Bought a yacht lately? Visited the Riviera? Traded in the old clunker for a new sports model?

Watch out. You may get an Economic Reality check from the Internal Revenue Service.

Unless you received a large gift from Aunt Martha or your lavish life-style coincides with your tax return income, the IRS may include you in its new program.

This is part of the agency effort to narrow the gap between what taxpayers pay and should pay. It estimates it collects only 86.5% of taxes due. Its goal is 90%.

Does the taxpayer's life-style equate reported income? In future audits, instead of focusing only on the return, reviewers also will examine the person filing.

The IRS tagged Robert Asmar for unreported income by comparing his lifestyle for five years with his returns. Asmar made a large down payment on a new house, put in a swimming pool, bought new furniture, a new Buick, a new Cadillac, a new beauty salon and took his brother on a vacation to Puerto Rico. His returns' income averaged less than $16,000.

Using the Economic Reality mode to audit taxpayers will be one of the agency's biggest guns in its battle to force them to report every cent. At this very moment, agents are being trained. They are learning how to snoop through banking and credit records, car and boat registrations, property tax rolls and court documents. They are studying business statistics. They show the income a certain level of expenses usually generate from a service station, a flower shop, a restaurant.

Deficient income reporting is the scourge of the IRS. Agents find improper deductions easily. They look at returns, select deductions they think are excessive and make taxpayers prove the deductibility.

But there are no lists of unreported income. The agency must be creative in finding this. One successful method is use of reports from third parties. Employers report wages, lenders report interest paid out, corporations report dividends, pension plans report distributions. Businesses now report cash transactions over $10,000. The agency assumes anyone receiving this much cash probably isn't reporting it as income.

Once the IRS suspects the taxpayer under reported income, it determines the amount. Agents frequently estimate income using these methods:

• Adding taxpayer's bank deposits.
  
• Adding taxpayer's business and personal expenditures.
  
• Using statistics showing average income for taxpayer's economic level and family size.
  
• Adding expenses to the increase in net worth. Net worth includes home, cash, car, securities and business assets minus debt.
  

For a business, determining supplies used and sales based on those supplies. Once the IRS used a formula from General Mills to measure the number of bagels produced from 100 pounds of flour. The tax man figured the bakery sold 1,100 bagels for every 100 pounds of flour. It determined the bagel baker beat the government out of tons of dough.

PLANNING TIP: Maintain records supporting nontaxable funds you receive. If you receive loans or gifts, keep records to support the source. A copy of the thank-you letter to Aunt Martha or a copy of the promissory note supporting the loan would help.(more at IRS Audits)

Released 3-27-95