As 1996 dawns, you may want to be especially careful with your record-keeping. Why? Because a revived IRS program will be peering into your lifestyle if you're unfortunate enough to be selected for an audit. It's all happening under the guise of something called "economic reality."
The reality of the situation is that if your return gets selected for an audit, the IRS will essentially audit your lifestyle in an effort to uncover unreported income.
What does this mean? Let's say the issues on your return are too complicated to be handled by mail. This would require you to visit an IRS field office. As you arrive for your scheduled appointment, don't be surprised if you see the agent peeking through the miniblinds to see what kind of car you drive. And if you step out of a chauffeur-driven Rolls Royce, wearing a full-length mink coat and a blinding array of diamonds-well, be prepared for some tough questions. It may well be you won it all on "Wheel of Fortune," but you'd better be prepared to prove that with documentation.
What's all the fuss about? The IRS, in its never-ending quest to close the tax gap (that is, the measure of tax Americans owe vs. what they actually pay), has determined that the majority of this gap comes from unreported income. "Especially cash transactions," says Steve Pyrek of the IRS. "We're looking for people who have cash businesses on the side and are not reporting income." To uncover this income, the IRS has recently begun making greater use of an old technique now known as the economic reality audit, the financial status audit or, perhaps most evocatively, the "financial probe."
The concept is that once a return is selected for an audit, the auditors should go beyond what is reported on the return and look at how the person is living or how the business is being operated. "The concept that you should take a look at how someone is living when conducting an audit has been around for about 30 years," says Jack Heaney, a CPA in Union City, New Jersey, who formerly worked for the IRS. "But this is the first time it's been formalized. They're now training their personnel to go into targeted businesses."
Pyrek agrees. "It's a classic technique," he says. "All agents should be doing this when they conduct an audit. When something doesn't make sense on a return, financial probes are aimed at finding unreported income."
Nancy Scarlato contributed to this article.