IRS Returns to Tougher Stance on Tax Cheats

The federal government is making it tougher for Americans to get away with cheating on their taxes.

The Internal Revenue Service’s announcement last week that it is stepping up efforts to nab taxpayers who hide income in offshore accounts is the latest move to turn up the heat on tax cheats. A surge in hiring at the IRS, better technology, stricter sentencing guidelines, a pledge to reverse the decline in audit rates and a wave of patriotism that may be pushing judges to impose stiffer penalties make tax fraud increasingly risky, experts say.

“[IRS officials] are putting more resources into audits. They are getting agents back and hiring new agents,” said Philadelphia attorney Ian M. Comisky, co-author of the legal guide “Tax Fraud & Evasion.” “They are going to up the audit rate this year for the first time in years and they are working on a project to figure out who to audit.

“There is never a good year to be a tax cheat, but this is a worse year than in the past.”

That hasn’t always been the case. Audits are at historically low levels, with less than one-half of 1% of individual taxpayers coming under IRS scrutiny. On the criminal tax fraud front, investigations initiated, indictments and convictions dropped during the last three months of 2001. But these numbers don’t tell the whole story.

Experts acknowledge that taxpayers who simply fudge on a deduction or two are highly unlikely to attract IRS scrutiny. But those who fail to pay taxes at all, hide income in offshore havens or create bogus trusts or businesses to avoid federal taxation increasingly are targeted for prosecution, said Charles P. Rettig, partner with Beverly Hills law firm Hochman, Salkin, Rettig, Toscher & Perez.

“People might be tempted to play the audit lottery because the stated audit rates are very low,” said Rettig, who represents taxpayers in trouble. “But the numbers are distorted. The audit rate isn’t that low for people who have reason to be audited,” such as self-employed people who operate cash-intensive businesses, or those who try to “untax” themselves under the guise of a debunked theory about income from wages being exempt from U.S. taxation.

At the same time that it’s taking a harder stance on serious tax fraud, the IRS is ratcheting up its search for the more mundane forms of tax cheating.

Last month, IRS Commissioner Charles O. Rossotti told Congress that the agency plans to boost the national audit rate because of a funding increase that has allowed the IRS to hire hundreds of new auditors and collection agents. Congress, which only four years ago forced the agency into a “kinder, gentler” era after critical hearings about IRS abuses and passage of a bill of rights for taxpayers, now is supportive of the agency’s renewed efforts to crack down on cheats.

“At our hearing last year, the IRS promised to crack down on tax cheats. I’m glad to see the IRS following up so aggressively,” said Sen. Charles Grassley (R-Iowa), ranking minority member of the Senate Finance Committee. “Since tax cheats are endlessly creative, the IRS has to be just as creative to catch the crooks.”

Grassley’s committee will hold a hearing on tax schemes and scams next month to gauge the IRS’ progress in pursuing tax cheats over the last year.

The reason for this renewed emphasis on taxpayer compliance? Officials believe tax cheating has soared and is causing the loss of about $200 billion in revenue each year. Moreover, as news has gotten out about the declining audit rate, government officials have become increasingly concerned that normally honest citizens will be tempted to cheat.

“We have to deter the small percentage of people who would cheat to convince the rest of the community at-large that they are not a chump for paying their fair share,” said Mark Matthews, chief of the IRS’ criminal investigation division.

Pendulum Has Swung Back to More Audits

The shift toward a more aggressive IRS doesn’t show up in recent statistics for several reasons. The latest figures for prosecutions and other actions are for the IRS’ fiscal first quarter, October through December of last year. During that time, hundreds of agents were diverted to serve as air marshals and to investigate the financial side of terrorism after the Sept. 11 attacks, Matthews said.

But the agents are wrapping up their terrorism-related work and are pouring back into IRS offices. At the same time, he said, the IRS has been hiring and training hundreds of new agents.

“The pendulum is now in the process of swinging back,” said Elliott H. Kajan, principal with Beverly Hills tax firm Kajan, Mather & Barish. “There will be more examinations, more audits; there will be more civil, if not criminal, penalties.”

Internal changes at the IRS are having an effect as well. The agency gradually has been replacing outdated computer systems and adding income-matching software, which makes it easier for the IRS to identify taxpayers who fail to report income.

The agency also is trying to root out taxpayers who use offshore bank accounts to hide income. These accounts long have been favored by tax cheaters because foreign banks are unwilling to share their records with U.S. tax authorities.

Holders of offshore accounts often use credit cards to access their cash, however, and the IRS has been gathering records from major credit card companies to identify them.

Last week, American Express Inc. said it would join MasterCard International Inc. in supplying information to the IRS, and the Justice Department has requested records from Visa International, the largest issuer of credit cards.

The IRS is beginning to see results from its move several years ago to a “specialist” system designed to give auditors an area of expertise. The agency’s auditors now are far more effective at quickly rooting out cheating, Rettig said.

“The agents focus in a hurry. They ask the right questions. They have a lot of tools to get information from third parties,” Rettig said. “And, I’ll tell you, they hit home run after home run. It’s frightening.”

Sentencing Guidelines Have Been Revamped

The conviction rate for tax-related crimes, already high, has been going higher--to 93% last year from 91% in 1999.

In addition, sentencing guidelines for tax cheats were revamped late last year. For example, the mandatory sentence for someone who had evaded $200,000 in taxes was increased to 27 to 33 months from 21 to 27 months, tax fraud expert Comisky said.

Those tougher sentencing guidelines should continue the recent trend of rising prison terms for tax cheats--which have grown from an average of 18 months in 1998 to about 25 months this year. And Matthews of the IRS said sentences being handed down today are for crimes committed two or three years ago, when the sentencing guidelines called for shorter prison terms. The average term probably will increase as tax cheats are sentenced under the new guidelines, he said.

Some think the wave of patriotism that followed last fall’s terrorist attacks may be spurring judges to impose prison terms at the higher end of the sentencing guidelines.

“The idea of being one country and doing the right thing against self-interest has certainly been the tone since Sept. 11,” Rettig said. “There are judges who believe that reporting your income and paying the right amount of taxes is a patriotic act. Somebody who plays loose with the rules certainly pays the price when they end up before those judges.”

At a recent sentencing hearing in federal court in Sacramento, U.S. District Judge Frank C. Damrell Jr. lectured Richard Pfeiffer, a 67-year-old Northern California orthodontist, about “the obligations of citizenship.”

“It’s too bad that the widow of the Special Forces soldier who was cut down ... can’t sit here and listen to you talk about avoiding your taxes,” Damrell said as he sentenced Pfeiffer to 27 months in prison for concealing taxable income in a series of offshore accounts. “That young person gave up his young life to protect you

Whether heightened enforcement and tougher sentencing lead to a noticeable increase in taxpayer compliance remains to be seen, of course. But officials are convinced they’re already having an impact.

“It used to be that going to jail for a tax crime was the exception,” said Edward M. Robbins Jr., assistant U.S. attorney in the Justice Department’s tax division in Los Angeles. “These days, the rule is that you go to jail.”