Don't Tangle with Pesky Tax Infractions

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Physician's Money Digest, February15 2003, Volume 10, Issue 3

Although the most effective actions are takenin the year affected, there are some movesyou can make to reduce prior year taxes.Most of these pertain to retirement plans. IRAscan be established and funded in 2003 for 2002until April 15. SEPs can be established and fundedfor 2002 by the due date of thereturn plus extensions. Profit sharing401(k)s must be established by the endof the tax year affected. If you were ableto defer income from 2002 to 2003 andlater years, you may receive an addedbonus of lower tax rates in 2003 thanwere expected.

UNDER INVESTIGATION

On September 12, 2002, the IRSunveiled a new audit strategy aimedmostly at the wealthy and intended touncover illegal tax-dodging schemesand strategies. This step is importantbecause higher-net-worth folk are animportant revenue-generating segmentfor the government. By IRS estimates,some 60% of income taxes arepaid by persons with incomes in excess of$100,000. According to a recent IRS report, theIRS is realigning its limited audit resources tofocus on high-risk areas of noncompliance.Priority areas will include:

• Offshore credit cards. They're not illegal,says the IRS, but they do provide easy access tooffshore funds in tax-haven countries, thus allowingincome to be hidden.

• High-risk, high-income taxpayers. Upper-income taxpayers often have resources to"engage in pass-through entities such as partnerships,trusts, and corporation," making income anddeductions difficult to identify.

• Abusive schemes and promoter investigations.Various schemes are used to reduce aperson's tax liability by claiming inflated expenses,false deductions, unallowable credits, orexcessive exemptions.

• High-income nonfilers. "The most egregiousand high-risk segments of thepopulation," according to the IRS.

• Unreported income. This representsthe largest component of thecurrent tax gap.

COVERT OPERATION

In terms of methodology, the IRSwill not rely, as it has, on random audits.Rather the IRS says it will employ"secret" statistical techniques to identifytaxpayers who failed to report theirfull income, and will use a "full scope"of tools and techniques,including summonsenforcement, injunctions,criminal investigationof promoters,and civil audits ofparticipants. For example, theIRS reports it has developed anew tool, the Unreported IncomeDiscrimination IndexFormula (UDIF), for identifyingreturns with a high probability ofunreported income. The resulting"score" rates the probability of income beingomitted. Beginning in the fall, all returns willreceive a UDIF score, as well as the traditionalDiscrimination Index Formula Score.

Therefore, it's all the more important thatyou carefully review your tax strategies, especiallythose that are aggressive and based onnonauthoritative pronouncements.At this time of the year, we would probably bemore productive thinking about wise financialmoves we could make rather than taxes. The followingare some moves that might prove productivefor your finances:

1. Get debt-free, this especially pertains to consumerdebt, recourse debt, and debt on depreciatingassets. Refinance your mortgage with an eye toa plan to pay it off as soon as practicable.

2. Always save for the future. Establish anemergency reserve; establish a long-term savingsplan that is invested in a broad array of investmentoptions, not forgetting fixed-income,including tax-exempt bonds.

3. Create a financial plan that addresses all ofyour insurance needs (ie, life, disability, liability,property, and long-term care); long-term retirementgoals; income tax issues; an effective, comprehensiveestate plan; and,finally, a well-conceived investmentplan that is consistentwith your goals.

4. Review all of your tax-deferredretirement plans inlight of the new laws.

5. Review college savingsplans, considering the new lawsand options available.

These moves will probablypay greater dividends than allinvestment strategies put together.These activities are best accomplishedwith the help of a competent unbiased financialplanner who is well versed in all the above disciplines.This relationship not only injects expertiseinto the process, but also provides someoneto encourage and keep you on track and movingtoward your financial goals.

James B. Coffmanis with Austin Asset Management

Company, a fee-only comprehensive financial planning firm in Austin, Tex. He welcomes

questions or comments at 512-453-6622 or jbcplan@juno.com. For more information,

log on to www.austinassetmanagement.com.