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IRS Unveils New Audit Program

The IRS is bringing back dreaded random audits as part of a new National Research Program (NRP) study. This new study is expected to help the IRS fine-tune the tools it uses to select individual taxpayers for closer examination.

Ultimate goal: The IRS hopes to close an estimated $345 billion “tax gap” between the amount taxpayers pay and the amount that is actually owed.

The new NRP study, which will be launched this fall, will be the first of an ongoing series of annual individual studies using a multiyear rolling method. The study will focus on approximately 13,000 individual returns for the 2006 tax year. Similar sample sizes will be used in the following tax years.

According to IRS personnel, updated research on individual taxpayers is needed because the patterns of noncompliance tend to change over a period of time. The latest individual NRP study has been developed to examine samples from individual taxpayers at varying income levels. The study will also focus on the activities of farming operations and sole proprietors.

When will the random audits begin? The scheduled start date is right around the corner.

In fact, the IRS expects to begin notifying taxpayers selected for random audits in October. The majority of these individuals will have to justify amounts on specific lines of their returns through an in-person examination with an IRS staffer. However, certain individuals chosen for the study will not be contacted if the IRS is able to obtain matching and third-party data that will confirm the accuracy of the return.

Also, note that the IRS is in the final stages of a compliance research project examining returns of S corporations. This research involves 5,000 returns filed for the 2003 and 2004 tax years. Because the income and expense items for Scorporations flow through to individual shareholders, this study will provide more data relating to individual returns.

What should you do if you are contacted by the IRS? First things first: stay calm. Then contact your professional tax adviser for assistance.

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Bringing Up Tax Breaks for Adoptions

Is someone in your family attempting to adopt a child? Don’t discount the tax breaks available to the parents-to-be. For instance, an adopting parent may be in line for the adoption tax credit. Unlike a deduction, a tax credit is a dollar-for-dollar reduction of your tax bill.

More details: The adoption tax credit covers the reasonable and necessary expenses related to the legal adoption of a child who is under age 18 or is physically or mentally incapable of self-care. This includes adoption agency fees, court costs, attorneys’ fees, travel costs (including meals and lodging), and additional adoption expenses for foreign children.

However, illegal fees and surrogate parenting fees are not eligible. Also, you cannot claim the credit for government reimbursements or payments made under an employer-sponsored plan.

How much is the adoption tax credit? It is adjusted annually for inflation. For the 2007 tax year, the credit is equal to the actual amount of qualified adoption expenses up to $11,390. If a child with special needs is adopted, the maximum credit amount is allowed, regardless of the actual adoption expenses.

Note, however, that the maximum credit is phased out for certain high-income taxpayers. For the 2007 tax year, the phaseout occurs between $170,820 and $210,820 of adjusted gross income (AGI). No credit is available above the upper limit.

When do you claim the credit? Generally, it is available on the tax return for the year in which qualified expenses are paid or incurred. However, if the adoption of a U.S. citizen or resident is not finalized at the end of the year, you must wait until the following year to take the credit. At this point, you may claim the credit for all qualified expenses (even if the adoption is not finalized in that year).

Caution: Slightly different rules apply to the adoption of foreign children. In brief, you cannot claim any credit until the year in which the adoption is final. All of the prior expenses are grouped together for that year.

Of course, the parent of a child may be eligible for certain other tax breaks. This can include dependency exemptions, the child tax credit, the dependent care credit and medical expense deductions, just to name a few. Caution: These tax breaks may also be subject to phaseout rules based on AGI.

Final word: Obtain professional tax assistance to determine the exact amount of the adoption tax credit and related tax breaks.

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