Americans who get paid in cash and own a small business are at high risk of being audited – especially if they live in wealthy suburbs: the IRS is going after those from which the agency thinks they can get more taxes.
“It’s just a matter of them going where they think the money’s at,” Steve Rosansky, president and CEO of the Newport Beach Chamber of Commerce, told AP. “I guess if I were running the IRS I’d probably do the same thing.”
The Internal Revenue Service only audits 1 percent of tax returns each year and can yield greater taxes by targeting wealthy small business owners who might have underreported their earnings. As a result, the IRS is looking closely at small business owners in New Carrollton, Md., College Park, Ga., Beverly Hills, Calif., and Newport Beach, Calif. – suburbs that are home to wealthy and middle-class Americans, many of which are sole proprietors.
These five metropolitan regions are more likely to host tax cheats than other neighborhoods, according to a study conducted by the National Taxpayer Advocate, an independent office within the IRS. And those who own construction companies or real estate rental firms are considered by the IRS to be most likely to cheat on their taxes.
Despite the outcome of the study, which looked at tax cheat clusters from 2009, the IRS denies that a person’s ZIP code or employment status determines their likelihood for an audit.
“The IRS initiates audits based on information the taxpayer includes – or doesn’t include – on a tax return,” the agency told AL.com. “We don’t base audits on geography. City or state location plays no role in the audit process whatsoever.”
But data collected by the National Taxpayer Advocate did find that audits were more likely to occur in specific regions and target small business owners – even if the IRS denies using regional information as an auditing factor.
The agency runs all of its tax returns through a program that gives each return a score called the Discriminant Inventory Function (DIF). Higher scores indicate that there are higher chances for the IRS to collect more money from conducting an audit.
“If your return is selected because of a high score under the DIF system, the potential is high that an examination of your return will result in a change to your income tax liability,” states an IRS publication, according to AP.
Sole proprietors, many of whom have cash businesses, need to be particularly careful about reporting large charitable contributions or home-office expenses if they want to avoid an audit.
“If you’re reporting $8,000 of charitable contributions when you’re only making $50,000, that’s a red flag,” Bob Meighan, vice president of TurboTax, told AP. “Likewise if you’re reporting business or employee expenses that are out of the ordinary for your income range, that would attract the interest of the IRS as well.”
Elizabeth Maresca, a former IRS lawyer and professor at Fordham University, told the newswire that claiming unusually high employment-related expenses is another red flag that could increase a taxpayer’s DIF score.
“I had a case here where the person made about $40,000 and they claimed $25,000 of employment-related expenses,” she said. “Most people don’t spend $25,000 to earn $40,000. That’s an unusual number.”
The IRS says it conducts audits primarily to minimize the “tax gap”, which is the difference between what the federal agency is owed and what is actually paid. The National Taxpayer Advocate study found that this gap is largest among small business owners.
In 2006 – the most recent year for which the IRS provides an estimate – the tax gap was $345 billion. The study pointed out 350 neighborhood communities whose residents face higher risks of being audited as the IRS attempts to collect more money, particularly from those it believes are well-off.