IRS to Increase Number of Audits

The IRS will audit significantly more Americans over the next three years as the agency tries to reverse a decline in taxpayer scrutiny that officials fear is fueling an epidemic of tax cheating, lawmakers were told Thursday.

To achieve that goal, the IRS has added more than 1,000 collection agents and examiners and revamped its procedures, IRS Commissioner Charles O. Rossotti told a subcommittee of the House Appropriations Committee.

Rossotti said he expects the changes to begin bearing fruit this year.

“We believe that compliance activity levels will increase over the next three years,” Rossotti testified, referring to the number of audits and collection actions the agency conducts.

“We will also be able to better identify and focus on key compliance problem areas.”

Rossotti, who plans to leave the Internal Revenue Service in November when his five-year term expires, didn’t provide an estimate of how many more audits will be conducted in coming years. However, a return to historical audit rates would mean hundreds of thousands more Americans would be audited each year.

The rate of so-called field audits--the in-depth face-to-face examinations designed to catch tax cheats--continued to fall last year, reaching an all-time low.

The number of all audits conducted by the IRS actually rose slightly last year when compared with 2000, but was still down by more than half from 1996.

“This issue is so critical to where we are fiscally in this country,” said subcommittee member Steny H. Hoyer (D-Md.). “We have cut audit rates very substantially to the point where 99% of filers figure they aren’t going to get audited.”

The IRS has been cutting audits for years in response to budget reductions imposed by Congress in the mid-1990s, when the tax agency fumbled efforts to modernize its technology and began attracting harsh criticism over its mistreatment of taxpayers.

The abuses led to a series of reforms, including a sweeping public apology by senior IRS officials in 1998 for violating federal law by dunning individuals for taxes that were not even owed.

But no restrictions were placed on the number or scope of audits and the continuing decline in such examinations appears to be eroding tax compliance.

Rossotti said Thursday that underreporting of income and fabrication of deductions costs the Treasury an estimated $250 billion annually, up from an estimate of $195 billion made in 1998 and $170 billion in 1996.

The total number of audits conducted in 2001 was 731,756, down from 1.9 million in 1996. The audit rate--the percentage of taxpayers who are audited--fell during the same period from 1.7% of all taxpayers to 0.6%. The number of field audits fell to 202,515 last year, down 20% from the year before and off 73% since 1996.

As manpower dwindled, the IRS increasingly has come to rely on so-called correspondence audits. These reviews are done completely by mail and deal primarily with such problems as math errors and failing to report easily identified income.

In an effort to reverse the naggingly low audit rate, the agency hired 568 collection agents and 733 tax examiners last year.

That didn’t boost the 2001 audit rate because some people were hired late in the year and had to be trained before they were sent out into the field, Rossotti said.

“This was the first time in six years that we were able to replenish these critical compliance positions,” Rossotti said. “The full effect of these new workers will not be felt until fiscal 2002.”

News of the promised increase in audits comes only six weeks after the IRS said it is reviving the old, dreaded line-by-line “taxpayer compliance” audits.

Rossotti said these compliance audits, which have been revamped to be somewhat less onerous, are necessary to identify areas of widespread cheating.

Also Thursday, the IRS and the Treasury Department announced the formation of a joint task force dedicated to the earned income tax credit, a tax break for the working poor.

A Treasury study found that nearly one-third of the $31.3 billion in earned-income-tax-credit refunds sent out for the 1999 tax year--between $8.5 billion and $9.9 billion annually--shouldn’t have been paid.

The largest amount of bogus claims related to taxpayers claiming children that did not qualify for credits under the program, sometimes because they lived with another, higher-income parent, according to the report.

So-called overclaims reflect just a portion of the problem, however. Rossotti said that about 4 million individuals who could claim the earned income tax credit don’t.

The agency believes the credit is so complex and cumbersome that many taxpayers simply err.

The 2001 tax law simplified some of the rules, and the IRS is getting better at catching errors because it recently implemented a data sharing program where it gets information about child custody from the Federal Case Registry, Rossotti told the subcommittee.

However, the IRS-Treasury task force intends to look for additional ways to improve the accuracy of the program for the earned income tax credit, while reducing the complexity.

“We believe we can make some administrative changes to improve the program, but it may require legislative changes as well,” Rossotti testified.

“The objective is to see whether there’s a better way to supplement the income of low-income taxpayers through the income tax system.”

The IRS in the past has been criticized for picking on lower-income taxpayers, and subcommittee members warned Rossotti that the agency’s revitalized enforcement efforts shouldn’t be focused solely on catching lower-income tax cheats.