Take Steps to Avoid IRS' Audit Dragnet

Physician's Money Digest, April30 2003, Volume 10, Issue 8

Dragnet.

ABC-TV recently dipped into its bagof golden oldies to bring back anupdated version of the 1960's crimedrama Former fans of the showcouldn't be happier.

Less pleasing is the IRS' recent reinstatementof its own dragnet, a resurrectionof its dreaded audit program that,according to the National Taxpayer'sUnion, intensely scrutinizes nearly 50,000randomly selected tax returns each year.But being forewarned is being forearmed.Here's an overview of the IRS' plans andwhat you can do to stay out of harm's way.

PASS-THROUGH CLAIMS

It's quite possible that your medicalpractice falls under the heading of a partnership,S-corporation, or limited liabilitycorporation (LLC). If that's the case, you'reprobably aware that these types of structuresare known as pass-through entities(ie, they're not subject to corporateincome tax). Income and losses are passedthrough to the individual partners, shareholders,and members. For example, ifyou're a 50% partner in a medical practicethat experiences a $50,000 loss for theyear, a $25,000 loss will be passed throughto your personal income tax return.

Some individuals are either overstatingpass-through losses or understating passthroughincome to their advantage. As aresult, the IRS is giving added attention tothe K-1 forms that report pass-throughincome and losses, thus increasing yourchance of being audited.

In addition, the IRS has begun usingnew computerized filters as a way of identifyinghigh-risk, high-income individuals—those earning in excess of $1 millionannually. If you fall into this bracket andreceive 1 or more K-1s, your chances of anaudit substantially increase.

To stay below the IRS' radar screen,make certain that you properly report allK-1 items on your tax return. Historically, S-corporationsand LLCs received much lessIRS scrutiny than sole proprietorships andC-corporations. That's unlikely to change.

OFFSHORE CREDIT CARDS

The IRS is also cracking down on offshorecredit cards. No, it's not illegal tohave one, but you can't use it as a vehiclefor avoiding US taxes. Individuals transfercash into an account in an offshore, tax-havencountry. No tax is owed on theincome that generated the cash, and thesame is true for future earnings from investingthe cash. The problem comes whenindividuals are told they can access the hiddencash whenever they like by using acredit card that has been set up as part ofthe scam. That's illegal, and the IRS is afterthe tens of thousands of individuals whohave employed this scheme.

The IRS has also stepped up its crackdownin 4 other areas that could pose athreat to you and your practice. Here's abrief rundown to get you caught-up:

• The IRS has a new computer programto identify unreported or underreportedtaxable income. This practice can causeindividuals more trouble than overstatingdeductions. Double-check your records toensure you haven't made a mistake.

• Charitable tax scams claim you cancontribute to a charity, claim a huge writeoff,and still maintain control over yourmoney. Not true. To be entitled to charitabletax benefits, the assets typically have tobe placed beyond your legal reach.

• Advocates of abusive trust deals inaccuratelyclaim that you can place all yourbusiness assets in a trust, thus avoidingincome taxes while maintaining access tothe funds. In reality, unless the assets areowned by a separate taxpaying entity, likea C-corporation, you will likely owe taxeson income generated by assets you control.

You're still entitled to take advantageof legitimate tax-saving strategies. Just letcommon sense, proper documentation,and the advice of a reliable tax professionalbe your guide.