USA Today (Society for the Advancement of Education): When in doubt, deduct it out

HAVE YOU EVER THOUGHT of bungee jumping? Have you skydived or considered exploring the ocean floors? Would you rather gamble in Las Vegas or lie on the beach? Just how much risk do you enjoy taking?

If you really enjoy the adrenaline rush of risk-taking, then the tax game may be for you. No, I'm not advocating cheating on your taxes. What I am suggesting is that there are situations where the tax law may be vague or subject to different interpretations. In fact, there have been many tax decisions where four out of nine of our top jurists on the Supreme Court got the answer wrong!

Our tax code is not known for its clarity or its simplicity. Former CitiCorp Chairman Walter Wriston called it a system where "All the Congress, all the accountants and tax lawyers, all the judges, and a convention of wizards cannot tell for sure what the tax law says." Current Treasury Secretary Paul O'Neill was more blunt. He called our tax code an "abomination."

Each year, Money magazine asks 50 tax professionals, including attorneys and CPAs, to complete a tax return for a hypothetical family. The publication normally gets 50 different answers--with spreads that have approached nearly 1,000%! How about the supposed "know it alls" from the IRS? Last year, the percentage of wrong advice given by the agency to investigators posing as taxpayers was 47%.

Again, I'm not suggesting that you cheat or make up numbers. What I am noticing is that there are many gray areas with potential to push the envelope--especially when the odds of being audited have been so decimated.

Audit odds

Now that you've filed your tax return, what's the chance of your actually being audited? The latest numbers have shown an enormous decrease in the "audit rate"--the amount of returns examined divided by the total number of returns filed the previous year. The total audit rate for Fiscal Year 2001 was a mere 0.58%. That's more than the 0.49% rate for 2000, but still only about one-third of the 1.67% rates for 1995 and 1996. The number of individual returns examined in 2001 rose to nearly 732,000, from a Fiscal Year 2000 low of about 618,000, but audits for returns showing income of more than $100,000 declined from 99,547 in 2000 to 91,550 the following year. Do you feel lucky? In many cases, the difference between a legitimate tax shelter and "abusive noncompliance" is whether or not you win the audit lottery.

According to the IRS, wealthy individuals and big corporations took more than $16,000,000,000 in improper tax deductions in recent years. The tax shelter business has flourished because there is little real financial risk. Investors are shielded from basic IRS penalties by lawyers' opinion letters ratifying the deals.

Want to play IRS roulette? Most individuals are selected for audit on a random selection basis or on what's known as your DIF (or differential) score. That is where the IRS compares your deductions with other taxpayers comparable to you. For example, if you have a Beverly Hills zip code, the IRS might want to know why your income is so low. Alternatively, if your zip code puts you in an urban ghetto neighborhood and you report minimal income, the IRS is going to question a five-figure charitable deduction. The more "inconsistencies" that exist, the more the computer is going to click and the greater the odds that a real human being is going to review your return.

If you're way above average for a specific deduction, I strongly recommend that you attach substantiating documentation to your return. That way, the IRS gets the proof that it wants without contacting you--and it may actually decrease your audit odds. You have just proven to them that you know how the system works and that you're ready to play. The IRS doesn't want to audit those who know the rules and are ready with substantiation. It costs them examination time and doesn't generate any additional revenue.

Get aggressive!

Get aggressive! After all, what's your downside? As long as it's not clearly fraud, if you have at least an arguable position, you're probably only facing having to pay the tax you would have paid anyway, plus an interest charge, currently at six percent. Meanwhile, you've had the use of the dollars you would have paid in taxes. It's like borrowing the money at a six percent rate, with no points. If that's your cost, and only if you get audited, your actual risk is minimal.

Don't cheat! However, if you have a legitimate expense or charitable deduction, but have lost your receipt, don't be afraid to claim that deduction. Even with the IRS again doing super audits (the old Taxpayer Compliance Measurement Program designed to establish the norms for the DIF program), where every number on your return is subject to review, the odds are still in your favor that you won't be audited since, according to the IRS Manual's Audit Guidelines for Examiners, adequate evidence does not require complete documentation. Statements made by the taxpayer or others may serve as adequate evidence in an audit.

Do you feel lucky? If so, when in doubt, deduct it out.

Jeff A. Schnepper, Associate Economics Editor of USA Today, is an attorney and estate planner in Cherry Hill, N.J., and author of How to Pay Zero Taxes.