Here are a few highlights from the IRS's audit activities in 2007:

For the first time since 1998, the percentage of individual tax return audits was higher than one percent. Audits of S corporations and partnerships increased. 1 out of 11 millionaires faced an audit in 2007.

What is triggering this increase in audits?

The IRS is under great pressure from Congress to show results in closing the $300 billion tax gap, the difference between what taxpayers owe and what they pay. The IRS reported that enforcement and examination revenue totaled more than $55 billion in 2007, up from roughly $45 billion in 2006.

Audits of Individual Tax Returns:

Audits of all individuals across all income levels increased in 2007. The IRS reported that the total number of individual returns audited in 2007 was 1.38 million compared to 1.29 million in 2006.

Audits of "High Income" Individuals:

The IRS considers "high income" individuals to be those who have "Total Positive Income" (TPI) of $100,000 or more. Generally, TPI is calculated by using only positive income values from specific income fields on the tax return and treats losses as zero. This is important for those with real estate losses!

Example:

You file a return showing wages of $80,000, interest of $10,000, business income of $40,000, and a $35,000 loss from rental real estate. Your net income is then $95,000. However, your TPI is $130,000, so your return is considered a high income tax return by the IRS.

The IRS audited 293,188 of these returns in 2007, up nearly 14 percent from 2006.

The IRS also audited more individuals with incomes above $200,000 in 2007 than in 2006. Audits of individuals with incomes over $200,000 reached 113,105 returns, reflecting an increase of nearly 30 percent from 2006!

Audits of Millionaires:

Audits of individuals with incomes of $1 million or more increased 84 percent from 2006 to 2007. More than 30,000 millionaires were audited in 2007 compared to 17,000 in 2006.

Audits of Businesses:

The IRS took special interest in two popular business entities: S corporations and partnerships. Audits of both entities were up in 2007 compared to 2006 by roughly 25 percent.

With the tax gap as large as it is, the IRS is likely to keep up this new pace. Are you prepared?