With revenues declining and budgets tight, both the state and federal governments are making a greater effort to find and prosecute tax cheats.
The increased interest in enforcement and auditing predates the recession but has taken on greater urgency as governments look for ways to drum up cash.
The state and federal governments are both targeting wealthier individuals, although the overall audit rate for all taxpayers has risen.
Over the past few years, the number of active audit cases in New York has increased from around 700,000 per year to 1.2 million per year, according to the state Department of Taxation and Finance. This inventory consists of cases that are open for several years and others that are opened and closed within the same year.
As the Department of Taxation and Finance’s audit caseload has risen, so has the number of cases that are successfully closed each year. Over the last four years, the agency has gone from closing approximately 550,000 cases per year to 967,028 in 2008-09. This year the agency expects to close more than 1 million.
The department’s Office of Tax Enforcement, which includes audit, collections and criminal enforcements, has also grown, from 2,438 employees in 2006 to 3,029 employees this year.
In the summer of 2007, the department published a strategic plan laying out goals and priorities.
“We recognized that New York was really losing a lot of money in the tax gap — the gap between what is paid and what is owed,” said Bill Comiskey, deputy commissioner of tax enforcement for the state Department of Taxation and Finance. “There’s money that people don’t pay because they don’t realize it’s owed, but there’s also an unacceptable level of non-compliance.”
Beefing up enforcement
In the past, the criminal side of tax enforcement “was virtually an afterthought,” Comiskey said. He said that the field staff that investigates tax fraud was “down to a skeletal crew,” about 15 people. That number has “quadrupled or quintupled, depending on the day.
“There are so many reasons why tax evasion is something the government should take seriously,” Comiskey said. “Businesses that pay taxes and do things right are at a competitive disadvantage. Honest taxpayers are asked to pay ever increasing taxes.”
The push to increase enforcement and audits comes after a two decade decline in the IRS audit rate, said David Pratt, a professor of law at Albany Law School who teaches an introductory tax law course.
“The audit rate was low, way too low,” Pratt said. “The tax system relies heavily on individual compliance. If people don’t believe the system is fair, then the rate of voluntary compliance goes down. There’s a growing reluctance among individuals, particularly wealthy individuals, to pay any taxes at all.”
He said taxes are needed to fund essential services that are necessary to maintaining a civilized society.
“No one gets elected by trying to get more money to the IRS,” said Bryan Skarlatos, a member of the New York State Bar Association’s tax section executive committee and an attorney at Kostelanetz & Fink, a tax litigation boutique in New York City. “But you need enforcement, especially today.”
In 2000, 0.49 percent of individual taxpayers were audited by the IRS. By 2009, that figure had risen to 1.03 percent, though millionaires were six times more likely to be audited than someone earning less than $200,000.
“There’s been a small uptick in audit action,” Skarlatos said. “They’re doing more focused audits and they’re more aggressive. They’re more likely to assert penalties and they’re dedicating more resources to high value targets.”
He said the audit rate for all taxpayers is climbing but that it’s climbing more quickly for wealthy taxpayers. “Those people are more likely to be in a position where they’re underreporting,” he said.
IRS increases staff
The Internal Revenue Service is also allocating more resources for examinations, or audits, increasing its enforcement staff from 20,832 in 2000 to 21,059 in 2009.
As staff has increased, so has the amount of money collected through examinations. In 2000, the IRS collected $10.2 billion through examinations; in 2009, the agency collected $17.4 billion, a dip from $20.6 billion the previous year.
In 2006, the IRS audited 1.29 million individuals; in 2009, the agency audited 1.45 million individuals — the most in 10 years.
The IRS also has a heightened focus on businesses. In 2000, the agency examined 49,574 returns from businesses; by 2009, that number had jumped to 58,144.
In remarks to Congress, Douglas Shulman, commissioner of the IRS, talked about the agency’s funding request for the 2011 budget. “In recognition of the critical role that the IRS plays in the nation’s economy, [the budget] includes a judicious investment in the IRS’ core service and enforcement programs.”
The goal, he said, is to provide better service to taxpayers and maintain “a robust and targeted enforcement program to address offshore tax evasion and improve tax compliance for corporate and high-income taxpayers.”
Shulman noted that in 2009 individual audits increased 2.9 percent while “high-wealth” audits increased 11.2 percent and large corporate audits increased 2.6 percent. Last year, the IRS launched the Global High Wealth Industry Group, a new enforcement unit that targets the wealthy.
“Initially, the IRS will be focusing on individuals with tens of millions of dollars of assets or income,” Shulman told the House Appropriations Committee’s Subcommittee on Financial Services and General Government. “Going forward, the IRS will take a unified look at the entire complex web of business entities controlled by high wealth individuals, which will enable us to better assess the risk such arrangements pose to tax compliance.”
The agency has also unveiled a new initiative to oversee tax return preparers and require that tax return preparers undergo registration, minimum competency testing and continuing education.
The IRS’ budget request for 2011 is $12.9 billion, a 4 percent increase over the agency’s current budget of $12.1 billion. The 2011 budget request includes a $293.4 million increase in funding for enforcement which, among other things, will focus on the underreporting of income associated with the international activities among corporate and high-wealth taxpayers.
The state Department of Taxation and Finance has also created a data mining group. Three new laws, passed in 2009, require certain types of businesses to submit additional information that can be put into a database. Businesses that have franchises in the state are required to provide an annual return showing how many sales occurred at each franchise; this information will then be compared with the returns submitted by those franchises.
“We don’t know how much those stores make,” Comiskey said. But statistics show that 54 percent of businesses underreport their income, he said.
Beer and wine wholesalers are now required to submit information showing how much they sell to retailers, and insurance companies are now required to submit records showing how much money they give to every car repair shop in the state.
“These are baby steps in the development of a data warehouse so we can identify places that warrant scrutiny,” Comiskey said.
The state Department of Taxation and Finance has also created a new program through which eligible taxpayers who owe back taxes can avoid monetary penalties and possible criminal charges by telling the department what taxes they owe, paying those taxes and entering an agreement to pay all future taxes.
New York has also tried to make the tax process simpler.
Last year the state Department of Taxation and Finance created a new position, taxpayer rights advocate, to act as an ombudsman between the public and the department in resolving taxpayer disputes. Duties include informing taxpayers of their rights and responsibilities with respect to audits, protests, reviews of adverse decisions, collection activities, mediation services and enforcement procedures; and identifying patterns in tax matters that may indicate systemic problems in department procedures or policies.
“We’re trying to make it easier for the compliant taxpayer to do the right thing,” Comiskey said.
Skarlatos said the audit rate plummeted after the Senate Finance Committee investigated allegations of improper conduct against the IRS in the late 1990s. These hearings resulted in a restructuring of the agency and during this restructuring, “audit activity fell off a cliff,” he said.
Then, in the early 2000s, when the economy was strong and the tech bubble had yet to burst, audits were not viewed as a priority because revenues were strong — for a brief period of time, there was even a budget surplus.
Pratt said the IRS is generally careful not to disclose its audit criteria but people are more likely to be audited if they make an unusually large charitable donation, are unusually wealthy or have received an earned income tax credit. The EITC is a refundable federal income tax credit for low- to moderate-income working individuals and families; Pratt said the program, which has gradually expanded, is susceptible to fraud.
“If there’s anything unusual about the return, you’re more likely to be audited,” Pratt said.
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