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The IRS released it’s latest data book which summarized the audit activity for fiscal year 2005 (ending September 30, 2005). 1.2 million returns were audited in FY 2005 out of 130.6 million filed, which works out to an audit percentage of 0.93%. So, you’re chances are 1 in 100, right? Well, not exactly. It depends how much you made, what forms you filed, and how you filed.

If you made less than $25,000 and filed a 1040A, the audit percentage was 0.5%. If you filed the full 1040 (meaning you took itemized deductions), your chance of being audited tripled. Made over $100,000? Your chance of being audited acutally fell from 1.4% to 1.2% in FY 05. Are you a farmer? Congratulations! You had some of the lowest audit rates at less than 0.5% if you made under $100,000.

The highest percentage of audited returns were people that filed a Schedule C for an unincorporated business. As I’ve discussed before, the IRS is hitting these returns hard because of rampant fraud in claiming personal expenses as deductible business expenses. If you made less than $25,000 or more than $100,000, you had a 1 in 25 chance of being audited (still not a great chance). If you made between $25,000 and $100,000 your audit chance was 1 in 50.

All of this doesn’t include computer matching audits (matching your income to filed W-2s from employers) and simple mathematical mistakes.

Now, if you’re lucky enough to get selected for audit, what are your chances of making it through without an adjustment? Well, not very good. The IRS broke it down by who does your examining, but none of the subsets had more than a 1 in 5 chance in getting a “no adjustments” audit. If you get referred to a tax examiner, your chances are 1 in 20 of not getting at least one adjustment.

So, your chances of being selected are not very good (as long as you file a correct return) but if you get selected, the IRS will likely make changes to it. Remember though, that the IRS uses a computer scoring program to score you against the norms for your income group and uses a different program to match you to any 1099s and W-2s filed by others. So, even though your chance of being selected is low it still doesn’t pay to cheat on your taxes.

Earlier this week, I mentioned target retirement date mutual funds in a post about money managers. I mentioned that the funds are often too conservative, but I didn’t go into great detail.

Luckily, the Washington Post saved me a long post by explaning this exact phenonoma in a recent article. The Vanguard funds are far too conservative. A portfolio aimed at a 45 year old, still 20 or more years from retirement, has only 57% of its assets in equities. A 45 year old should have more than 80% of their assets in stocks because they are far enough from retirement to ride out any short term ups and downs. During retirement, the Vanguard fund will drop to 30% stocks. Again, this is far too low to benefit from the long term trend of higher returns on stocks.

People will be using their retirement funds for 15 years on average and they may run out of money using such a conservative allocation. Fidelity does a little better job with 73% and 45% for their version of the same funds. T. Rowe Price does the best to take advantage of stock returns with 82% and 55% in their funds at the same timeframe.

T. Rowe Price has the highest cost, however, at 0.82% which still lower than most actively managed funds. And all of the funds are simply a “fund of funds” apporach that invests in other funds managed by the three companies, so you still need to look at the underlying funds to make sure that it fits in with your overall portfolio.

The IRS has released 5 Revenue Rulings describing various tax scams that people should not expect any mercy from the IRS if they use them on their tax returns.

Revenue Ruling 2006-17 emphasizes to taxpayers, promoters and return preparers that inserting the phrase “nunc pro tunc” on a return or other document submitted to the Service has no legal effect and does not validate an invalid return, make a delinquent return timely, invalidate a signature, create a claim for refund of taxes previously paid, or reduce one’s federal tax liability.

Revenue Ruling 2006-18 emphasizes to taxpayers, promoters and return preparers that any argument that Forms W-2 only record and report payments made to federal employees, or that only federal employees or residents of the District of Columbia or federal territories and enclaves earn wages subject to tax, has no merit and is frivolous.

Revenue Ruling 2006-19 emphasizes that an individual cannot escape taxation by attributing income to a purported trust. The Service will take vigorous enforcement action against frivolous arguments relating to trusts.

Revenue Ruling 2006-20 emphasizes to taxpayers, promoters and return preparers that any argument that Forms W-2 only record and report payments made to federal employees, or that only federal employees or residents of the District of Columbia or federal territories and enclaves earn wages subject to tax, has no merit and is frivolous.

Revenue Ruling 2006-21 emphasizes that an individual cannot escape taxation by attributing income to a purported trust. The Service will take vigorous enforcement action against frivolous arguments relating to trusts.

Additionally, the IRS issued a Notice that explained these and even more common frivilous arguments (PDF link) and reminded taxpayers what the penalties for making frivilous arguments for delay of collection are (read: not fun).

I love reading tax protestor arguments and laughing. Again, if anyone tells you that you can avoid all taxation and they have the answer (for a large fee, naturally) run the other way. If you get a card, call the IRS; you may just be in for a reward.

Yes, another post bashing looking closely at H&R Block. Their current advertisements feature a guarantee that customers will get the largest possible refund from the IRS. They will refund their fees to you if you can find a way to get a bigger refund.

Sound familiar? Looking at the IRS Press Release on finding a tax preparer, the number one hint was:

Be careful with tax preparers who claim they can obtain larger refunds than other preparers.

While the IRS press release was primarily dealing with scam artists tax soothsayers that file zero tax due returns for people and then leave town, it is odd that H&R Block would have commercials that go against exactly what the IRS says to look for in a tax preparer.

CNN Money’s “Ask the Expert” column takes on professional money managers.

The basic question is whether a science teacher should ditch his collection of mutual funds for a professional money manager that will take 2% of assets as his fee. The Expert says it’s likely that he’ll lose out since he’ll be paying 1% more annually than he is paying now for a service he could do himself.

He does have a good point. The “lifestyle” funds that he mentions are a great tool for those that don’t want to deal with rebalancing and tracking their own portfolio of mutual funds. These funds are far from perfect (and often way more conservative than they should be) but for a market-phobe it’s a decent tradeoff of risk and return.

Another option would be to pick up either Kiplinger Personal Finance or Money when they do their annual Mutual Fund guides and use those model portfolios as guides for setting up your own portfolios.

Stay away from money managers unless you have enough money that you absolutely need to diversify into commodities, real estate, and the like. If you’re asking yourself if you meet that test, you probably don’t. Spending a few hours reading one of the publications above should give even the market novice a good head start.

If that still isn’t an option, going to a fee-only personal financial advisor would work as well. They can guide you to a diversified portfolio without taking a percentage off of the top every single year.

The US Senate passed the necessary, but politically senstive, bill to raise the debt of the United States to $8,985,000,000,000. The reckless spending of the US Congress has to come to an end soon as the debt is now nearly 3/4 of our annual GDP (according to the CIA Factbook) and has increased by 50% since President Bush took office.

Congress needs to follow the same rules as everybody else that runs up tons of long term debt to pay for short term items. Either get more income (raise taxes) or cut spending. If the Treasury is paying an average of 4.75% (based upon the current yield which may or may not reflect the true interest paid), the annual interest cost of carrying the current debt of $8.2 trillion is $392.8 billion. Every single year that’s the amount going just to service the debt, not to pay any of it off.

The debt is unsustainable, but nothing will happen until the mood changes in Washington (or a fiscal catastrophe happens). Unfortunately, this debt glut trickles down to people who often joke that why should they balance their budgets when Congress can’t? It’s a good question.

H&R Block is back in the news. This time, Eliot Spitzer is suing the company over what the company calls “Express IRAs”.

These accounts were created to take advantage of their customers a 2002 tax law change that allowed low income taxpayers that contributed to a retirement account to take a tax credit for the amount they contributed. H&R Block set up these accounts so that their customers could deposit their tax refunds directly into the accounts and would, therefore, get a larger refund.

This seems like a great program that could actually benefit customers. People, especially lower income people, need to save for retirement. This allows them to use money that they never had to fund these accounts. But, the Devil is in the details.

According to Mr. Spitzer, 85% of accounts paid more in fees than they earned in interest. The median account balance of $323 earned $3 per year in interest but paid $10 per year in maintenance fees, $15 to set up the account, and a $15 “re-contribution” fee (whatever that is). Customers also paid $25 if they wanted to close the account. Customers could only invest in H&R Block’s money market account, so they could not get better returns even if they wanted to.

So, these accounts paid a return that was below inflation. That meant accounts were losing purchasing power every single year. On top of that, the median account was being charged around 7.75% in annual fees ($25/$323) in order to earn 1% ($3/$323) meaning the account was slowly being drained by H&R Block.

Brilliant! H&R Block figured out how to capture customers total refunds (albeit slowly) on top of their fees! Throw in funding via Refund Anticipation Loan and these appear to be a blockbuster (for H&R Block at least).

So, in the past few weeks we’ve learned that H&R Block charges outrageous interest rates on “loans” it pushes, cheats on its own taxes, sells your tax data, and now sets up IRAs for its customers that do nothing but enrich itself.

People may say that I’m anti-H&R Block. Really, I’m anti anyone that has a fiduciary duty that repeatedly uses that duty to enrich itself at the expense of people that they know do not know any better, which is apparently what H&R Block is doing over and over again.

Friends don’t let friends use H&R Block.

CNN Money has a list of 5 tax items that may red flag your return for audit by the IRS. Keep in mind that the IRS keeps what actually goes into the decision very secret, so this is just a guess. It’s a pretty good guess based upon experience, but it can change at any time.

1. Overkill on Charitable Contributions

Aah, the prototypical “fudge” number on people’s tax returns. These have been abused so long (and now in lots of more ways) that the IRS will look at any return that has a much higher percentage of charitable contributions than other taxpayers in their income bracket.

2. Self-Employed Expenses

Another oldie but goodie. People have been writing off all kinds of items as “business deductions” for so long that taking any sort of S/E expenses (especially if you have a full time job elsewhere) might as well be printed on bright red paper and have flashing lights on it. I would add abuse of the hobby loss rules to this as well.

3. Above Average Deductions

The IRS uses a computer matching program that scores your return against others in your tax bracket in various ways such as deductions, credits, and exclusions. If your score is too high, you’ll get flagged for audit. Does that mean you should tailor your return to score low? No, you should take every deduction and credit you are entitled to. Just make sure that you are entitled to it and that you keep documentation so that it can withstand an audit.

4. Making Six Figures

IRS audit records have shown for years that you are much more likely to get selected for audit if you make $200,000 than if you make $20,000,000. The simple fact is that the more money you make the more likely you are to use a professional that is legally bound to file a correct return. People making low six figures can still file their own returns and may be tempted to stretch deductions (see #1 and #2) to lower their tax bite.

5. Careless Omissions

If you don’t attach a W-2, or worse yet don’t include it income, you’ll be flagged immediately as part of the IRS push to match documents like W-2s and 1099s to tax returns. So, report everything!

Previously, I had blogged about H&R Block’s use of customers tax data to sell them stuff. I suggested that wasn’t such a good idea and may be illegal. Well, it seems like they were just ahead of the curve.

Currently, companies can give your tax return information to affiliates if they bury it in a disclosure that you have to sign. The IRS has decided it just might be a good idea to allow companies to sell your tax return data to unaffiliated companies if they get permission. The IRS says this will empower consumers to use their tax return data how they see fit. I say it’s a scam and many people will have no idea that their tax return data is being marketed to the highest bidder.

It also seems to be a bright shiny beacon to identity thieves. Here! Buy people’s most sensitive data! You don’t even have to fake out ChoicePoint anymore!

Bad, bad, bad idea. I really hope the IRS wises up and quick.

I am participating in the Carnival of Personal Finance this week. Go check out the Investimist post as well as all the other excellent posts. I will likely be posting on several in the upcoming week.

For anyone checking out the Investimist for the first time, welcome and get comfortable. I can be reached by leaving a comment (I will always try to respond). I welcome comments (and even the occasional criticism).