Low Incomes More Prone to Audits by IRS

Low-income taxpayers last year faced Internal Revenue Service audits at a higher rate than high-income filers for the first time in recent history, raising troubling questions of fairness and sparking new concerns that IRS reforms may have gone too far.

Figures released today by the Transactional Records Access Clearinghouse, a nonpartisan data research organization at Syracuse University, showed a reversal of a longtime trend that once had wealthy taxpayers audited at more than 10 times the rate of the working poor. Last year, the IRS audited 1.36% of taxpayers with incomes under $25,000, compared with 1.15% of taxpayers with incomes over $100,000. The clearinghouse’s data are generally regarded as the most complete on IRS audit rates.

“It’s outrageous. It’s almost as if the IRS has nothing better to do than hassle the working poor,” said law professor Edward J. McCaffery, executive director of the USC Tax Institute and a frequent commentator on issues of tax justice.

A Treasury Department spokesman said the IRS is not unfairly targeting low-income taxpayers and that the majority of the agency’s time and resources are spent reviewing returns of higher-income filers.

IRS officials say they have just been following the directives of Congress, which has ordered the agency to crack down on abuse of a popular low-income tax break, the earned-income tax credit. More than 70% of the low-income auditswere related to misuse of this refundable credit, designed to help the working poor climb out of poverty. Eligibility for the credit is based on a complicated formula that includes income, marital status and number of children.

Number of Audits Reaches New Low

At the same time, lawmakers demanded massive reforms that have hobbled the IRS’ ability to audit the more complicated returns of the well-off.

Those audit cutbacks also contributed to a steep three-year decline in the rate at which all taxpayers are subjected to audits, the figures show. As taxpayers rush to meet Monday’s filing deadline, fewer are facing IRS scrutiny than at any time since at least 1981, the earliest year for which the clearinghouse has data.

Sen. William V. Roth Jr. (R-Del.), whose high-profile hearings on the IRS in 1997 led to the agency’s massive reorganization, said in a statement that he found the audit statistics “troubling.” Roth has previously protested the decline in audits and collections, saying his landmark reform legislation was not intended to disable tax enforcement.

“Tax laws must always be applied with integrity and fairness,” Roth said. “Fair treatment of taxpayers should and can go hand in hand with collecting the proper amount of tax.”

Roth is not alone in his concern. Other lawmakers, tax experts and IRS rank-and-file employees have also voiced concerns about declining enforcement, which could encourage some taxpayers to cheat.

The IRS says the trend is a temporary phenomenon that is likely to reverse as the agency finishes its internal overhaul later this year and petitions Congress for money to step up enforcement of more complicated returns.

In an attempt to make the agency more user-friendly, experienced auditors were removed from their jobs to staff IRS hotlines, create taxpayer education programs and design a new organizational chart that will largely replace the IRS’ 33 districts with four huge new divisions for wage-earners, small and medium businesses, large corporations and tax-exempt organizations.

Some tax observers question the IRS’ commitment to change, however, saying the agency is finding it easier and cheaper to target the poor.

“The fact is, it’s easier to beat up on the little guy who can’t pay somebody like me $250 an hour to represent him,” said Ernest Howard, a certified public accountant and chairman of the California Society of CPAs’ Hollywood-Beverly Hills sub-chapter. “The IRS is going after the little guy because it’s easier to get him to cave in.”

The bulk of the IRS audits are not grueling face-to-face confrontations, but semiautomated “service center” reviews that on average took only an hour of an auditor’s time and resulted in the assessment of $2,085 in additional taxes and penalties, clearinghouse figures showed. The average assessment was slightly higher--$2,171--for audits of low-income filers, which made up 70% of the service center total.

By contrast, the average face-to-face audit took nearly 12 hours and resulted in additional recommended taxes of $7,672, or $659 per hour.

The IRS conducted fewer of these face-to-face audits last year than the year before--in fact, fewer than in any year for which the clearinghouse has records. IRS districts last year audited just 31 of every 10,000 taxpayers nationally. Adding in semi-automated service center audits brought the rate to just 91 per 10,000--also a new low. Collections--which include seizures, levies and liens--have fallen as much as 98% in two years.

In the past, the IRS has focused more of its audit attention on higher-income taxpayers because of their greater ability to hide income and misuse tax breaks. For example, higher-income people would claim personal expenses as business deductions, fail to report non-wage income or construct elaborate and expensive tax shelters.

The opportunities for most other taxpayers to cheat, meanwhile, have shriveled as the IRS has grown more proficient at using computers to match taxpayers’ returns with employer-provided W-2s and 1099s from banks, lenders and brokerages.

There is still plenty of room for taxpayer error, however.

IRS taxpayer advocate W. Val Oveson has told Congress that the most basic aspects of the tax law--such as determining a taxpayer’s filing status, interpreting rules about dependents and computing the earned-income tax credit--are too complex for the average taxpayer to understand. Someone who is a dependent for purposes of claiming an exemption, for example, might not be considered a dependent for the earned-income tax credit, said Deborah Schenk, a professor at New York University Law School and member of the American Bar Assn.’s committee on low-income taxpayers.

“It’s not the kind of thing the average low-income person could even figure out for themselves,” said Schenk, who runs a tax clinic for low-income people in New York and who says even her law-student preparers have trouble figuring out how to properly apply the credit. “But they try to do their own return or have a fly-by-night outfit do it, and they make errors. It’s not like taxpayers who can hire [a top accounting firm] to do their return.”

The earned-income credit is refundable, which means low-income taxpayers can get money back from the government even if they paid little or no taxes during the year. That has made it a target for scam-artist preparers who concoct phony refund claims or mislead taxpayers into filing inflated claims and then take some or all of the refund. Several arrests of earned-income tax cheaters were made in Los Angeles during the 1990s; one of those arrested was the so-called welfare queen, a woman who a decade earlier had been convicted of collecting bogus aid checks while living in a mansion.

Immigrants and the poor are particularly vulnerable to scam artists “because they often don’t understand the tax law; they’re susceptible to practitioners who abuse the system,” said Steve Jensen, director of the Los Angeles IRS district and acting director of the Southern California district, which led the nation in audits of returns showing incomes under $25,000.

The IRS has estimated 20% to 25% of the earned-income credit filings are fraudulent or contain errors. At Congress’ direction, the agency spent $140.5 million in 1999 and $135.9 million in 1998 to combat earned-income tax credit fraud, reviewing more than $2 billion in credit claims.

The IRS estimates that 85% of the audits for incomes under $25,000 were either earned-income credit reviews or audits of people who failed to file a tax return. Although the IRS did not break down the proportion by income, generally earned-income credit returns outnumber non-filers by about 7 to 1, IRS spokesman Don Roberts said.

Tax Code Complexity Hinders Compliance

District audit figures, which do not include service center audits, show about 10% of audits last year were due to the taxpayer’s refusal to file a return. The IRS has no idea how many taxpayers fail to file, although they suspect the number is in the millions.

Schenk believes compliance would increase with tax simplification, particularly for the poor, which she and the bar association committee have pushed for in vain.

“There is absolutely no political interest at all,” Schenk said.

Much of the clearinghouse’s data is available free to the public at https://www.trac.syr.edu. For more information about taxes, visit https://www.latimes.com/taxes.

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Tables Turned

Last year, the poor faced higher audit rates than those with returns showing $100,000+ income.

1988; 11.415

1999*: 1.36%

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* Doesn’t include most international audits.

Source: Internal Revenue Service

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STATE OF AUDITS

California is again the most-audited state. Higher incomes and fraud are to blame. C1