More Audits of Wealthy
The IRS increased its audits of individuals and couples making more than $100,000 last year, focusing most of the extra attention on people making $250,000 or more. Still, even high-income taxpayers faced low odds of being called upon to document their expenses and deductions. Despite the 24 percent increase for taxpayers who earned $100,000 or more, the IRS audited only one in 95 returns filed by big earners. Individuals at all income levels faced slightly higher chances of an audit last year. Overall, the IRS examined 1 in 153 returns last year, compared with 1 in 174 the previous year. The audit rate still lags from the rates in the mid-1990s when the agency looked at about 1 in 60 individual returns.
In an effort to best use its money and manpower, the IRS has focused its search for unpaid taxes on high-income individuals, corporations and income hidden in offshore accounts. The IRS last year reaped $35.5 billion through collection efforts last year, the most in a decade. Audits of the nation's largest corporations, nevertheless, fell for the 8th consecutive year. About 12 percent of corporations with assets exceeding $10 million were audited, compared with more than 14 percent the year before. Audits for small and midsize businesses also dropped slightly.
Clearly, IRS is back in the audit business!
Recent IRS media would suggest that the overall audit rate for individual taxpayers as distinct from businesses and corporations has increased from their all-time lows of a few years ago. However, the claimed increases are entirely the result of the agency's growing reliance on computer-generated correspondence audits that by their very nature are comparatively superficial.
In fact, when only face-to-face audits are counted, the audit rate for all individual taxpayers has not changed at all for the last three years only 1.6 audited for every 1,000 returns filed.
Focusing just on high income individuals, there was a slight rise in face-to-face audit rates for wage-earners last year- 3.8 per 1,000 returns audited in FY 2002 and 4.0 in FY
2003. However, the audit rate for high income Schedule C (business) filers fell slightly from 11.4 to 11.0 per 1,000.
The Small Business/Self Employed (SB/SE) division of the Internal Revenue Service initiated its Examination Reengineering effort to improve the quality and consistency of income tax examinations. SB/SE interviewed a wide range of individuals both internally and externally to find and identify best practices and potential areas of improvement in its examinations. Among the individuals the reengineering teams interviewed were previously audited taxpayers, tax practitioners, federal and state government agencies, financial institutions, examination employees, and many others involved in the tax community. SB/SE tested the redesigned examination process in both rural and urban areas to ensure the new process is equally effective and consistent throughout the country. The reengineered process was adjusted according to the feedback from taxpayers, practitioners and employees involved in the examinations during the test period.
Features of the New Process
Some of the features of the reengineered field examination process are:
- Clearly communicated expectations of both the taxpayer and field agent through mandatory discussions between the revenue agent and taxpayer regarding the specific examination issues, required documentation, and a mutually agreed upon date to complete the examination.
- At the beginning of each examination, field agents and their managers will meet to discuss the agent's approach to the examination, the plan to close the examination, and the mutual commitment date arrived at with the taxpayer.
- Field agents will use standardized templates for every examination issue to gather the information necessary to resolve issues. Agents will use a standardized guide when deciding if additional issues need to be added to the examination. The agent will explain to the taxpayer if any additional issues are included in the examination.
Some of the features of the reengineered office examination process are:
- Clearly communicated expectations of both the taxpayer and the examiner prior to the initial appointment. Office examiners will provide the taxpayer with focused document requests that specifically identify the information needed.
- Improved flexibility in the scheduling process will enable examiners and taxpayers to reduce the time it takes to complete an examination.
- Office examiners will use standardized templates for every examination issue to gather the information necessary to resolve issues. Examiners will use a standardized guide when deciding if additional issues need to be added to the examination. The examiner will explain to the taxpayer if any additional issues are included in the examination.
Abusive Tax Avoidance Transactions (ATAT)
Under the terms of the IRS' longstanding partnership with States [see below], IRS and the States coordinate efforts to address common compliance concerns in the area of Abusive Tax Avoidance Transactions (ATAT) by working in tandem and avoid repeating each other's efforts. The states and the IRS routinely share information, but the ATAT program presents IRS with an exceptionally fertile opportunity to help one another. The initial leads transferred to states involved scams using offshore transactions, abusive trusts, employee leasing, home-based
businesses, employment taxes and other tax-avoidance schemes. The IRS, states and cities will subsequently share information on any resulting tax adjustments from the audits allowing them to piggyback on the results of each other's work. The process allows the agencies to leverage resources by greatly decreasing the possibility of two or even three tax agencies performing a lengthy examination of the same taxpayer.
State And Cities Participating
The cities and states that have signed partnership agreements and that received information include: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Montana, New Hampshire, New Jersey, New Mexico, New York City, New York State, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Utah, Vermont, Virginia, Washington, West Virginia and Wisconsin.
IRS Sets New Audit Priorities
The Internal Revenue Service has realigned its audit resources to focus on key areas of noncompliance with the tax laws. The strategy represents a new direction for the agency's compliance effort.
Following months of research and planning, the new approach now focuses on high-risk areas of non-compliance. The IRS effort has generally focused first on promoters and then on participants in these various schemes. The initiative features new and enhanced efforts on several priority areas, including:
- Offshore credit card users.
- High-risk, high-income taxpayers.
- Abusive schemes and promoter investigations.
- High-income non-filers.
- Unreported income.
- The National Research Program.
The strategy reflects the new way of doing business at the IRS. Several of these efforts -- such as the National Research Program and the credit card initiative - reflect innovative approaches to tackle long-standing tax problems. The new audit initiative will include similar emphasis for the agency's collection area. And new levels of cooperation and coordination are underway on initiatives that involve both civil actions and criminal investigation. These illustrate how the new IRS business model positions the agency to respond to high-risk tax areas. For the six new areas, the agency will direct more examination resources to address these issues. However, the IRS will maintain a presence in other audit areas to maintain core tax administration responsibilities. Additional exam resources will help meet this requirement.
Offshore Credit Card Project
It is not illegal to have an offshore credit card. However, there is a reasonable basis for believing that some people are using offshore credit cards to evade paying U.S. taxes. Credit cards provide easy access to offshore funds and accounts in tax haven countries that allow income to be hidden. U.S. citizens must pay tax on their worldwide income. The IRS has taken several major steps to combat tax-avoidance schemes involving credit cards issued by offshore banks.
The first summons alone yielded data from MasterCard on 237,000 cards issued through 28 banks in three countries. The majority of the cards appear to have been issued to U.S. customers. If the MasterCard information is representative of the industry, there could be 1 million to 2 million U.S. citizens with debit/credit issued by offshore banks. This compares with only 170,000 Reports of Foreign Bank & Financial Accounts being filed in 2000 and only 117,000 individual 1040 filers indicating they had offshore bank accounts (tax year 1999).
Number of Taxpayers
Credit cards do not equate to taxpayers. The IRS must utilize an extensive process to identify the taxpayer associated with each card. Spending patterns, unusual expenses, proximity of spending and repetitive expenses are all considered in the process. Once taxpayers are identified from cards, case building begins. The IRS already has developed hundreds of cases for civil audits or potential criminal investigations.
High-Risk, High-Income Taxpayers
High-income returns are often more complex and, generally, upper income taxpayers have resources to engage in pass-through entities such as partnerships, trusts and corporations. Even utilizing IRS's various matching programs, income and deductions from such activities are more difficult to verify.
While the IRS has begun to match K-1 forms from pass-through entities, the technique does not provide any verification of income reported by the entity itself. Verifying the income on these returns requires an examination. Starting in Fiscal Year 2003, the IRS will be utilizing a combination of filters to identify high-risk, high-income returns. The returns selected for examination will be those most likely to have unreported income or structured transactions.
A structured transaction is one with limited economic benefit and whose primary purpose is to reduce or eliminate a tax liability. Structured transactions are generally done through one or more pass-through returns, such as Forms 1065 or 1120-S. The passthrough returns create paper losses that flow back to individual income tax returns offsetting income from other sources.
Abusive Schemes And Promoter Investigations
IRS efforts to combat abusive schemes and scams (including the Offshore Credit Card Project) will significantly increase from FY2002 to FY2003. Schemes and scams on the rise include:
- Schemes, reducing a person's tax liability by claiming inflated expenses, false deductions, unallowable credits or excessive exemptions.
- Frivolous return arguments, telling taxpayers compliance is voluntary or the U.S. Constitution does not provide for tax collection.
- Promotion of slavery reparation claims, scams that claim compensation for people who have ancestors who were slaves.
- Abusive shelters and trusts, investments established for the purpose of hiding income from taxation.
- Employment tax schemes, employee leasing, paying in cash and filing false payroll tax returns.
Abusive Scheme Groups are being established in each Area and the use of Fraud Specialists will increase. To identify and address promoter activity, a Promoter Lead Development Center has been created. The Center systematically monitors the Internet to identify promoters of abusive activities and develops cases for injunctive investigations.
The IRS efforts to address non-filers in FY 2003 will focus on the most egregious and high-risk segments of the population.
The non-filer strategy will be pursued on many fronts:
- Re-engineered processes and work streams to improve efficiency and productivity.
- Identification and expedited assignment of the most egregious non-filers.
- Expanded and centralized automated enforcement.
- Outreach and education efforts.
Unreported income represents the largest component of the tax gap. IRS has developed a new tool for identifying returns with a high probability of unreported income. The new tool is known as Unreported Income Discriminant Index Formula (UI DIF). All individual returns have traditionally been assigned a DIF score rating the probability of inaccurate information on the return. The new UI DIF score rates the probability of income being omitted from the return. The IRS has customarily used indirect examination methods to identify unreported income but until now has had no systemic method for selecting the returns at highest risk for unreported income. UI DIF gives the IRS the ability to systemically identify returns at high risk for unreported income and beginning this fall all returns will receive a UI DIF score in addition to the traditional DIF score.
National Research Program
National Research Program (NRP) examinations are very successful in measuring reporting compliance and identifying compliance issues. NRP enables the IRS to improve the examination selection process. The latest iteration of NRP is very different from its predecessor, the Taxpayer Compliance Measurement Program (TCMP). NRP no longer relies heavily on time-intensive, "line-by-line" audits for establishing a baseline measure of reporting compliance.
Previous to this most recent wave of NRP audits, the IRS had not conducted updated research on the distribution of errors on returns for more than 13 years, a period when the economy and the tax law have changed dramatically. Without the information that is gathered through NRP, the IRS has less ability to direct examinations and other compliance activities with accuracy and precision. With updated information, the NRP effort prevents thousands of "no change" audits each year.
The NRP effort has been a review of a small, statistically valid sample of individual returns. As the program continues and moves forward, we should expect that the NRP process will continue to have four main categories:
- No IRS contact. Varying numbers of returns will be checked relying solely on information already available to IRS.
- Correspondence. These will be less intrusive correspondence exchanges with taxpayers - rather than the old standard of sit-down audits. This process, while intended to limit the Taxpayer or Representative's time commitment, instead produces other frustrations [time zone issues, voice mail, short time deadlines, etc...]
- Less intrusive audits. Instead of the old "line-by-line" examination approach, the IRS will gather more information beforehand from agency records and focus only on selected parts of the tax returns examined.
- Calibration audits. These consist of a small number of examinations that still check each line of the return. But, in a major change from earlier programs, taxpayers will not be required to provide line-by-line substantiation.
Combating Abusive Tax Shelters: A Summary
As part of a comprehensive strategy to ensure all taxpayers pay their fair share, the Treasury Department and the IRS continue to move aggressively to combat abusive tax avoidance transactions. This multi-pronged strategy includes requiring prompt disclosure of potentially abusive transactions by taxpayers and promoters, providing more timely analyses of these transactions and publishing legal guidance as early as possible. It also involves auditing taxpayers and promoters to ensure that they have complied with their obligations under the tax rules.
IRS Updates the 'Dirty Dozen' for 2009: "Phishing" is at the head of the list
In an update of an annual consumer alert, the Internal Revenue Service again urged taxpayers to avoid falling victim to one of the "Dirty Dozen" tax scams and a variety of other schemes. The "Dirty Dozen" for 2009 includes several new scams that either manipulate laws governing charitable groups, abuse credit counseling services or rely on refuted arguments to claim tax exemptions. The agency also sees the continuing spread of identity theft schemes preying on people through e-mail, the Internet or the phone, sometimes with con artists posing as representatives of the IRS.
Involvement with tax schemes can lead to imprisonment and fines. The IRS routinely pursues and shuts down promoters of these scams. But taxpayers should also remember that anyone pulled into these schemes can face repayment of taxes plus interest and penalties.
The IRS website discusses these tax scams and even includes a video! The URL is: http://www.irs.gov/newsroom/article/0,,id=98269,00.html