Budget-Taxed IRS to Audit 18% Fewer Returns This Year

The Internal Revenue Service will audit 18% fewer tax returns this year, resulting from a sharp reduction by Congress in the agency’s budget, IRS Commissioner Margaret Richardson said in an interview Thursday.

The agency is planning to audit 1.4% of all returns this year, down from 1.7% last year--a cutback at a time when the agency is increasingly concerned that long-term changes in the economy could make it harder to keep track of taxpayers.

Still, tax accountants said Thursday that the penalties for cheating remain so severe that the audit cutback is unlikely to spur a rise in noncompliance.

Nationwide, the IRS is cutting 8,000 jobs, reversing an effort last year to add 5,000, Richardson said. Plans for a major new audit program, in which selected taxpayers would be subject to a line-by-line audit, were canceled late last year.

“Unfortunately, we got caught in the budget problem like many other agencies,” Richardson said. “And we’re not seen as part of the solution sometimes, we’re seen as part of the problem.”

Although many taxpayers will no doubt cheer the audit reductions, Richardson lamented that the audits also ensure that the system maintains the appearance of fairness to those who are paying their share of federal taxes.

Moreover, the IRS conducts most of its audits on higher-income Americans, who represent the richest targets of opportunity for collecting more taxes. Computerized analysis of returns has all but eliminated the so-called random audit, in which a return is simply plucked out of a stack for no reason.

Congress cut the agency’s budget for conducting audits and other enforcement actions by more than $400 million last year. When the budget battle in Congress was over, the IRS ended up with total appropriations of $7.3 billion, down from a requested level of $8.2 billion and even less than the $7.5 billion it received in fiscal 1995. At the same time, its expenses for postage and rent, among other overhead, is up $200 million, an IRS official said.

Though Richardson did not say the reductions will trigger more cheating, she warned that tax compliance has always depended on the agency’s enforcement efforts.

“When people are on their honor, the compliance levels are significantly lower,” she said.

The IRS collects about 86% of the taxes it estimates should be paid by individuals and corporations, a figure that has not changed much in recent years. But as the economy has grown, the amount of uncollected taxes has also increased, now standing at $170 billion annually, or enough to almost wipe out the entire federal budget deficit.

Trends in the economy, in which more workers are employed by nontraditional corporations, also suggest that the IRS may have a tougher job collecting taxes in the future.

“As we’ve moved into a service economy and people work in smaller businesses and entrepreneurial things, we have noticed a shift in compliance,” Richardson said.

In cases where individuals are subject to wage reporting by their employers or interest income reporting by their banks, compliance levels are almost 100%, Richardson said. But otherwise, compliance sometimes drops as low as 40% or 50%, she said.

However, tax accountants noted that the chance of an average person getting audited is already minuscule. Reducing the chance slightly is not going to change anyone’s behavior, said Harvey Gettleson, partner at Ernst & Young in Los Angeles.

Moreover, while the number of audits may be declining, the penalties for cheating--or simply erring in your own favor--are way up, said Bernard Oster, partner at Cohen Primiani & Foster in Los Angeles.

In the 1980s, the penalty for negligence was 5%. Now it’s 20%. Fraud penalties--which used to amount to 50% of the tax owed--now top out at 75%, Oster said.

The cutbacks in audits would presumably result in a direct impact on IRS collections. Richardson said that in 85% of audits, the amount of tax owed by a taxpayer changes--almost always going up rather than down.

The number of audits conducted by the IRS has been dropping for years, because the computerized models give the agency much better ability to select returns that will generate additional taxes.

Times staff writer Kathy M. Kristof contributed to this report.