TAX REPORT By TOM HERMAN
High Earners Face Surge in Tax Audits
The IRS is turning up the heat on high-income taxpayers, especially those who work for themselves. IRS officials say audits of taxpayers making $100,000 or more rose 14% last year from 2006. Recent IRS data also show a 29% increase in audits of people making $200,000 or more -- and an 84% surge in audits of those with incomes of $1 million or more.

IRS research indicates much of the tax-noncompliance is committed by self-employed workers, such as consultants and small-business owners, whose taxes aren't withheld from their pay and whose income isn't reported separately to the government. By contrast, compliance is much higher among people whose pay is reported by their employers and whose taxes are withheld from their pay.
This year, "we will continue to focus on audits of high-income individuals," Linda Stiff, the IRS's acting commissioner, said in an interview. She also says IRS agents are intensifying their focus on "abusive" tax shelters, loosely defined as transactions with no real business purpose other than to avoid taxes.
In addition, agents have increased audits of taxpayers involved in partnerships and businesses organized as "S corporations." With a typical S corporation, income isn't taxed at the corporate level. Instead, profits and losses flow through to shareholders, who are supposed to pay taxes at their own individual rates.

For the vast majority of taxpayers, the odds of getting audited remain quite low. Only about 1% of all individual income-tax returns filed in each of the past few years have been audited. But the chances of attracting the IRS's attention now are significantly higher than they were just a few years ago.
In fiscal 2007, the IRS examined a total of nearly 1.4 million individual income-tax returns. By contrast, the IRS audited only 617,765 returns in fiscal 2000. The IRS's "coverage" rate -- audits divided by total number of returns filed the previous year -- has also been rising in recent years. For fiscal 2007, it stood at 1.03%, up from 0.98% the prior year and 0.49% in 2000. Even so, it's lower than where it was as recently as 1997.
IRS coverage rates are rising especially rapidly for higher-income taxpayers:
The IRS audited 31,382 returns with incomes of $1 million and higher in fiscal 2007, up from 17,015 the prior year. The coverage rate rose to 9.25% from 6.30%.
The IRS audited 113,105 returns with income of $200,000 and higher, up from 87,558 the prior year. The coverage rate: 2.87%, up from 2.57%.
The IRS audited 293,188 returns with income of $100,000 and higher, up from 257,851. The coverage rate: 1.77%, up from 1.67%.
The IRS relies on numerous techniques to choose which returns are audited. Many returns are selected on the basis of a secret computerized-scoring system that the IRS recently has updated, which is based on a continuing research project involving in-depth audits of thousands of returns. Computer programs assign each tax return a score that evaluates the potential for inaccuracies, based on the IRS's experience with similar returns. IRS staffers then pore through those returns with the highest scores to see which would make the best targets.
Many returns are picked because of "mismatches" -- which means that something a taxpayer reported doesn't match what was reported separately to the IRS by employers, banks or other financial institutions. Thus, one way to reduce your chances of hearing from the IRS is to double-check your return to see if what you reported matches what appears on those forms.
Other returns get audited because they were done by a paid tax preparer whom the IRS suspects of wrongdoing. Still others are picked based on information the IRS has obtained through its growing efforts to identify promoters and participants of tax shelters and other abusive tax-avoidance transactions.
Some returns get selected because of a tip from confidential informants, such as former business partners, ex-spouses or an angry neighbor. Separately, thousands of audit victims are picked at random among various income groups.
Most IRS probes are conducted by mail and are known as "correspondence" audits. These focus on a limited number of specific issues on a return and are designed to address those topics that don't require a full-scale, face-to-face audit. More complex issues are handled through what are known as "field" audits and are conducted in person. These may involve a trip to an IRS office or to the taxpayer's home or business.
In fiscal 2007, just over one million of the 1,384,563 individual income-tax audits were correspondence audits. Of the 31,382 audits of people with income of $1 million and higher, 19,123 were correspondence audits and 12,259 were field audits.
One of the easiest ways to attract IRS attention in a hurry is to claim there's no law that you have to pay federal income taxes or even file a return. IRS officials refer to these and similar excuses as "frivolous" arguments. Don't even think about trying to make such claims. Courts consistently reject them, and the penalty can be severe.