The Wall Street Journal-20080130-High Earners Face Surge In Tax Audits- Hoping to Catch Cheaters- IRS Is Setting New Snares- Targeting Foreign Athletes
Return to: The_Wall_Street_Journal-20080130
High Earners Face Surge In Tax Audits; Hoping to Catch Cheaters, IRS Is Setting New Snares; Targeting Foreign Athletes
Full Text (1369 words)The IRS is turning up the heat on high-income taxpayers, especially those who work for themselves.
Internal Revenue Service officials say audits of taxpayers making $100,000 or more rose 14% last year from 2006. Recent IRS data also show a 29% increase in audits of people making $200,000 or more -- and an 84% surge in audits of those with incomes of $1 million or more.
Overall, the number of individual income-tax audits reached a 10- year high in 2007 -- and the IRS plans to increase the number of audits this year.
The push comes as the agency faces heavy pressure from Congress to raise additional revenue and shrink the nation's $290 billion "tax gap," or the difference between what's collected and what should be collected each year. At the same time, Congress is scrambling to wrap up an economic-stimulus package, estimated to cost around $150 billion.
IRS research indicates much of the tax-noncompliance is committed by self-employed workers, such as consultants and small-business owners, whose taxes aren't withheld from their pay and whose income isn't reported separately to the government. By contrast, compliance is much higher among people whose pay is reported by their employers and whose taxes are withheld from their pay.
This year, "we will continue to focus on audits of high-income individuals," Linda Stiff, the IRS's acting commissioner, said in an interview. She also says IRS agents are intensifying their focus on "abusive" tax shelters, loosely defined as transactions with no real business purpose other than to avoid taxes. While the IRS has been waging war on shelters for years, officials see continued problems. "They tend to morph from year to year," Ms. Stiff says. "They shut down in one area and turn up somewhere else."
In addition, agents have increased audits of taxpayers involved in partnerships and businesses organized as "S corporations." With a typical S corporation, income isn't taxed at the corporate level. Instead, profits and losses flow through to shareholders, who are supposed to pay taxes at their own individual rates.
It's not just Americans who face the IRS's intensified crackdown. IRS officials say they have uncovered "significant noncompliance" among foreign athletes, such as golf and tennis stars, and foreign musicians who perform in the U.S., says Barry Shott, IRS deputy commissioner, international, in the large and midsize business division. IRS agents have about 60 open cases involving such individuals, he says.
IRS officials won't divulge any names of foreign athletes or entertainers under scrutiny. But Mr. Shott said at a recent tax conference in New York that the cases involve not only taxation of prize money won by athletes competing in U.S. events but also product- endorsement money. This can be an enormously complex issue, especially since many top professional athletes perform in many countries each year.
"The IRS is definitely targeting [foreign] entertainers and athletes," says Charles Lubar, a senior tax partner in the London office of law firm Morgan Lewis & Bockius. "They believe there has been a lot of avoidance by foreign artists and entertainers who go in and out of the United States and don't pay their proper U.S. taxes."
For the vast majority of taxpayers, the odds of getting audited remain quite low. Only about 1% of all individual income-tax returns filed in each of the past few years have been audited. But the chances of attracting the IRS's attention now are significantly higher than they were just a few years ago.
In fiscal 2007, the IRS examined a total of nearly 1.4 million individual income-tax returns. That's up 7% from the prior year and the highest number since 1997. By contrast, the IRS audited only 617,765 returns in fiscal 2000. The IRS's "coverage" rate -- audits divided by total number of returns filed the previous year -- has also been rising in recent years. For fiscal 2007, it stood at 1.03%, up from 0.98% the prior year and 0.49% in 2000. Even so, it's lower than where it was as recently as 1997.
IRS coverage rates are rising especially rapidly for higher-income taxpayers:
The IRS audited 31,382 returns with incomes of $1 million and higher in fiscal 2007, up from 17,015 the prior year. The coverage rate rose to 9.25% from 6.30%.
The IRS audited 113,105 returns with income of $200,000 and higher, up from 87,558 the prior year. The coverage rate: 2.87%, up from 2.57%.
The IRS audited 293,188 returns with income of $100,000 and higher, up from 257,851. The coverage rate: 1.77%, up from 1.67%.
The IRS relies on numerous techniques to choose which returns are audited. Many returns are selected on the basis of a secret computerized-scoring system that the IRS recently has updated, which is based on a continuing research project involving in-depth audits of thousands of returns. Computer programs assign each tax return a score that evaluates the potential for inaccuracies, based on the IRS's experience with similar returns. IRS staffers then pore through those returns with the highest scores to see which would make the best targets.
Many returns are picked because of "mismatches" -- which means that something a taxpayer reported doesn't match what was reported separately to the IRS by employers, banks or other financial institutions. Thus, one way to reduce your chances of hearing from the IRS is to double-check your return to see if what you reported matches what appears on those forms.
Other returns get audited because they were done by a paid tax preparer whom the IRS suspects of wrongdoing. Still others are picked based on information the IRS has obtained through its growing efforts to identify promoters and participants of tax shelters and other abusive tax-avoidance transactions.
When it comes to audits, "you are judged by the company you keep," says Bob Scharin, senior tax analyst at Thomson Tax & Accounting in New York.
Some returns get selected because of a tip from confidential informants, such as former business partners, ex-spouses or an angry neighbor. Separately, thousands of audit victims are picked at random among various income groups.
Most IRS probes are conducted by mail and are known as "correspondence" audits. These focus on a limited number of specific issues on a return and are designed to address those topics that don't require a full-scale, face-to-face audit. More complex issues are handled through what are known as "field" audits and are conducted in person. These may involve a trip to an IRS office or to the taxpayer's home or business.
In fiscal 2007, just over one million of the 1,384,563 individual income-tax audits were correspondence audits. Of the 31,382 audits of people with income of $1 million and higher, 19,123 were correspondence audits and 12,259 were field audits.
One of the easiest ways to attract IRS attention in a hurry is to claim there's no law that you have to pay federal income taxes or even file a return. IRS officials refer to these and similar excuses as "frivolous" arguments. (For a long list, click on the IRS's Web site at www.irs.gov and type "frivolous" in the search box.)
Don't even think about trying to make such claims. Courts consistently reject them, and the penalty can be severe. In 2006, Congress increased the maximum penalty for making frivolous arguments to $5,000 from $500. Also, U.S. Tax Court judges have imposed penalties of as much as $25,000 on some people who have persisted.
---
THE IRS FACES PRESSURE to send out stimulus-package checks quickly.
At his Senate Finance Committee confirmation hearing yesterday, Douglas Shulman, President Bush's nominee to head the IRS, was told by one senator: "We need to be certain of the ability of the IRS to respond quickly in getting much-needed tax rebates into the hands of millions of Americans." Mr. Shulman said he would work with Congress to do so as quickly as possible.
Separately, Mr. Shulman said the IRS must "continue its rigorous enforcement programs." In a prepared statement, he said the IRS "must deter those who may be inclined to evade their legal tax obligations and pursue those who engage in evasion."
Mr. Shulman is vice chairman of the Financial Industry Regulatory Authority, a nongovernmental regulator of securities firms doing business in the U.S.
---
Email: [email protected]
