Tax Lawyer's Blog

Reporter: Hey, Willie, why do you rob all them banks?

Willie Sutton: ‘Cause that’s where the money is.

The New York Times reports that the Internal Revenue Service has lived up to its word and is intensifying its scrutiny of wealthy Americans:

The federal agency increased its audits of taxpayers who earned $1 million to $5 million by 33 percent last year compared with 2008, new IRS figures show.

The numbers, released late Thursday in the agency’s 2009 annual data book, also show that the IRS. increased its audits by 16 percent for those earning $5 million to $10 million last year. Audits of those who made at least $10 million rose by 8.5 percent, according to the data.

The figures are the strongest evidence yet that the agency is honoring a vow by the IRS. commissioner, Douglas H. Shulman, to increase scrutiny of wealthy taxpayers.

Taxpayers who earned at least $1 million a year made up 0.25 percent of the more than 144 million individual federal returns filed last year, the data showed, but affluent Americans account for a far greater share of the underpayments in federal income tax returns.

“The 2009 results show our emphasis on higher-income individuals,” Bruce I. Friedland, an IRS spokesman, said Friday in a statement. “We will continue to focus our enforcement efforts on high-income taxpayers, particularly those hiding their assets overseas.”

From a purely business perspective, the IRS has a dilemma in choosing whom to audit. While I suspect it is true that auditing a big fish taxpayer is more likely to result in a greater deficiency assessment, the pursuit of lower income individuals, who, for example, have claimed fraudulent earned income credits, may be more lucrative.¹

The IRS probably gets a bigger bang from its tax collection buck by pursuing lower income tax evaders because the cost of pursuing high income taxpayers is many times that of pursuing lower income taxpayers. For example:

• High income taxpayers are more likely to have had their tax returns prepared by reputable professional tax preparers who will be eager to vigorously defend their tax advice;
• High income taxpayers are more likely to have implemented a plan of asset protection thereby making it difficult for the IRS, even if it makes a legitimate deficiency assessment, to collect the taxes owed;
• High income taxpayers are more likely to challenge an IRS assessment and have the wherewithal to fight the government in the Court system;
• The IRS can handle most audits of low income taxpayers through correspondence and simple field examinations; and
• Low income taxpayers generally cannot afford tax representation and are therefore more likely to concede the IRS’s assessment either outright or by default.

Of course, I am not suggesting that the IRS avoid the pursuit of high-income tax cheats. On the contrary, I think the government should pursue all tax cheats in an effort to close the tax gap and thereby avoid, or at least diminish, Congress’ appetite for new tax increases. What I am saying, however, is that the IRS – if it ran itself like a for-profit business, which it should – must take into account the costs associated with its collection efforts to determine the best use of its vast, but still finite, collection resources.

In short, if it costs the government 40 cents for each dollar it collects from rich tax cheats and just 10 cents for every dollar it collects from low-income tax cheats, it makes more business sense to pursue the low income tax cheats.

Who said life was fair?

Footnotes:

¹  The symbolic value of pursuing rich tax scofflaws is not lost on me. In order for people to have confidence in the efficacy and fairness of the system, the IRS may be duty-bound, regardless of the relative cost, to pursue rich, middle-class and poor tax cheats with equal vigor.

Related Posts:

• IRS Rarely Audits the Poor
• IRS Auditors to Target the Rich
• WebCPA Tax Advice: Avoid IRS Audit by Hiring Licensed Tax Preparer
• 5 Slam Dunk IRS Audit Red Flags

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