California preparer Carol Thompson tells of clients who were dunned $9,000 by the IRS when they outspent their earnings on luxuries. The IRS grilled the couple on their restaurant meals, vacations, clothes and cars, and measured them against Labor Department household-spending data that pegged the couple as high earners. But they weren’t tax cheats; they were just big spenders, buying the good life on credit cards and not with taxable income. It cost them an additional $1,000 in accounting fees to prove it to the IRS.
How likely are you to endure an IRS reality check? If legislators have their way, not very. Congress has asked the IRS to cut back on the number of lifestyle questions it asks taxpayers. Last week the agency defended the economic-reality audit as “part of a quality examination,” but agreed to limit its use. IRS examinations chief Thomas Wilson told examiners to save the reality checks for taxpayers most likely to be hiding income: entrepreneurs in cash businesses with sloppy records and big bank accounts.
