The Internal Revenue Service has shifted its enforcement priorities from tax shelters to high-impact tax cheats -- including attorneys and CPAs.
In its 2006 business plan, the IRS Criminal Investigation Division stated its intention to "aggressively develop investigations of high-income, high-impact non-filers."
This especially includes attorneys and accountants, according to Kathryn Keneally, a partner in the New York office of Fulbright & Jaworski LLP. "The likely spotlight in the coming year or two will be trained on lawyers, accountants and other high-profile people," said Keneally, who focuses on civil and criminal tax matters. "For tax professionals who practice before the IRS, this is a particularly serious matter. In addition to jail time and penalties, attorneys and accountants risk disciplinary sanctions."
The benefits to the IRS are twofold, according to Keneally. "By targeting high-profile individuals, they get everybody's attention. There is less public sympathy for them, and the publicity has a deterrent effect. So you can expect to see the IRS go disproportionally after tax professionals and high-net-worth individuals."
Failing to file a federal tax return is a misdemeanor with a maximum sentence of one year, although in egregious cases, a failure to file may be elevated to a felony. Not every instance of non-filing results in a criminal proceeding, and for those that do, the government faces the high burden of proving that the failure to file was willful in order to obtain a conviction. To those who might be willing to take their chances, Keneally believes history is instructive.
"During its last major initiative against non-filers a decade ago, the IRS directed its efforts against high-income professionals, particularly attorneys," Keneally explained. "In New York, the Criminal Investigation Division looked at tax returns for the largest law firms in the city, and then looked for the returns of the individual partners. A surprising number of large law firm partners had not filed personal income tax returns. The IRS started investigations against those attorneys. New York State followed with its own criminal and professional disciplinary proceedings."
Since it cannot prosecute every case, Keneally noted, the IRS will often choose to bring criminal charges in those cases with the strongest facts and the greatest possibility of publicity - those that are already newsworthy, or where the person's failure to file a return will get public attention.
"The IRS does not meet its goal of deterrence if it brings a case and loses," she said. "Factors that make it more difficult for the IRS to win over a jury may also convince the government not to file charges in the first place."
"In the usual case, the IRS will not take action against someone who cleans up the situation before it begins an investigation," said Keneally. "The time for people who have failed to file tax returns in past years to come forward is now. Once the IRS has started enforcement activities against someone, the challenges become much greater."
Getting the word out
The IRS is taking other steps to increase awareness of its enforcement efforts. At the end of tax season, the IRS released the 2005 IRS Data Book, which contains tables detailing the amount of revenue collected, the number of audits and the number of refunds issued for fiscal year 2005 - Oct. 1, 2004, to Sept. 30, 2005.
The increase in enforcement by the IRS documented in this year's Data Book shows that during FY 2005, the IRS completed more than 1.215 million audits of individuals, up almost 21 percent from last year's figure of 1.008 million.
This came on the heels of a new estimate of the 2001 tax gap based on the National Research Program. The updated estimate of the overall gross tax gap for 2001 - the difference between what taxpayers should have paid and what they actually paid on a timely basis - comes to $345 billion. This figure falls at the high end of the range of $312 billion to $353 billion per year, an estimate released last March.
IRS enforcement activities, coupled with other late payments, recovered about $55 billion of the tax gap, leaving a net tax gap of $290 billion for tax year 2001.
"The magnitude of the tax gap highlights the critical role of enforcement in keeping our system of tax administration healthy," said IRS Commissioner Mark W. Everson.
An important step already taken to improve compliance has been the updating of the audit selection system with the NRP information. The newer statistics enable the IRS to audit more efficiently, and improve the detection of underreported income and overstated deductions and credits.
The IRS launched the NRP in 2002, and completed it in the fall of last year. It involved a study of 2001 returns of individuals, and included the review and examination of about 46,000 random returns. The IRS is now ready to apply the results to gain a better estimate of taxpayer compliance.
The return selection process for the NRP included an over-sampling of high-income returns, which helped researchers to draw conclusions about sub-categories of taxpayers.
The updated estimate of the tax gap shows that the largest component of the tax gap - more than 80 percent - comes from underreported taxes. Underreported income tax is the largest component of this, with non-filing and underpayment of tax comprising the rest.
According to the Data Book, 1 percent of all wage, salary and tip income is misreported, contributing an estimated $10 billion to the tax gap. The IRS increased its enforcement revenues by nearly 40 percent, from $33.8 billion in 2001 to $47.3 billion in 2005. Audits of high-income taxpayers - those earning $100,000 a year or more - topped 221,000 in FY 2005, the highest number in the past 10 years. Total audits of all taxpayers topped 1.2 million last year - a 20 percent jump from the prior year.
Meanwhile, Syracuse University's Transactional Records Access Clearinghouse said that its analysis of the data showed that, contrary to targeting high-income individuals, the IRS had audited only 30 of the nation's millionaires in 2005, out of 184,054 individual tax returns reporting a total positive income of $1 million or more.
When the simpler and more common correspondence audits are combined with face-to-face audits, poor taxpayers are more likely to be audited than the wealthy, according to Susan Long, co-director of TRAC.
"Their Data Book numbers may be wrong. It does seem outlandish that they would only audit 30 millionaires," she said.
IRS spokesman Bruce Friedland confirmed that the TRAC analysis reflects a reporting anomaly due to the phasing in of a new category in this year's Data Book.
"Exams are coded at the beginning of the process, which can take awhile. The 30 were started and completed during the initiation of the code change," he explained.
"In reality, 11,715 returns were closed with total positive income greater than $1 million. Of those, 7,197 were field, or 'face-to-face' audits, while 4,518 were document-related and correspondence audits. That's a 22 percent increase in the numbers of returns over $1 million in income that were audited over fiscal 2004," he explained. "Basically, there were 235,000 returns with more than $1 million in total positive income, and the audit rate is about 5 percent of those. The audit rate really does go up substantially for those with greater income."
"The actual data support the strong effort at enforcement the IRS has made following the commissioner's direction," Friedland said. "We try to balance the compliance risk, and we're very sensitive to taxpayer burden and the fact that the code is complex."
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