Freedom Lawyers of America

by Roger Russell

Internal Revenue Service compliance efforts, on the back burner for a while following charges of intrusiveness and misconduct during congressional hearings several years ago, are once again moving to the fore.

Last year, IRS compliance efforts reached more than 11 million contacts with taxpayers. And incoming IRS Commissioner Mark Everson said at his nomination hearings that curbing tax evasion would be among his priorities.

An important area of focus, he said, "will be to strengthen the integrity of the tax system through enhanced enforcement activities. The IRS must deter those who might be inclined to evade their legal tax obligations, and appropriately pursue those who actually do so."

Part of the process will be closer work with practitioners, according to Everson. "Attorneys and accountants should be pillars of our system of taxation, not the architects of its circumvention," he said.

Acting Commissioner Bob Wenzel said that, in terms of compliance results, fiscal 2002 revenue from IRS collection activity increased to more than $32 billion, reaching the highest level in eight years - a $371 million increase from the previous year.

According to Wenzel, compliance activities increased in a number of areas over the past fiscal year:

* The number of levies issued by the IRS increased by nearly 50 percent.

* The number of liens filed increased by nearly 15 percent.

* Audits of the returns of high-income taxpayers - those earning $100,000 and more - increased by 22.

* Overall individual audits of taxpayers stayed about even, while audits of taxpayers earning less than $100,000 declined slightly.

* The number of math error notices mailed to taxpayers increased to 8.3 million.

* As part of the document-matching effort, the IRS contacted more than 3.4 million taxpayers in fiscal 2002 through the under-reporter and non-filer programs, an increase of 36 percent from 2.5 million contacts in fiscal 2001.

In addition, the IRS is resuming matching information from Schedule K-1s filed by partnerships, S corporations and trusts to the tax returns of individual partners, shareholders and beneficiaries. Where there is a mismatch of information, taxpayers involved will receive notices.

Wenzel said that the National Research Program, launched last November, will help ensure that the right tax returns are selected for review.

Charles Bennett, senior analyst at the National Research Program, said that the old measurement process - the Taxpayer Compliance Measurement Program - selected returns at random and required complicated line-by-line audits, with taxpayers required to verify each line with extensive documentation.

The new program "is a result of going for many years without much of the data that we previously obtained through TCMP," he said. "This will provide us with the data that we used to get with TCMP, plus a lot more."
Among the differences in the NRP compared to TCMP, according to Bennett, is the size of the sample. The NRP sample is smaller, with about 47,000 returns targeted. Under the NRP, rather than require line-by-line audits, the IRS will do preparatory work or "case building" before documentation is submitted to examiners.

The examiner has the ability to expand the scope of the exam without the approval of the audit group manager, but "in doing so, it is expected that the examiner will be consulting with the group manager on the identification and development of issues, not necessarily for permission purposes, but to get input and suggestions," said Bennett.

If the practitioner feels that the examiner is unreasonably expanding the scope of the exam, he should work with the examiner to answer any questions, then notify the manager.

Examinations under the NRP began last November with a handful of returns, with the target date for completion set at March of 2004. However, it may extend beyond that date because "we were a little late in rolling out the program," said Bennett.

Of the 47,000 audits, about 7,000 returns will be checked relying solely on information already provided, and about 7,000 more will be conducted by correspondence with the taxpayer. Approximately 32,000 returns will be "limited scope" audits, no more intrusive than ordinary audits, while 2,000 audits will be line-by-line, with reasonable substantiation required.

The NRP, like the former TCMP, has elicited some skepticism from practitioners. William Stevenson, chairman of the National Society of Accountants f Federal Taxation Committee, said that the reason behind the NRP - the current audit selection system is producing too few "no change" audits - is not because current IRS data is flawed, but because of other factors, such as management pressure to close cases quickly.

"The program is not going to accomplish what they want it to. A lot of audits will simply be taken to appeals. In the past, appeals results were never considered in the TCMP data, so whatever data they acquire won't be as valid as they expect."

Stevenson noted that many small businesses don't keep good records. Tax preparers are faced with preparing returns based on prior years experience with the taxpayer, and oral testimony. The IRS is looking for information to make a part of their statistical records that just doesn't exist for the small business taxpayer - the cost of keeping the kind of records that the IRS would like to see is too great.

For example, said Stevenson, "a taxpayer may fall into the Alternative Minimum Tax because he has substantial miscellaneous deductions. If you eliminate the miscellaneous deductions, the regular tax will go up, but why should we spend the time to justify mileage and business meals if the taxpayer won't get the benefit anyway?

He added, "There's so little to attack on a tax return today. Mortgage interest is reported to the IRS by third parties, such as banks and mortgage companies, so they already have that information. High-income taxpayers lose their deductions because of the phase out, so they're left with charitable deductions and real estate taxes. The upshot is they are going to attack the low-income taxpayer who doesn't have AMT or a phase out."

Congressional leaders don't expect to see overnight success from the IRS's latest attempts at compliance. Sen. Chuck Grassley, chairman of the Senate Finance Committee, said at Everson's nomination hearings, "It is clear that it unfortunately will take years to get the IRS to where it provides first-rate customer service, as well as an appropriate enforcement presence that respects taxpayer rights."