Depending on what report you read, and how the statistics get manipulated, the Internal Revenue Service gets a grade somewhere between tremendous and embarrassing for its work auditing the returns of wealthy taxpayers.
I'm going to put my trust in a report released last week from the Treasury Inspector General for Tax Administration, if, for no other reason, that a lot of the report made common sense. According to the report, while audits of high-income taxpayers have increased, the actual impact on compliance may be limited.
The inspector general found that while the Internal Revenue Service has increased its audits, the majority of those have been conducted as correspondence examinations, which limit the issues the agency can address compared with to a sit-down examination. Never mind the relative expedience of sitting down and hashing out a return's rights and wrongs in person, compared to months, or years of faceless correspondence delivered via registered mail. The report said that the end compliance result could also be limited because more than half of all wealthy taxpayer assessments are not collected in a timely manner.
IRS Commissioner Mark Everson has routinely said that improving the agency's enforcement is one of the keys to reducing the country's tax gap, and the inspector general's report seems to back that up -- in 2004, the IRS assessed over $2.1 billion in additional taxes on wealthy taxpayers through audits. That figure includes assessments of $1.4 billion on taxpayers who did not respond to the IRS during correspondence examinations.
But while the audit coverage rate nearly doubled -- from 1.45 percent for the 2002 fiscal year to 3.52 percent in 2005 -- during that same period, those effective face-to-face examinations increased by just 25 percent. And correspondence examinations increased by 170 percent. Correspondingly, the percentage of audits conducted remotely rose 18 percentage points over the same three years, to 67 percent in 2005.
For a method of enforcement that appears to be reaping significant rewards, that seems to make little sense. Especially considering that nearly every day news of the latest tax shelter targeted at a wealthy clientele seems to break. Meanwhile, in addition to news of the relocation of hundreds of its attorneys -- borne out of the flooding of its Washington headquarters -- the only human resources news out of the IRS is that about half of its lawyers who handle estate taxes would be laid off in the coming months. That story, which the agency offered only perfunctory comment on earlier this month, doesn't seem to bode well for plans of upping enforcement.
There have always been rumblings about whether the IRS sees enough cases through to trial, especially when stakes are highest and the returns in question belong to individuals with deep pockets for legal expenses. The outcome and the case law that will come out of the agency's fight against the 19 former executives and tax attorneys who handled tax shelters through KPMG will go a long way to setting the agency's enforcement tone for the years to come. But there's also a chance to make an enforcement statement by the individual case and word-of-mouth by beefing up its in-person audits.
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