Slide in Income Tax Audits Continues
New data show that a taxpayer’s chances of being audited by the Internal Revenue Service declined dramatically last year, even in Southern California, which has long led the nation in the percentage of returns that get extra scrutiny.
An individual’s chances of a face-to-face audit dropped by 25% last year to the lowest level since 1981, according to statistics compiled by Syracuse University’s Transactional Records Access Clearinghouse. Audit rates for corporate returns, small businesses and the self-employed also declined, both nationally and locally.
The trend raises concern among some observers that the lack of IRS enforcement could erode the effectiveness of the U.S. tax system.
“Those kind of numbers tell people that you probably can push the envelope without getting caught, but in the end, that costs everybody else a lot of money,” said Noelle Allen, a Cupertino certified public accountant and chairman of the California Society of CPAs’ tax committee.
IRS officials say new efforts to improve customer service have combined with a hiring freeze and employee attrition to lower the number of audits. The agency lost 900 of its 16,700 full-time positions last year and redirected another 400 employees to staff expanded telephone hotline hours and new problem-solving days, among other initiatives, said Tom Smith, the IRS executive in charge of measuring the agency’s performance.
“It’s part of their goal to be a kinder and friendlier IRS,” agreed Diana Sanderson, president of the California Society of Certified Public Accountants. Sanderson said she had no audit notices in her practice last year.
The clearinghouse collects data from the IRS and other federal agencies using Freedom of Information Act requests. For the fourth year, much of what the watchdog group finds is posted on its Web site, https://trac.syr.edu.
Last year’s data reflect a trend: Face-to-face audits have plummeted more than 70% in the last two decades. The IRS reviewed 1.59% of taxpayer returns in 1981. By the 1990s, the rate had slipped to about 0.6%, and dropped last year to 0.46%, or 46 out of every 10,000 filers.
In Southern California overall, the percentage of returns being audited has fallen by nearly half since 1996, to 88 out of 10,000 filers, and by more than a third in the Los Angeles district, to 98 out of 10,000.
Northern California was the most audited district overall last year, supplanting Los Angeles, which was first in 1997. But Los Angeles still leads the country in audits of higher-income taxpayers--in fact, Los Angeles taxpayers with incomes over $25,000 are up to four times more likely to be audited than the national average.
The third most-audited area is what is called the Southern California district, which excludes Los Angeles County but includes Orange, San Diego, San Bernardino, Riverside and Imperial counties.
IRS officials credit California’s high audit rate to large numbers of high-income taxpayers, cash-based businesses and tax scofflaws. Clearinghouse experts add that California districts also tend to be better staffed than the national average, allowing more audits.
In the Southern California and Los Angeles districts, most audits were triggered by a secret IRS computer formula known as Discriminant Function System, which scores returns based on national averages for incomes and deductions, or by information-gathering studies conducted by the IRS. These studies, which in recent years have targeted attorneys, commercial fishermen, ministers, taxi drivers and entertainers, among others, have been criticized in Congress as invasive and unnecessary. The IRS says the studies help the agency understand the targeted groups so that auditors can better spot anomalies.
Another major reason for an audit is that the return was somehow related to another return already being audited. If a taxpayer claims during an audit to have received a gift of cash from another person, the IRS may audit the supposed benefactor for confirmation.
A flat refusal to file a return triggered one in 10 audits in the Southern California district--a rate three times as high as in neighboring Los Angeles and nearly twice as high as the national rate. (When the IRS thinks a return should have been filed, it may create a substitute return for the taxpayer. The taxpayer can accept the substitute, modify it or prove that no return needed to be filed. If the taxpayer and the IRS can’t reach an agreement, the agency can start an audit.)
Defying the System
Judith Golden, IRS spokeswoman for the Southern California district, attributed some of the refusal-to-file trend to the popularity of schemes and seminars that promote tax-avoidance trusts or that contend the income tax system is illegal or voluntary.
“We get letters from people who’ve declared themselves citizens of the Republic of California and who say they don’t have to file,” Golden said.
One taxpayer targeted by the IRS, who asked that his name not be used, said he refuses to pay income tax because he believes the term “income” has been inadequately defined by tax law. “They [the IRS] are coming at me with notices and warnings and all sorts of attempts at what is legally extortion and fraud,” he said.
An increase in refusal-to-file audits may also stem from the IRS’ improved efficiency at matching various documents, such as employment records and mortgage interest statements, with taxpayers’ returns to find people who haven’t filed who probably should have, Golden said.
Chances of being audited generally rose with income in 1998 and varied widely by region. Among the findings:
* Taxpayers who report incomes under $25,000 are more than five times as likely to be audited if they live in the Southern California district than they are if they live in Los Angeles, which had the lowest audit rates for low-income taxpayers filing 1040A or 1040EZ returns.
* Taxpayers who report incomes over $100,000 are nearly six times as likely to be audited if they live in Los Angeles than if they live in Houston, which had the lowest audit rates for wealthier taxpayers.
* The total amount of extra taxes and penalties recommended after audits fell 28% nationwide, to $4.31 billion, in 1998 compared to a year earlier. In Los Angeles, the amount fell 43%, to $188 million, while the Southern California district assessed $258 million, or 43% less.
* The IRS is targeting fewer small businesses.
The audit rate for most taxpayers reporting Schedule C self-employment income has declined as much as 60% in the last five years, although higher income returns in California are audited at comparatively high rates--the largest returns, with self-employment income over $100,000, had an audit rate of 5.74% in the Southern California district and 3.89% in the Los Angeles district.
* Data on criminal prosecutions of tax cheats was not available for 1998, but figures through 1997 show a general decline. Again, the types of prosecutions varies dramatically by region. The most common charges in the federal district that includes Los Angeles and Orange County was willful failure to file taxes and fraud, while the most common charges in New York are tax evasion and money laundering.
A Kinder, Gentler IRS
The IRS’ Smith said audits will continue to decline in 1999. The agency is expanding its efforts to be more taxpayer-friendly, with employee retraining and an extension of office and telephone hours for taxpayer help. In addition, the agency has launched more taxpayer education projects, such as one that taught food service and gambling employees how to properly account for tip income. Smith said the project has increased the reporting of tip income “by billions of dollars.”
The agency also is grappling with millennium bug problems, trying to ensure that its aging computer systems will not balk at midnight Dec. 31.
The prospect of fewer audits is a two-edged sword for taxpayers, said Sue Long, a statistician and the clearinghouse’s co-director.
“No one loves an audit, but on the other hand, our system depends on voluntary compliance,” Long said. “No one knows what the effect of a drop in audits might be.”
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Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com.
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