IRS Wants States in on Hunt

The federal government is about to introduce new weapons in its campaign against tax cheats: the states.

This month, California’s Franchise Tax Board expects to conclude an agreement with the Internal Revenue Service to divert 30 of the state’s most seasoned examiners to ferret out Californians illegally evading federal taxes.

And although IRS officials say California is likely to be among the first states to sign such a deal, it’s not likely to be the last. In an era when state and federal budgets are strained, tax cheats, who are believed to cost the U.S. government billions of dollars annually, are getting more attention.

“Now is the time to collect every dollar that we can,” said California Controller Steve Westly. “We are in a tough budget time. We want to make sure that we are identifying everyone who is cheating the system and use our resources more efficiently to collect every dollar that is owed under the law.”

The IRS hopes to sign agreements with tax authorities in all 50 states -- even those that don’t have a state income tax, IRS spokesman Ken Hubinak said. Like the agreement with California, these deals are expected to combine the IRS’ relatively meager resources with those of the states, allowing the agency to pursue hundreds of individuals and businesses that it otherwise wouldn’t have the time and staff to handle.

“Historically, the IRS has been outgunned,” said tax specialist Philip Wolman, a partner at Los Angeles law firm Buchalter, Nemer, Fields & Younger. “But as I see recent events, they’re catching up quickly.”

The states are willing to work closely with the IRS for two compelling reasons.

First, by helping the IRS, states help themselves. People who cheat on federal income taxes typically also cheat on their state income, property or business taxes.

A multi-state task force recently estimated that abusive corporate tax shelters identified by the IRS were costing state governments about $10 billion a year. The task force found that California, which is grappling with a $38-billion budget shortfall, was taking the biggest hit -- an estimated loss of $1.3 billion annually.

Moreover, the federal government, which is in the middle of a two-year effort to ferret out offshore and domestic tax shelters used by individual taxpayers, recently wrapped up a tax amnesty program that yielded a gold mine of investigative leads: 450 names and addresses of tax-shelter promoters and details of their schemes.

That not only will spur audits of those individuals but also will generate lists of all of the promoters’ clients, who will be scrutinized too, said Dale Hart, a deputy IRS commissioner in charge of the tax-shelter effort. The audits are expected to be unusually quick and efficient because examiners can zero in on areas of known abuse.

“We know exactly what we’re looking for,” Hart said. “That can speed the process tremendously.”

Although state and federal tax authorities have shared information for some time, it generally wasn’t done in a timely manner, Hart said. As a result, state and federal authorities would sometimes complete independent audits only to discover they were looking at the same people and had duplicated each other’s efforts.

Under the proposed cooperation deals, state and federal examiners would share files and data before launching audits, discussing who they believe is cheating, in what areas and what led them to those beliefs.

State examiners would handle some files and federal examiners would take others, eliminating the duplication.

“We are taking a proactive approach so California can work cooperatively and strategically with the IRS to identify tax evaders. No state has ever done this before,” Westly said. “But it makes sense because the FTB and the IRS are often looking at the same people, businesses and documentation.”

But that may be just the beginning.

California legislators also are weighing bills that would dramatically tighten the penalties for promoters of illegal tax avoidance schemes and for tax-return preparers and taxpayers who use the schemes, Wolman said. The bills in the Senate and Assembly, which are identical, also would eliminate “privileged” communications between taxpayer and preparer when it comes to shelters. The measures aim to mirror an expected future crackdown in federal tax law, Wolman added.

Whether these proposed laws pass at either the federal or state level remains to be seen. But one thing is certain, said Charles P. Rettig, a Beverly Hills tax attorney who represents people in tax trouble: Tax authorities are getting smarter, more efficient and far more aggressive.

“If you are thinking about cheating, stop,” said Rettig, a partner at Hochman, Salkin, Rettig, Toscher & Perez. “If you think you might have been confused in the past about what was acceptable, now is the time to get some advice and clean things up.

“The future is clearly going to be different than the past has been as far as enforcement is concerned.”