According to IRS estimates, in a calendar year employers, businesses, financial institutions, credit card companies and other third party payers will file 2.3 billion information statements. These information statements report income and financial transactions, and can help individuals and businesses prepare accurate tax returns. Using information-matching programs, the IRS compares third-party information statements with taxpayer data, and sends a notice to taxpayers when IRS systems detect inconsistencies.
Here are some of the programs IRS has in place to help select tax returns for audit:
Individual Automated Underreporter (AUR) program
This matching program is better known by its primary notice: CP2000, Notice of Proposed Adjustment for Underpayment/Overpayment. IRS systems automatically send this notice when items reported on Form 1040, U.S. Individual Income Tax Return, don’t match information reported to the IRS by employers and other payers. The first round of these notices arrives just after Thanksgiving, and the second round arrives toward the end of the next year’s filing season.
The CP2000 notice has been a mainstay of IRS information reporting for decades. In 2012, the IRS issued more than 4.5 million CP2000 notices, with an average of $1,572 in additional taxes owed.
Form 1099-K merchant card transaction matching program
In 2012, the IRS started receiving from credit card companies, Forms 1099-K, Payment Card and Third Party Network Transactions. With merchant card transactions now being reported to IRS, the IRS quickly began using this information to match against business returns. However, because businesses do not specifically report merchant card transactions as separate line items on business tax returns, the IRS can only infer potential underreporting. For example, if a business has a disproportionate amount of cash to credit/debit card sales, based on its line of business, the IRS may look closer. These kinds of mismatches have led the IRS to develop compliance initiatives, including “soft” notices requesting explanation and mail audits requesting documentation.
The IRS is developing a Form 1099-K matching initiative that will make the IRS more efficient in identifying problem tax returns. But for now many initial notices indicate that the IRS is focusing on underreporting cases in which merchant card payments appear to make up the majority or even exceed the total business receipts reported on the return. In these cases, the IRS perceives that the business is underreporting cash sales due to the disproportionate share of merchant card payments. Accrual-basis taxpayers and e-commerce businesses whose receipts do not neatly match merchant card transactions are likely early targets in this program and we have had our share of this cases where that is what happened.
Automated Substitute for Return program
When a taxpayer does not file and the IRS has information statements indicating a filing requirement, the IRS uses the data to file a return on behalf of the taxpayer if there is a projected balance owed. In 2012, the IRS used information statements to file 803,000 returns for taxpayers, totaling $6.7 billion in additional taxes owed. And the sad thing about this is in just about every case, the amount actually owed when a tax return is filed by the taxpayer is much lower than what the IRS says a non-filer taxpayer owes. We even had cases where the IRS ended up owing our clients money.
Where in the future is the IRS going with their use of Big Data?
The IRS has been getting a lot of help from Congress where Congress has expanded the IRS’ reach to access more information to enforce compliance and implement new legislation.
1. Foreign Account Tax Compliance Act (“FATCA”)
This legislation became law in 2010. Starting in 2014, the IRS will have the ability to match taxpayers’ returns against the information it receives on U.S. taxpayers with accounts at foreign financial institutions. The IRS will likely scrutinize taxpayers who have not filed the required Form 8938, Statement of Specified Foreign Financial Assets, or FinCEN Form 114, Report Of Foreign Bank Account (commonly known as “FBAR”). Our office has a lot of cases representing taxpayers with undisclosed foreign bank accounts – it is a hot issue with IRS.
2. Patient Protection and Affordable Care Act (“Obama Care”)
As this Act is implemented in the next several years, the IRS will start using information statements for individual and employer compliance with the Act’s mandates. Starting in 2012, employers reported the value of employer-provided health insurance on Forms W-2, Wage and Tax Statement, to inform taxpayers of the value of their health insurance coverage. In 2015, the IRS will also receive information from health insurance companies on employee coverage, including the name and identifying information of the employer. The IRS can use the information to identify and penalize individuals and employers for noncompliance with Obama Care mandates.
The Stakes Are High!
A recent U.S. Government Accountability Office study showed that the IRS spends $267 million on underreporter matching programs, compared with the $4.2 billion it spends on audits. But automated information-matching programs return almost six times more revenue than audits. You can see why with fewer IRS agents and reduced budgets, the IRS will increasingly rely on technology-driven matching programs to bring in more tax dollars.
So if you receive one of these audit notices it is important that you don’t ignore it. Protect yourself from excessive fines and possible jail time. Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego, San Francisco and elsewhere in California defend you from the IRS.
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