How to tell if the IRS is eyeing you
By Kelley Holland, CNBC
(CNBC) -- You consider yourself a law abiding citizen, and you are not starting a non-profit organization with conservative ties.
Even so, you may be a candidate for a tax audit—and you may have no clue what you have done to warrant the attention of the IRS.
The nation's tax collectors have long made it a practice to look for discrepancies, omissions and suspicious activity to uncover tax evasion and fraud. And lately, the IRS has expanded its monitoring to include social media.
The agency now keeps an eye out for online discussions about nonpayment or underpayment of taxes, and even sale prices of goods on sites like eBay that don't match what taxpayers report.
In a world where companies like Amazon can keep tabs on consumers' online activities, the shift by the IRS is reasonable, says Edward Zelinsky, a law professor at Cardozo Law School. "This was always known to people in the tax community that the IRS, like everybody else in the 21st century, was monitoring online."
But Zelinsky is just one expert concerned about the lack of transparency around the IRS' practices. The agency "is so secretive about what is going on that really erodes public confidence," he said.
The American Civil Liberties Union has also expressed qualms about IRS secrecy. That group filed a Freedom of Information Act request for documents explaining whether the IRS always obtains search warrants to read email and other electronic communications. "Unfortunately, while the documents we have obtained do not answer this question point blank, they suggest otherwise," wrote Nathan Freed Wessler, a staff attorney at the ACLU.
So how can you know if you are under scrutiny? You can't know exactly, but some moves are more likely than others to attract attention.
Noncash deductions are a prime example, according to several tax experts. If you donate a car to the American Lung Association, or a large quantity of clothing to the Salvation Army, make sure that the deduction you take is reasonable, and that you can document how you came to that amount.
Taxpayers who are self employed often appear to face more scrutiny as well. "If you are in business for yourself, or you work for someone who is, know that the IRS is watching," Frederick W. Dailey III, a tax lawyer and the author of "Stand Up to the IRS," said on his website.
The IRS also keeps an eye out for cash-based businesses, and for mismatches between what others file about you and what you file. For example, if you neglect to include a payment for some freelance work during the year, and the payer reports that as a business expense, you are likely to get some scrutiny. This would also hold true if you neglect to report gains from an investment account, and the investment firm reports them.
Wealthier taxpayers seem to be more likely to get chosen for audit, perhaps because that gives the IRS a greater chance to recover significant sums. (Every year the government collects only about 83 percent of what it is owed, a gap of several hundred billion dollars at a time when the budget deficit is a flashpoint.)
According to IRS data, taxpayers making $1 million or more are more than 12 times more likely than the rest of the population to be examined. In 2010, about one in 100 Americans were audited. The IRS audited 3.8 percent of returns for those making $200,000 or higher, versus 12.5 percent of returns for those making $1 million or more.
As for the online monitoring, Zelinsky says it may be simply the application of new tools to old agency search standards. So while he is deeply frustrated by the IRS' lack of transparency, he added, "If they are using social media to find cash based businesses, or looking for phony medical deductions or the other hot buttons, then I would applaud that."
There is no surefire way to prevent an audit. But experts say one practice definitely improves your odds: Don't do what the IRS does. Be open. About everything.
The agency declined to comment about this story.