The IRS radar for 2006 and 2007

It seems the Internal Revenue Service will continue its aggressive tactics of score profiling when auditing everyone's just filed tax returns and for the upcoming year. The General Accounting Office has targeted the following groups in the hopes of collecting even more revenue for federal government coffers.

1) Schedule C filers. Specifically targeting sole proprietorships, the focus is on three lines: sales income, sales returns, and write-offs for inventory adjustment. In addition, the IRS is starting to pay attention on whether the "business" is attempting to make money or whether the "business" can be classified as a hobby. You can only report net losses for 2 out of every 5 year period before the IRS will start taking a line by line evaluation.

2) S Corporation filers. Watch the dividend line versus the salaries expense line. If an S Corporation's shareholder income is classified as a dividend, it's likely not subject to payroll tax liability such as social security or medicare. Given the pending shortfalls in both programs, they will be looking to see if this expense can be reclassified as subject to additional taxes.

3) 1099-G form submissions. This is the statement you receive when you win at a casino or gaming establishment. The IRS wants to crackdown on winners not reporting their losses on the current line at the bottom of Schedule A. Since most 1099-G filers don't have enough deductions to file Schedule A, it results in an additional tax bill.

4) Schedule A filers. While the deductible portion of medical expenses is virtually unchanged in 20 years, its one of the most common red flags on the GAO review. Usually, the first 7.5% of the adjusted gross income (AGI) is NOT deductible. For example, if your AGI is 100k, then the first 7,500 of medical expenses you incur are not deductible on Schedule A. You can only report the qualified medical expenses above 7,500 on Schedule A. In addition, because the charitable contributions' rule changed last year, requiring a letter from the organization for amounts above $250 or a a copy of a cancelled check if under $250, the IRS will be quick to red flag anyone who shows a dramatic change in contributions from one year to the next. Employee job related expenses is something that has recently shown up on the GAO review as it seems some taxpayers are getting creative on what classifies as a legitimate expense. Reminder that the total of valid job related expenses must exceed 2% of your AGI to be potentially deductible.

5) Filers of the Earned Income Tax (EIT). What once was a noble gesture pretty much turned into a means to abuse the system and some (EIT) filers continue to claim 10 children as dependents without disclosing valid social security numbers. It might be better off to modify this credit given its unlikely someone who have a certain number of children by accident.

6) Schedule D filers. Now that vacation and home flipping has slowed down, the IRS will be looking at whether capital gain filers report the correct cost basis and allowable expenses. Some expenses of the past have noticably disappeared and might be a rude awakening to anyone who sold a home pre-1986 versus selling one today without benefit of the 250k (500k married filing jointly) lifetime capital gain exemption for real estate.