YOU may be audited within the next -5- years.
A) WHY ARE YOU THE AUDIT TARGET? Because …
The IRS audits 1.25 million returns of the entire 350 million US population. If, for some reason, they chose New York for a full 50% of their audits, New York would be subject to 600,000 audits annually. In fact, the New York State Department of Taxation and Finance is mass auditing 700,000 individual (not corporate) tax returns per year. In 5 years, they'll audit 3.5 million returns. New York population: 19 million.
Some people receive so little income that they are not required to file a return. Children or spouses do not file their own return because they are dependents on a return. There is no need to audit the many simple returns claiming the standard deduction.
So who is left to be the targets of audits?
A few high income taxpayers and a large group of ordinary middle class taxpayers (like you!) who itemize their deductions on Schedule A. This includes medical expenses, state/local income tax, real estate tax, mortgage interest/points, charity, and work-related, investment and other miscellaneous expenses.
Other 2 Major Targets: 1) Small businesses who report income/losses on Schedule C, and 2) Rental real estate landlords who report income/losses on Schedule E.
B) WHAT CAUSED THIS CHANGE?
The IRS has had political problems with Congress for a number of years. Congress has cut the IRS budget each year for the last 6 years. The number of IRS audits has been declining for years. All of the states had previously benefitted from the reciprocal Information Sharing Agreements with the IRS [IRC. Section 6103(d)], in which they automatically share the results of audit adjustments with each other. The states’ stream of free money was adversely affected by this decline in IRS audits.
California and New York took the initiative and launched efforts to modernize their tax systems utilizing advanced Supercomputer technology with Artificial Intelligence (AI). They took control of their tax base. They became more important than the IRS, in their own states. Their audit formulas are more restrictive than the IRS. The flexibility of the Supercomputer allows their formulas to change and adapt more frequently than the conventional IRS computers. They mass audit significantly more tax returns in their states than the IRS. Each state audit is more extensive than the IRS. Now, the IRS benefits more from the reverse direction of audit adjustments under the reciprocal Information Sharing Agreements.
Results: After a 6 year modernization program, California boosted their tax collections from this specific program by $1 Billion per year. New York State increased their tax collections by more than $100 million per year after only 3 years of the new system. We can reasonably expect other states to follow this pattern in the foreseeable future.
C) WHAT ARE THE 2 KINDS OF AUDITS? (and why does it matter?)
1) In-person face-to-face field audits, 7,000 per year and 2) Correspondence/desk audits, 700,000 per year, in New York State. The vast majority of IRS, California and New York audits are correspondence audits. You simply mail your documents to an address and wait for a decision. There is no opportunity for face-to-face discussion or explanation. There is no required or standardized format. The auditor must try to understand the taxpayer’s record keeping system, while under time pressure to finish and move to the next case. If the auditor is confused by unclear documents or messy paperwork, the taxpayer loses.
The requirements for proof are difficult to meet. Success is unlikely for an inexperienced taxpayer, with no professional guidance. There are too many “gotcha” pitfalls.
D) THE NEW MASS AUDIT CAPABILITY:
1) This is a newly acquired capability, which did not exist before 2013. In 2013, the New York State Dept. of Taxation and Finance received a new IBM Watson Supercomputer.
Short description: Artificial Intelligence (AI) combined with advanced analytical software, with Constrained Markov Decision Processes; processes at a rate of 80 teraflops (trillionfloating-point operations per second); employs 90 IBM Power 750 servers, each uses a 3.5 GHz Power7 eight-core processor, with 4 threads per core; total 2,880 processor threads; 16terabytes of RAM; combined data store of 200 million pages, which it processes against 6 million logic rules; self-contained in the space of 10 refrigerators. Built for “Big Data.”
The IRS does not have a supercomputer, yet. Currently, the only other state than New York with a supercomputer and capability for mass audits is California. All states, including these two, have Information Sharing Agreements with the IRS. They automatically share the results of audit adjustments with each other. You will pay twice.
2) New York built a new department of auditors to review the taxpayer’s documents.
They are not instructed to comply with IRS rules that protect the taxpayer. For example: they use an unrealistic standard “ordinary and mandatory” which they created and which does not exist in tax law. Internal Revenue Code Sec. 162 allows “ordinary and necessary" expenses. The IRS defines the word “necessary” as merely “appropriate and helpful to your business,” specifically “NOT required,” and certainly NOT mandatory. This is just one of the ways NYS unfairly disallows thousands of dollars of properly documented and legally allowed tax deductions.
Sixty percent (!) of taxpayers do nothing and ignore the NYS audit letter. They quietly accept defeat. They pay dearly for this costly mistake.
Standard Deduction Seduction: Many taxpayers are seduced into taking the easy way out of this problem. It seems simple and avoids a fight with a powerful government authority. The NYS letter states: “If you can’t send us proof of your itemized deductions, you can still take the standard deduction. Just write “standard deduction” on the enclosed Response to Audit Inquiry document and return it to us.” The next paragraph reveals the real danger of this approach.
Two Year Lookback Ambush? One important aspect of the New York State audit which is almost always overlooked:
“If the documentation you submit results in an adjustment to your tax return, a similar adjustment may be made to the income tax returns you filed in the two previous tax years. You may then protest the adjustment by providing the necessary documentation.”
The NYS tax owed would triple.
All states have Information Sharing Agreements with the IRS. They automatically share the results of audit adjustments with each other. The Federal tax may be 3-10 times the state tax. This audit can become very expensive, very fast!
This is why a strong, clear, and professional audit defense is so important, from the beginning.
E) HOW CAN YOU PROTECT YOURSELF FROM THIS THREAT?
1) Save ALL Documentation for 7 years:
When NYS sends an audit letter, they include this sentence:
“We won’t accept Credit Card Statements without supporting receipts.” You need the credit / debit card statements AND receipts. You need your EZ pass, appointment calendar, monthly statements from banks, cell phones, internet/cable, Staples receipts, restaurant receipts with the name of who you dined with. You will need notes about business gifts you gave at work, to whom and for what occasion. You must have receipts for ALL medical expenses, charitable contributions, and business deductions.
These need not be stored in an elegant manner. You can organize and categorize your records later, when and if you need them. However, to prepare your return, you still need to summarize these receipts.
2) GET PROFESSIONAL HELP to WIN YOUR AUDIT:
If you have no experience, training, or resources, do not defend yourself alone. Use the Audit Defense Package. There is no better response than this. It has worked successfully many times, because of the defensive IRS rules, US Tax court cases, worksheets, questionnaires, etc. built into its clearly organized structure.
If you have already been audited, regardless of the outcome, you can be audited again.
If you have not been audited yet, be patient. You may get your opportunity.
This is the new normal. Now you know.
Fortunately, you have been forewarned AND doubly forearmed!
Copyright 2017 Tax Strategies, Inc. Robert Greene CPA CMA