Monday, July 30, 2007

IRS to Begin Increasing Amount of Audits

Because of increasing pressure from Congress and the Executive Branch, the IRS has began an effort the drastically increase the number of audits they perform to help lower the ever growing tax gap. Eliminating the tax gap – estimated to be $312 billion to $353 per year – would provide enough money for the federal government to pay for Medicaid’s entire 2007 budget. Montana Senator Max Baucus, the top tax writer in Congress, has publicly demanded the IRS conduct more audits in order to continue to help lower the tax gap.

As a result, the IRS has announced that it plans to do more random audits in the next few years than it has in the past. In addition, the IRS announced plans to conduct more audits of high-risk groups. The Government Accountability Office recently concluded a detailed study on the tax gap and informed the IRS on which high-risk groups have the highest percent of misreporting on their tax returns.

With help from congress, The Government Accountability Office has identified the following groups of taxpayers to have the highest rates of misreporting on their tax returns:
  • Sole proprietors reporting on Schedule C forms
  • S corporations where owners aren’t taking enough wages in an effort to minimize payroll taxes
  • Taxpayers who gamble and underreport their winnings
  • Taxpayers who own a farm or are involved in farming
  • Taxpayers who take advantage of the Earned Income Tax Credit when they don’t qualify
  • Taxpayers who incorrectly report capital gains from sales of investments
  • Taxpayers who take itemized deductions on Schedule A for medical expenses, charitable contributions, and non-reimbursed job expenses

However, being in one of these groups does not mean a taxpayer will necessarily be audited. Based on 2005 statistics, a taxpayer’s average likelihood of being audited was around 1%. But if a taxpayer falls into one of the groups listed above their likely hood of being audited increases to above 5%.

The IRS had discontinued its random audit process five years ago in an effort to be seen as a kinder and gentler agency of the government. However, under pressure to increase revenue to offset the tax gap, the IRS has decided to once again target not only returns that raise red flags, but to also select taxpayers to audit at random. Beginning in October, it’s expected that the IRS will target approximately 50,000 income tax returns from 2006. The IRS is warning that not all taxpayers audited will be subject to a scrupulous line by line audit though. Out of the 50,000 returns the IRS aims to audit, they estimate that 8,000 will just be examined by the IRS requiring no action on the part of the taxpayer, and 9,000 of the taxpayers audited will be able to respond to audit inquiries via mail. The remaining 30,000 taxpayers will be required to make face-to-face meetings though. Many of these audits are to be conducted even if the IRS doesn’t suspect a problem, but the IRS is claiming they hope to use the audits to gather information about taxpayer norms.

Shortly after the IRS’s announcement of their plan to increase audits, National Taxpayer Advocate Nina E. Olson delivered a report to Congress identifying the priority issues the Office of the Taxpayer Advocate will address in the coming year. One important aspect of the report was the battle the IRS is facing because of all the pressure being placed on them to lower the tax gap quickly.

"For fiscal year 2008, both the IRS and the Taxpayer Advocate Service (TAS) face similar challenges," Olson claimed. "The IRS is under scrutiny for its efforts to close the tax gap, while TAS is struggling to address taxpayer difficulties that arise as a result of these very efforts."

In multiple prior reports to Congress, Olson has identified the tax gap as one of the most serious challenges in tax administration. She has put together numerous proposals to try and help address it, but nothing has come from her proposals. She has expressed concern that the pressure on the IRS to reduce the tax gap could result in the IRS excessively cutting corners in it’s treatment of taxpayers. She emphasized that Congress needs to play an important role in helping to achieve an appropriate balance.

"IRS oversight should not just be limited to urging the IRS to collect more tax revenue," Olson continued. "Even as Congress directs the IRS to address specific areas of noncompliance, Congress should require the IRS to adopt a long-term research strategy that focuses not only on "closing the tax gap" but also on understanding what it takes to encourage taxpayers to be voluntarily compliant and how to change taxpayer behavior."

IRS to start auditing more tax returns?
Congress Instructs IRS to Conduct More Audits
More Audits Are Coming; How Can You Cope?
IRS targeting certain deductions in effort to close tax gap
They're back! IRS resurrects random audits

Blog Archive