Entering the Tax Maze? Watch Your Step
The threat of being audited has waned dramatically in recent years, as a newly chastened IRS attempts to rehabilitate its image.
Does that mean it’s a good time to fudge the numbers on this year’s tax return?
Many professional tax preparers say no. Although some errors of tax commission and omission may be easier to hide, new technology and computer matching systems have made it harder than ever for most taxpayers to cheat successfully.
And the lull in audits will evaporate as the agency finishes its long process of reorganization. Some taxpayers may be counting on a docile IRS at just the time they should be most worried, said David Flamer, a certified public accountant with Lasher, Flamer & Associates in Woodland Hills.
“The returns being filed now are the returns that are probably going to be subject to examination on a full-court-press basis,” Flamer predicted. “People who play the audit lottery will lose and lose big.”
Others point out that the risk of an audit has always been relatively remote for most people, making the issue largely one of ethics. How do you decide what is legitimate tax avoidance and what is illegal tax evasion when the IRS is unlikely to review your answers?
“I have clients who are saying, ‘I’m going to push the envelope on this’ ” because the risks of getting audited are slim, said Paul Kuperstein, president of the California Society of Certified Public Accountants and a CPA with Braverman Codron in Beverly Hills. “We’ll ask, ‘Do you have the documentation to back this [deduction] up?’ And they’ll say ‘yes’ with a twinkle in their eye.”
The issue worries some in the tax community, who fear a deterioration of taxpayer honesty could undermine the whole tax collection system, which depends in part on voluntary compliance.
The Skinny on Tax Schemes
“There are always people in society who will push the limit, who only think about what’s in it for them,” said Mary Beth Armstrong, an accounting professor at Cal Poly San Luis Obispo and chairwoman of the CPA society’s committee on professional conduct. “What they don’t think about is that by underpaying their taxes, that means eventually somebody else will have to overpay. Tax rates will have to be raised.”
Only a tiny minority of taxpayers has ever been audited. That small group has shriveled further in the last generation.
The IRS conducted face-to-face audits on 1.59% of taxpayer returns in 1981. By the 1990s, the rate was down to around 0.60%. In 1998, it dropped to 0.46%--or just 46 out of every 10,000 filers.
Collections have dropped by 13% in the following years, and property seizures are almost nonexistent--161 in fiscal 1999, compared with more than 10,000 three years earlier.
Treasury officials say some IRS employees have been confused about how to proceed with collections and seizures in the wake of the 1998 Taxpayer Rights Act, and agency reorganization and education efforts have sapped the audit squad. They predict increased enforcement and collections as agency training continues.
The drop in audits is especially noticeable to professional tax preparers, who handle more than half the nation’s returns. CPAs throughout the state and the nation report dramatic declines in their audit caseload.
Noelle Allen, chairwoman of the CPA society’s committee on taxation, said many of her Silicon Valley clients would be considered at high risk for audits. They tend to make more than $100,000, some are self-employed, and their taxes are complex--all factors that boost the risk of IRS review even in these low-audit times.
Yet Allen said the IRS started no audits of her clients last year, compared with five or six a year her office fielded during the rest of the 1990s.
“Absolutely, we’ve seen the difference,” Allen said. “We’ve never had a lot of audits, but we got nothing [in 1999] other than computer-generated matching program notices.”
Those notices comprise the bulk of the IRS’ enforcement action--and serve as a caution to anyone who thinks the IRS is no longer paying attention to the nation’s 127 million taxpayers.
In fact, it’s becoming harder for most taxpayers to cheat, thanks to the agency’s computerized record-matching efforts. The IRS compares millions of W-2 and 1099 forms provided by employers, banks, brokerages, mortgage lenders and other financial companies with taxpayer returns and issues demands for more taxes when there are discrepancies.
The state Franchise Tax Board piggybacks on this effort, sending its own dunning notices after the IRS has been satisfied. In addition, the FTB uses mortgage lending records, among other documents, to look for taxpayers who try to avoid California taxes by pretending to live in another state.
The IRS also matches Social Security numbers, required on returns since 1987, to spot phony dependents and bogus exemptions. Recently the agency has cracked down even harder on returns with missing or erroneous numbers. Instead of notifying the taxpayer and waiting for an explanation when Social Security numbers are wrong, the agency simply recomputes a taxpayer’s bill, eliminating deductions and exemptions for those whose numbers are incorrectly listed.
All that adds up to much less wiggle room for taxpayers whose income comprises only W-2 wages and investment income and whose major deduction is their mortgage, Flamer said.
Still, accountants and other tax experts say there is still plenty of room for fudging, particularly for the self-employed, owners of small businesses and those who employ household help.
“A lot of bodies are buried in Schedule Cs,” the tax form the self-employed use to report income and losses, said Allen, author of self-published “Confessions of a Tax Accountant: Outrageous, Hilarious and Totally True Stories,” that includes some of their tactics. Taxpayers may fail to report income received or try to pass off personal expenses as business costs, so that a dinner out with friends becomes an “entertainment expense.”
The IRS typically can uncover hidden income and challenge personal deductions if the taxpayer is audited, but otherwise has no easy way to detect cheating.
In addition, the financial penalties for cheating are often relatively light. The IRS can levy penalties for underpayment of taxes or even have taxpayers prosecuted for fraud, but many times the agency simply levies additional taxes and interest, Kuperstein said.
“People say, ‘I’m not going to get fined, I’m just going to get charged the interest, and in the meantime I’ve got the use of the money,’ ” Kuperstein said.
Housekeepers, nannies and gardeners are another area where many taxpayers are flouting the law, accountants said. “There’s a lot of that [household help] that’s going untaxed,” Kuperstein said. “There’s a big underground economy there, and who’s going to prove it?”
A few taxpayers go even further, refusing to file or pay taxes based on arguments that the constitutional amendment that created the income tax is not valid or that the tax system is illegal. Courts have repeatedly rejected those arguments as frivolous and subjected tax protesters to $5,000 fines, said attorney Robert L. Sommers, a certified tax specialist and creator of the Tax Prophet Web site.
Perhaps the biggest barrier to compliance, however, is the tax code itself.
IRS taxpayer advocate W. Val Oveson maintains that tax law complexity is “the most serious and burdensome problem facing America’s taxpayers.” Oveson said the most basic aspects of the tax law, such as determining a taxpayer’s filing status, figuring exemptions and computing the earned-income tax credit, are so complicated that taxpayers with the best intentions find it difficult to figure out the right thing to do.
Computer programs and Web sites that help taxpayers prepare their returns rely on the taxpayer to input the right data--often a daunting task, Oveson said.
“The tax software’s marvelous, but it doesn’t solve the whole issue,” said Oveson, whose attempts to prepare his own taxes using Intuit’s TurboTax were stymied by a complicated issue involving how to allocate a state tax refund.
“I’m a CPA, and I’ve done taxes, and I still can’t figure it out,” Oveson said.
Even professionals face gray areas where there are no clear right and wrong answers, Armstrong said. Courts and IRS offices in different regions can interpret tax law differently; preparers often must wait years for definitive IRS regulations or Supreme Court rulings--if such definitive answers ever come.
Professional ethics require CPAs to deal with those gray areas by using their best judgment, Armstrong said.
“When confronted by an issue in a gray area, [CPAs] are supposed to ask themselves . . . ‘If the tax court were looking over my shoulder, is there a reasonable possibility they would agree with how I’m handling this?” “ Armstrong said. “The increase or decrease in the possibility of being audited should be irrelevant.”
