IRS to Step Up Its Auditing of ’86 Tax Returns

Taxpayers celebrating Wednesday’s passing of the 1986 tax-filing deadline should not cheer too loudly: the Internal Revenue Service is getting tougher--and better--at catching tax cheaters.

After a decades-long decline, the odds of getting audited will increase significantly this year, thanks in part to additional auditors, improved return-examination techniques and changes under tax reform, IRS officials and tax experts say.

The percentage of returns to be audited in fiscal 1987 is estimated to grow to 1.47%, meaning that taxpayers have a 1 in 68 chance of getting called onto the carpet by the IRS, with higher-income taxpayers facing higher odds. That is likely to result in about 1.5 million individual tax returns being audited this fiscal year.

Last year, about 1.09 million individual returns (1.1%), believed to be an all-time low percentage, were audited. That was the culmination of a steady decline since the mid-1960s, when as many as 5% of returns were audited, IRS spokesman Wilson Fadely said.

Those unfortunate enough to be selected for an audit also face higher odds of having to cough up more tax, as the IRS has grown more effective in spotting inaccurate tax returns in need of auditing and is exacting more taxes and penalties from the examinations.

Taxpayers not being audited also face greater scrutiny. The agency continues to expand and strengthen its document-matching program, under which it cross-checks taxpayers’ reports of their income with statements from their employers, banks and others.

“People who probably used to leave out income items, figuring the IRS would never catch it, are now more cautious,� said Sidney Kess, partner in the New York office of the accounting firm of Peat, Marwick, Mitchell & Co.

This year’s heightened efforts by the IRS come as the agency has enjoyed what IRS Commissioner Lawrence B. Gibbs said is one of its best tax-filing seasons ever, judging by the speed and smoothness with which it has issued refunds for 1986 returns so far.

The efforts to crack down on cheating come as the need for such action seems at least as great as ever. Congress wants to wring additional tax revenues from the populace to ease the bloated federal budget deficit. Meanwhile, non-compliance by taxpayers appears to be growing, a reflection in part of the growing “underground� economy, where people receive cash income that they often do not report to the IRS.

Narrowing the Gap

As evidence of this growing trend, the IRS points to a widening “tax gap�--the difference between taxes owed and those voluntarily paid. The agency estimates that the gap will grow to $103 billion in 1986 from $92 billion in 1985 and $29 billion in 1973.

IRS officials point to several reasons for the increase in the percentage of audits after such a long decline:

- Congress, in passing the Tax Reform Act of 1986, gave the agency additional money to hire more auditors. IRS officials had long argued that the growth in the agency’s budget and audit staff had not kept up with the growth in the number of tax returns filed in recent years.

Under the expansion, the agency is hiring 2,500 additional auditors this fiscal year and another 2,500 in each of the next two years, a partial reflection of an increase in the IRS budget from $3.6 billion in fiscal 1986 to $4.2 billion in fiscal 1987 and a proposed $5.1 billion in fiscal 1988, IRS spokesman Fadely said.

- IRS officials expect that they will not have to devote as many resources in coming years to tracking down abusive tax shelters. Such an effort has consumed a good share of the agency’s resources in recent years. But tax reform, by lowering individual tax rates and reducing tax breaks for certain shelters, lessens the desirability of shelters. That, Fadely said, will allow the agency to focus more on auditing ordinary tax returns.

- The IRS has developed more effective computer formulas to determine which returns should be audited. As a result, taxpayers selected for auditing face a higher chance of having to pay additional taxes.

Recovery Increasing

About 7 in 10 taxpayers audited in fiscal 1986 were assessed extra tax and penalties, up from about 6 in 10 six years ago. And, even though it has conducted fewer audits in recent years, the amount of tax garnered from them has steadily increased. The agency recovered $5.7 billion in tax and penalties as a result of audits in fiscal 1986, up from $4.9 billion in fiscal 1985 and $2.9 billion in 1982.

“They know better who they should audit,� said David J. Silverman, president of a tax consulting firm in New York bearing his name.

Further refinements in the formulas for selecting returns to be audited will come from a series of extremely detailed special audits under the IRS’ Taxpayer Compliance Measurement Program.

Under these audits, conducted every three years, the agency will thoroughly examine 50,000 returns for 1985, chosen at random, looking for patterns in taxpayer compliance. Agents conducting such reviews demand to see every detail of documentation, even including birth certificates of dependent children.

Meanwhile, the IRS continues to expand its document-matching program. Not only are more types of income being covered by such matching, but more returns. Increased computer capabilities have allowed the agency to apply the program to an increasing percentage of returns.

Cross-Checking Methods

The best-known examples of such methods involve cross-checking taxpayers’ income statements against wage information supplied by employers and interest and dividend data provided by financial institutions. In recent years, the agency has added ways to cross-check taxpayers’ income from sales of securities, bartering activity, tips and alimony, to name a few.

One of the latest requirements will cover income from sales of homes. The government estimated that it was losing $700 million a year because many people who sell their homes never report the profits as taxable income. But now, anyone selling a home after Dec. 31, 1986, is required to file a report with the IRS. The IRS will match the form against the seller’s tax return to determine if any taxable profit from the sale was reported as income.

The agency also is adding methods to check income from royalties, awards of federal contracts, and income for Americans living abroad or resident aliens working in this country.

The payoff from this cross-checking has been well worth the added cost, IRS officials said. The net revenue, after subtracting the cost of running the program, totaled $2.35 billion in fiscal 1985, up from only about $695 million in fiscal 1982. About 4.1 million returns were culled for reporting errors detected by document-matching in 1985, up from 1.2 million in fiscal 1982, IRS spokesman Fadely said.

Tax preparers, accountants and other experts generally agree that the IRS’ new efforts at auditing and document-matching are effective and are forcing taxpayers to be more precise in their returns, making sure that they have documentation to support their deductions.

‘Cautioning Clients’

“Tax preparers are more on guard� because of the IRS’ beefed-up document-matching efforts, Los Angeles accountant Irwin Pomerantz said. “We are cautioning clients not to miss anything.�

But the IRS’ methods are not perfect, experts said.

Some accountants wonder whether the new auditors will be adequately trained. They note a recent General Accounting Office study showing that IRS staff members provided wrong answers to 22% of inquiries from taxpayers calling its toll-free help lines.

“It’s not just hiring more bodies that’s important. . . . You need an intensive and continuous training program,� said accountant Kess of Peat, Marwick, Mitchell & Co.

“Because of an auditor’s ineptness, my client got away with exaggerated deductions,� one Los Angeles accountant said. Meanwhile, Kess said, sharper auditors are being hired away by private firms often willing to pay double the IRS’ salaries--or more.

Accountants add that document-matching has its flaws too. It is subject to computer error and also still cannot detect many cash transactions, Kess said. And, he added, more scrutiny could lead to more people insisting on cash payments.

“A lot of people today insist on getting cash,� Kess said. “You call a plumber and he won’t do the work unless you pay him in cash.�