Southern California: Capital of IRS Audits

California taxpayers are roughly twice as likely as other Americans to be called in for face-to-face audits by the Internal Revenue Service, according to figures released Saturday, raising questions about the federal agency’s enforcement procedures in the state.

What’s more, in Southern California, the people who go through these often nerve-racking IRS examinations face higher charges for penalties and back taxes than taxpayers in nearly every other part of the country.

IRS officials and some outside tax policy experts said the latest figures--disclosed by Tax Reform Action Coalition, a nonprofit watchdog group affiliated with Syracuse University of New York--should not be regarded as evidence that authorities unfairly singled out Californians for tougher treatment. And even though Los Angeles County, together with the rest of Southern California, is the nation’s tax audit capital, considerably less than 2% of returns filed here lead to face-to-face audits.

Still, critics said the regional differences tilting against California taxpayers raise additional questions about the IRS, which lately has been under close congressional scrutiny. The audit statistics were released over the Internet during a weekend when millions of Americans were scrambling to file their income tax returns in time for the April 15 deadline.

“The evidence suggested in all of this information is that the IRS has not paid enough attention to the fairness and effectiveness of the administration of tax laws across the country,” said David Burnham, co-director of TRAC.

Burnham, author of a 1990 book critical of the IRS and a former reporter for the New York Times, said the agency’s district directors may be taking a more “hard-nosed” stance toward taxpayers in California and other high-audit parts of the country.

Tom Smith, the IRS assistant commissioner in charge of audit practices, countered that the agency calls for face-to-face audits based on the same objective standards across the country. He and outside experts said the IRS zeros in on returns that claim unusually large deductions, report income that conflicts with a taxpayer’s W-2 or 1099 forms, or have other telltale characteristics that, history has shown, often are linked to underpayment of taxes.

Californians have been consistently audited at a higher rate than other American taxpayers over the years, Smith acknowledged. That, he said, is because Californians’ returns have more of the telltale characteristics--and because their returns more often are found to be wrong after being examined by the IRS.

Justification Cited by Some Policy Experts

Smith said he didn’t know whether that California pattern is due to intentional cheating or “a lack of education.” But some tax policy experts said that the IRS is justified in auditing a greater percentage of tax returns in California than in other parts of the country because of the state’s longtime reputation as a haven for fraud and tax-dodging schemes.

“That California has a higher audit rate than Kansas comes as no surprise to me,” said Michael J. Graetz, a Yale University Law School professor who was a deputy assistant secretary for tax policy in the Treasury Department during the Bush administration.

Whatever the reasons, California stands out dramatically in the statistics, with audit rates far higher than New York and New England, for example.

Only 0.66% of taxpayers across the country went through face-to-face audits in the federal government’s 1996 fiscal year, the most recent for which data was released. But in the IRS’ Los Angeles district, 1.59% of taxpayers were audited. Among the 33 IRS regions across the country, that was second only to the 1.62% rate for the agency’s Southern California district (which covers everything other than Los Angeles County between Ventura County and the Mexican border).

The other two California IRS districts ranked third and fourth highest in the nation, with Northern California posting a 1.24% rate for audits, and Central California, 1.17%. The TRAC information includes only face-to-face audits, and does not take into account less formal IRS examinations that are handled through the mail.

Partial Explanation Seen in High Incomes

Tax policy experts suggested that one possible partial explanation for regional differences is that the IRS is more likely to audit high-income taxpayers and that California has more than its share of big earners. But even when only people earning $100,000 a year or more are taken into account, Los Angeles and the rest of Southern California still come out on top.

For instance, in 1996 in Los Angeles, 4.54% of taxpayers reporting $100,000 or more in income were called in for face-to-face audits, according to the TRAC data. Next came the rest of Southern California, with an audit rate among those high earners of 2.77%.

By way of contrast, the national audit rate among those with earnings of $100,000 or more was 1.7%, New York’s Manhattan district posted a rate of 1.49%, and New Jersey was last, at 0.73%. Burnham pointed to the wide discrepancy between the California and New Jersey rates as likely evidence of inconsistent IRS practices.

“It’s hard to imagine that [Los Angeles residents] are six times more likely not to be paying taxes they owe than the taxpayers in New Jersey,” he said.

Pete Sepp, a vice president of the Alexandria, Va.-based National Taxpayers Union, said regional differences in audit rates “have been a curious question for some time now. Theoretically, if the IRS’s audit policies are etched in stone, there should be no, or little, geographic variation. . . . I don’t think the IRS has adequately explained it.”

When face-to-face IRS audits turned up problems, Southern Californians were hit especially hard in the pocketbooks, the data showed. Los Angeles again was first among the 33 IRS districts in that category; the figures showed that the median penalties and extra taxes sought by the IRS in the district due to such audits amounted to $11,415. Manhattan was next at $11,144, followed by the Southern California district at $9,436. Nationally, the median was $7,303. (The actual amounts collected by the IRS from its audits were not disclosed.)

A Higher Rate of Problems

Smith of the IRS said those figures reflect the track record of high numbers of costly problems with California tax returns. As a result, he said, the IRS has deployed disproportionately more tax auditors and revenue agents in the state. He disputed the notion, however, that the extra staffing in California has created a self-perpetuating situation in which more problems continue to be found with returns filed here. Rather, he said, the extra IRS staffers have been kept here because California has continued to outpace the rest of the nation with faulty tax returns.

On top of the heavier staffing, however, the IRS may have a different “culture” in its California offices, said Donald F. Kettl, an expert on the IRS at the University of Wisconsin.

Kettl, who expressed some surprise when informed of the TRAC figures, speculated that California’s size and distance from Washington may have given regional officials greater freedom to determine their enforcement practices.

Still, “IRS employees rarely get up in the morning trying to figure out what mischief to get into,” said Kettl, who is working on IRS reform proposals for the Brookings Institution, a Washington think tank.

Smaller Share of Basic Wages Found

Kettl suggested that most of the regional differences are “a product of the computer screens that the IRS has developed over time to focus its resources on places most likely to maximize revenue.”

For instance, he said, Californians might draw greater IRS scrutiny because they may report a comparatively smaller share of income in basic wages and more income from royalties, dividends and capital gains.

Likewise, he speculated that Californians might claim more deductions for mortgage interest or charitable contributions, and that the language problems among the state’s large immigrant population also may contribute to problem tax returns.

Kettl and Smith pointed out that the IRS pays special attention to the entertainment industry, which is concentrated in Southern California.

Graetz, the Yale law school professor, added: “Historically, California has been creative in developing tax-avoidance ideas.” He pointed to the tax-shelter industry that boomed in the state through the 1970s and the first half of the 1980s.

“I used to refer to Beverly Hills as the tax-shelter capital of the world because there was a lot of creativity there and a lot of demand for tax savings,” Graetz added. “There’s a history of California being a fruitful place for the IRS to put resources. The tax-shelter business was shut down by the tax reform act in 1986, but the taste for tax savings didn’t change.”