IRS Audits May Dip This Year Because of Staffing Shifts

As millions of Americans prepare for the April 17 federal tax filing deadline, the IRS is watching.

Mike Kemp  | Getty Images

But not always as closely as taxpayers might think.

Coping with federal budget cuts, a hiring freeze, staffing reductions, an increasingly complex tax code and a surge in tax refund identity fraud, the IRS has found it harder to fulfill its mission of detecting and stopping fraud while responding to taxpayer needs. Although the IRS increased the number and percentage of audits on all individual tax returns in the past decade, agency data show the rates plateaued at 1.1 percent in fiscal years 2010 and 2011.

At that rate, about one out of every 90 filers would be audited, said Michael Lacey, a Georgia Institute of Technology mathematics professor. A taxpayer would be more likely to roll six dice and have six unique numbers appear on the first roll than to be audited, said Lew Lefton, Internet technology chief at Georgia Tech's math school.

But wealthier filers face higher audit rates, IRS data show.

IRS Deputy Commissioner Steven Miller said in an interview that the audit rate "may drop a little bit this year" because the agency reassigned workers to help deal with a jump in cases of identity-theft-related tax-refund fraud.

If the overall individual audit rate drops below 1 percent, it would be the first time that's happened since 2001-2006.

"The IRS is put between a rock and a hard place" trying to balance its increasing duties and declining resources, said Mark Luscombe, principal tax analyst for CCH, a leading tax and business law information firm.

Is the IRS worried? "Not yet," said Miller. "We may not be able to do everything, but we're going to ensure that we do what we have to do."

As the USA's tax collector, the IRS processed more than 234 million tax returns in fiscal year 2011, bringing in more than $2.4 trillion to fund the federal government. Huge? Sure. Yet the IRS' latest estimate of the net tax gap — the difference between what taxpayers owe in a year and what's not paid on time because of mistakes or fraud — totals $385 billion.

That's not far below the market value of all ExxonMobil stock.

Budget Reductions

To handle its responsibilities, the IRS is funded by a 2012 fiscal year budget totaling $11.8 billion. That's a nearly 2.1 percent cut from 2011, and marks the second consecutive budget reduction.

Those decreases have left the IRS "unable to adequately detect and address non-compliance, requiring honest taxpayers to shoulder a disproportionately large share of the tax burden," National Taxpayer Advocate Nina Olson said in her 2012 annual report to Congress. She heads an independent IRS office that aids taxpayers having trouble with tax issues.

Amid federal budget-cutting efforts, the IRS was spared deeper reductions based on its "necessary services," Rep. Jo Ann Emerson, R-Mo., chairwoman of the House Subcommittee on Financial Services and General Government, told a March 21 budget hearing. "The IRS may have to bear a greater proportion" of future cuts, she said.

The IRS relies on computer technology to help spot potential abuses. As Miller put it, while not every tax return is manually pulled and looked at, "they are going through (computer screening) to see if they raise flags."

Some of the electronic screening uses so-called tolerance levels. These are closely guarded dollar values or other measures programmed into IRS computers as trigger points. If a given tax return's financial data fall within the tolerance level, it's less likely to be manually checked. The IRS suspects scammers constantly test the tolerance levels with fraudulent tax returns.

"Do I have proof of that? No. Do I have a pretty darn good idea of it? I think yes, because we do see bunchings of filings around a given number. At that point, we start to adjust the number," said Miller.

But a 2008 audit by the Treasury Inspector General for Tax Administration, which oversees the IRS, shows that the tax agency failed to use empirical data to set the tolerance levels and evaluate their effectiveness. Some tolerance levels were "picked by the seat of the pants," Mark Matthews, the IRS deputy commissioner for services and enforcement from 2003 to 2006, said in an interview last month.

Tolerance-level protocols and effectiveness are now checked annually, said IRS spokeswoman Michelle Eldridge.

Eye on Fraud

Computer screening issues aren't the only IRS enforcement area that has drawn questions.

The tax agency said it blocked more than $14 billion in refunds on fraudulent tax returns, much of it related to identity theft, during 2011 tax return processing.

But J. Russell George, who heads the inspector general's office, told Emerson's panel last month that Congress should expand IRS access to wage and withholding data that the Department of Health and Human Services gets from employers for Social Security records.

Complex code

That would make it easier for the IRS to spot fraudulent refund claims by checking taxpayer filings against the data, he said.

The IRS has 5,000 fewer workers this tax-filing season than in 2011, and about 60% of the cuts came in enforcement jobs, Commissioner Douglas Shulman told a congressional hearing in March. The total IRS workforce fell to 91,380 last fall, a 3.1 percent drop from 94,346 in 2010. The reductions can leave the IRS scrambling to deal with honest taxpayers and scammers.

Many IRS employees who currently work on identity-theft tax fraud cases are also telephone assistors trained to help taxpayers. But inspector general auditors cautioned that identity-theft cases are often complex and require skills the phone assistors lack.

The assistors work on a caseload in which confirmed identity-theft frauds soared by 431% from 2010 to 2011.

But these workers are also assigned to answer taxpayer calls on Mondays during tax-filing season, trying to cut call waiting times that have risen to an average of 10 minutes. That's up 137 percent since the 2007 filing season, the inspector general's office found.

"It just means their work cannot be done. There are only so many of them," said Colleen Kelley, leader of the National Treasury Employees Union, which represents IRS workers. "Those are the choices that the IRS has to make, and they'll continue to have to make as long as the IRS remains underfunded."

Similarly, the tax agency has difficulty administering some refundable tax credits. The largest, the Earned Income Tax Credit, is designed to help low- and moderate-income working individuals and families keep more of their paychecks.

But the program has been plagued by improper payments that resulted from fraud and from erroneous claims attributed to taxpayer mistakes. The IRS lacks effective procedures to determine whether applicants are eligible before payments are actually issued, George, the Treasury inspector general, warned in his March congressional testimony.

The result? The IRS found that improper Earned Income Tax Credit payments totaled between $14 billion and $17 billion in fiscal year 2011. "There's a large issue there, no question about that," Miller said.

Using screening filters and other checks, the IRS in 2010 blocked nearly $4 billion in Earned Income Tax Credit payments improperly claimed by filers, nearly double what the agency stopped in 2005, said Miller. The IRS hopes to stop even more with new rules that require tax preparers to register and complete a check sheet showing they made sure clients are eligible for the credit when filing.

Complex Tax Code

Citing an ongoing issue, Miller said the IRS — and taxpayers — face difficulty coping with the nation's complex tax code. "If it's harder for the taxpayer to fill out their return, it's harder for us to verify it," he said.

Senate Finance Committee Chairman Max Baucus, D-Mont., has set an April 26 hearing to examine tax law complexity and other hurdles taxpayers faced this filing season. "We need to make the process simpler and easier," he said.

To be sure, the IRS has produced some enforcement successes.

At a March congressional hearing, Shulman cited tax preparer registration and the ongoing crackdown on offshore tax evasion, which he said has collected more than $4.4 billion.

Additionally, the IRS is getting two new income information streams it will use to double-check some taxpayer-filed data.

Businesses that accept credit and debit cards as payment are having those gross and monthly totals reported to the IRS by banks and other settlement entities that process the transactions.

And the securities industry will report the cost basis value on stock sales.

But Congress recently repealed laws that would have required reporting of business transactions, as well as authorized government agencies to withhold 3% of their payments to contractors to cover taxes.

"We are better served where there's (tax) withholding at the source," said Miller. "That said, it's up to Congress to give us those tools."

This story first appeared in USA Today.