Computerized IRS Catching Fewer Cheats Than Before

The computerized matching system that is supposed to help the Internal Revenue Service scrutinize tax returns is actually catching far fewer cheats than it did 10 years ago--a revelation that shocked tax experts who had long assumed the program was helping offset a steep decline in face-to-face audits.

The number of taxpayers contacted as a result of the computerized matching system--which compares the income reported on taxpayer returns with records supplied by employers, banks, investment companies and mortgage lenders--dropped last year to 1.4 million from a peak of 4.8 million in fiscal 1991, according to a March 26 letter from IRS Commissioner Charles Rossotti to Senate Finance Committee Chairman Charles E. Grassley (R-Iowa).

Tax preparers and other experts worry that the falloff in cases generated by the automated matching system will further erode public confidence in the ability of the IRS to curb cheating.

“If the public gets wind of this, the temptation is not to report income,” said Curt Eakin, chairman of the California Society of Certified Public Accountants’ professional conduct committee.

“My biggest fear is that, with declining enforcement, there will be a loss of voluntary compliance,” Eakin said.

For years, the IRS has been touting its computerized document-matching system as a way to continue taxpayer scrutiny even as budgets cuts and reorganizations have led to fewer traditional in-person audits by IRS agents.

But in fact, the agency lacks the personnel it needs to follow up on leads generated by the computer-matching system, Rossotti said Wednesday.

“As staffing has declined during the last decade, so has the number of people available for the matching program,” he said.

The computers used in the matching program have actually been flagging an increasing number of returns as having potential problems, typically discovering that wages, dividends or interest paid by an employer, bank or brokerage have not been recorded on a taxpayer’s return.

The program red-flagged 14.1 million returns in 1998--the last year for which a detailed breakdown is available--compared with 11.6 million in 1995.

But only 2.5 million returns in 1998 were actually reviewed by agency employees, which is required before correction notices can be sent to taxpayers. That’s a 24% decline from the 3.2 million that were screened by IRS personnel in 1995. Most of the returns that were reviewed resulted in a correction notice being sent to the taxpayer.

In most cases, if taxpayers do not respond to a correction notice, the IRS computes a corrected return for them and bills them for the difference in taxes. Most of the cases involve under-reporting of income.

These correction notices generally do not lead to full-fledged audits.

The decline in the number of returns screened under the matching program follows the trend for other forms of taxpayer scrutiny by the IRS.

In-person audits, conducted by IRS agents in a taxpayer’s home or office or at an IRS field office, fell 36% from 1999 to 2000.

So-called correspondence audits, conducted largely by mail, dropped 48%, according to Rossotti’s letter.

Both audit rates are now more than 68% below their levels of the mid-1990s. Last year, only 19 taxpayers in 10,000 faced an in-person audit--the lowest level since audit figures have been tracked.

Rossotti blamed a 30% decline in IRS staff over the last decade, plus efforts to reform the agency after highly publicized Senate hearings in the mid-1990s, for the declining audit rates.

In addition, a number of auditors have been reassigned to staff taxpayer hotlines and help with taxpayer education, he said.

Tax experts have long known that audit rates were declining, but many were surprised by the scope of the falloff revealed in Rossotti’s letter.

“We were blown away” by the dramatic decline in correction notices generated by computer matches, said David Burnham, an investigative writer and co-director of the Transactional Records Access Clearinghouse, a nonpartisan research organization that tracks IRS enforcement efforts.

Like other tax experts, Burnham worried that decreasing enforcement on all fronts could lead to a major breakdown in taxpayers’ willingness to comply with tax laws.

The IRS says it has no clear idea of how widespread tax cheating might be. In the past, the agency conducted sweeping, random audits of taxpayers to try to judge the compliance rate, but those reviews were banned by Congress in 1988 as too invasive.

Grassley, whose Senate committee oversees the IRS, called for the agency to immediately beef up its enforcement efforts using the 2,036 new employees Congress has authorized it to hire.

“That the IRS is on the job is an important message the public must hear, particularly given the explosive growth we have recently seen in Internet tax schemes, scams and cons,” Grassley wrote in a return letter to Rossotti.

Internet tax scams were the topic of a Senate hearing Wednesday.

Grassley said the IRS should not use its reorganization and reform efforts as an excuse not to enforce the laws.

He noted that the agency’s enforcement budget has remained relatively constant, even as the IRS was reassigning auditors to other duties.

“Treating taxpayers fairly and assisting taxpayers are critical missions for the IRS. They shouldn’t inhibit the agency from performing any other responsibilities,” Grassley said.

“If they do, something’s fundamentally wrong.”