or by e-mail at


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