|Press Release: TRAC Sues IRS|
When it comes to audits, the large corporations providing the American people with investment advice, various kinds of banking and credit services and insurance are subject to a lot less scrutiny by the IRS than corporations in other lines of business.
The sharply varied corporate audit rates -- depending on the broad nature of the business activities -- are documented in three years of IRS data obtained and analyzed by the Transactional Records Access Clearinghouse (TRAC). In all cases the corporations studied had assets of $250 million or more. Here are the highlights:
On an annual basis, less than one in five of the large corporations falling into the IRS's financial services category were audited during FY 2002, 2003 and 2004 (affected industries).
For the big communication, technology and media corporations, more than three out of five were audited (affected industries).
When it came to the very large businesses in the retailing, food, pharmaceuticals and health care businesses, four out of five faced IRS audits (affected industries).
But for those corporations engaged in either agriculture, mining, and construction (affected industries) or in heavy manufacturing and transportation (affected industries), the audit burden was even heavier, 100 percent.
See Figure 1 and supporting table.
Considered together, for all the corporations with assets at or above $250 million, about one out of three were audited.
The corporations subjected to this diverse treatment by the IRS are an extremely small but powerful part of the economy. During a recent filing period, the 10,989 returns they sent to the agency represented only a fraction of all corporate filings -- 0.2% of the total. Despite their small numbers, however, these organizations controlled 90% of all corporate assets and received 87% of all the corporate income. [See Figure 2.]
The very low attention being given to the financial sector by the IRS is particularly surprising in light of the leading role this industry plays in the country's economy, including the level of income subject to federal corporate income taxes. A comparison of the economic activity carried out by these large corporations by most any measure shows that the financial sector is at the top or close to the top. For example, measured by the total dollars of receipts or by net income after expenses, the financial sector ranks number one or two against other major economic sectors, according to data from the IRS' own analyses. (See Figure 3 and Figure 4, and supporting table.)
In regard to the corporations categorized as belonging in the financial services sector, another insight about their power emerges from information collected by the Center for Responsive Politics (CRP). It indicates that in comparison to other segments, financial services corporations are among the most generous when it comes to making political contributions. Although the CRP's tables cover the donations of political campaign committees and individuals associated with corporations of any size, and not just the giants, among the most generous donors identified by the center in the 2003/2004 election cycle were Goldman Sachs, Morgan Stanley, J.P. Morgan Chase & Co., Citigroup and Bank of America.
How Can the Varied Audit Rates Be Explained?
The reasons for the sharp differential in IRS audit rates are not obvious, even to experts in the field.
Sheldon Cohen, a former IRS commissioner, offered one explanation. "It would seem clear that the IRS has not kept up with the economy," he said in an interview. "I guess the different rates don't really surprise me," he added, " although they don't make any sense."
Charles Rossotti, another former commissioner, said that in his view the different audit rates were not a matter of concern. "Off the top of my head I don't think this means anything because the banking field is so concentrated. The question is what percentage of the ten or fifteen of the very largest banks are being audited. That's really all I have to say." Although the IRS does not publish audit rates for the giant corporations -- those with assets of $2.5 billion or more -- other available information indicates that audit rates for the finance sector corporations of this gigantic size are substantially lower than the rates for companies one-tenth this size in other industry sectors. See table.
Stanley I. Langbein, a leading expert on taxation of the financial services industry and a law professor at the University of Miami, said "you have to think that the IRS would if anything audit this area more heavily than the others." He added, however, that like Cohen he was not entirely surprised. "During the last five or six years there is anecdotal evidence that this has been an area of neglect."
But Larry Langdon, a former top IRS administrator who was the first commissioner of the Large and Mid-Size Business (LMSB) Division during the Clinton Administration, had a somewhat different view. "I am surprised by the 15% rate for the financial services corporations," he said in a telephone interview. Langdon, who was responsible for establishing the division's basic structure and the distribution of auditors to its five components, did not fault the organization, emphasizing instead the problem of staff shortages. "We asked for more resources that frankly we didn't get."
The IRS did not respond to written questions concerning the evidence that the expert auditors required for the examination of large corporations had not been properly allocated to the five industry components.
In setting up the LMSB Division, the data show the IRS decided to create five roughly similar-sized staffs for each of the five industry sectors. As a result, the sectors that have fewer companies in them are audited a lot more, and those with more companies get audited a lot less. In fact, the smallest sectors -- natural resources/construction and heavy manufacturing and transport -- are the ones with the highest audit rates. And the sector with the most corporations, financial services, has the lowest audit rates. (See Figure 5 and supporting table.)
While the IRS over the years has undertaken a number of special studies aimed at tracking the compliance levels of taxpayers with various incomes, it has not undertaken such research in relation to major corporate industry groups. Therefore, the possibility that the different audit rates are based on any sort of research showing that one of the sectors is more or less law abiding than the others can be ruled out.
This rate has been in general decline for many years. (See Figure 6 and supporting table.) Just in the last year it dropped an additional 11 percent. A decade ago the corporate audit rate was three times higher than it was last year.
Several other business enforcement activities of the IRS also have continued their downward spiral. Among them:
Audit rates for so-called pass-through entities have continued to slide, dropping 30 percent in just the past year. (See Figure 7 and supporting table.) These partnerships and S-corporations continue to be in the news because of their improper use of tax shelter mechanisms. While the IRS has said that cracking down on improper tax shelters is a top priority, the numbers suggest IRS actions may not have kept pace with the agency's rhetoric.
Further, when corporate misdeeds rise to the level of negligence or even civil fraud, few get punished. While this has always been the tendency the numbers today are much lower than in the past. In fact, in FY 2004, civil penalties were assessed against only 132 corporations for tax fraud. And negligence penalties were assessed against only 25 corporations out of the roughly 2.5 million corporations. (See Figure 8 and supporting table.)
Trends in Large Corporation Audits. While the overall audit rate for corporations has continued to decline, the FY 2004 rates for the larger corporate returns with assets of $10 million or more increased for the first time in many years. Still the FY 2004 rates for these are only a fraction of what they were a decade ago. (See table.)
The reality behind this very recent increase in the audits of larger corporations is not clear, partly because the IRS currently is withholding essential data. Because the IRS has refused to make public supporting details to back up Commissioner Everson's official statements or to provide other material about a wide range of other IRS enforcement activities, fully documenting what the agency is doing, and not doing, has become more and more difficult. The agency's current closed-door policy reverses information practices that have been generally followed for the last three decades. In a series of requests under the Freedom of information Act, TRAC is challenging the withholding. [See sidebar, "Dangers Posed by IRS Secrecy".]
Here is one concrete example of how the absence of data makes oversight by the American people and congress a challenge. For more than 30 years, the IRS has made public information on the actual number of audits for dozens of classes of taxpayers, including breakdowns for corporations according to their total assets. The IRS also made public figures on the audit hours spent for each of these groups by the agent's "grade" -- reflecting the expertise and experience of the auditor. With the availability of both measures a judgment was possible about the actual thoroughness of the audits. If, for example, the data show that the number of audits has gone up but total audits hours have declined, the actual impact of the agency's enforcement activities may be less than suggested by a simple increase in the audit counts. But IRS has refused to release this information. Without it, the significance of claims that corporate audits are up cannot begin to be judged
In connection with the auditors working in the Large and Midsize Business Division, B. John Williams Jr., a former chief counsel of the IRS, has expressed concern about the possibly counter-productive pressures that can develop. In an article in Tax Notes (October 21, 2003), a leading trade publication, Williams was quoted as saying that the IRS is generally attuned to giving the commissioner what he or she wants. "The problem," he said, "is that people need to think about what it's going to cost to get there." The article paraphrased him saying, "... [S]wamped agents will start bailing water and throwing things overboard to lighten the ship ... And issues will get tossed overboard."
Other IRS Responses
In an apparent attempt to counter the impact that these various declines may have on public attitudes towards paying their taxes, IRS Commissioner Everson has emphasized the agency's achievements in single high-profile cases. In late March, for example, Everson announced that the IRS had collected $3.2 billion in taxes and penalties from participants in one abusive tax shelter plan known as Son of Boss. Tax experts like former IRS Commissioner Sheldon Cohen have expressed skepticism about the importance of single cases.
Mr. Everson also has given numerous speeches in the last few months boasting about the agency's aggressive enforcement efforts. Appearing before the National Press Club on March 15, 2005 for example, he said the IRS's first priority was "to discourage and deter non-compliance, with emphasis on corrosive activity by corporations, high-income individuals and other contributors to the tax gap."
The commissioner also emphasized the tax shelter issue and sought to support his claims regarding the newly energized IRS enforcement program by citing data in a way that left at least as many questions as they answered.
Trends in High Income Individual Audits. Everson told the March 15 press club audience that the audits of high-income taxpayers had "jumped 40 percent from the year before." And his claim was true, providing the agency's less intrusive "correspondence audits" were included in the calculation.
The picture is dramatically different, however, when the correspondence audits are subtracted and the rates for the wealthier taxpayers are examined in terms of the face-to-face audits so vital to identifying those individuals who have systematically sought to hide parts of their income from the government. For examinations that go beyond cursory correspondence programs, the audit rate for upper income taxpayers is in fact at the lowest point it has been in the last decade. Ten years ago the rate was fully five times higher. Last year alone face-to-face audits fell over 12 percent. Last year, out of every 1,000 high income taxpayers only between three and four actually faced a regular audit.
Other information from the Justice Department goes to the question of whom the IRS is targeting. According to data the department has recently started to collect, in FY 2004 there only were 263 federal convictions for corporate fraud in the entire United States. The investigations leading to these convictions were conducted by many agencies including the IRS, the FBI, the Securities Exchange Commission, and the Postal Service. According to the prosecutors bringing these cases, however, only 28 of the total corporate fraud convictions were attributed to the IRS. (See Figure 12.)
Ways and Means
For more than a year, Commissioner Everson has assured numerous audiences that the funding requests by the Bush Administration are adequate to meet all the administrative and enforcement demands of the federal tax system. This was true even though individual taxpayers today are filing 26% more returns than they did in 1988.
"While we have made progress over the past years, there is much to be done," he said in his March 15 speech to the press club. "And we will continue to do it. " The administration, he explained, had just called for a 4.3% increase in IRS funding in the 2006 year budget with nearly an 8% increase in enforcement spending.
Impressive though this increase may sound, Everson failed to inform his audience that the non-partisan IRS Oversight Board had already advised him and Treasury Secretary Snow, his boss, that the request was inadequate.
"Enforcement activities are still at an unacceptable level simply because the IRS does not have the resources needed to accomplish its mission," said Board Chairman Raymond T. Wagner. He then noted that, because of a series of budget decisions by the White House and Congress during the last decade, staffing for the enforcement and collection arms of the IRS had declined by more than a third since FY 1996. The key problem, Wagner said, was this. Although small annual increases in the IRS budget have been requested, this additional funding has not been sufficient even to maintain the current level of staffing because the increases have been devoured by a range of unfunded expenses such as congressionally-mandated pay raises, inflation and rent boosts.
As a result, although the number of individual tax returns has climbed by about 16 million since 1995, the IRS staff has substantially declined. The number of IRS employees in FY 2004 was around 95,000. Ten years ago it was about 110,000. The recent data suggest the situation may be stabilizing. See Figure 13 and supporting tables for individual return filings and IRS staff.
However, the mix of returns is changing. Returns of pass-through entities continue to increase. According to IRS published figures, both partnership and S-corporation filings were up over 5 percent last year.
Adam Smith, the great eighteenth-century economist, considered the fair collection of taxes essential. "The tax that each individual is bound to pay ought to be certain, and not arbitrary," he wrote. "The time of payment, the manner of payment, the quantity paid, ought to be clear and plain to the contributor and every other person, so the taxpayer is not put in the power of the tax gatherer." While making sure that a large agency like the IRS is achieving, or even trying to achieve, the objectives laid out by the plain-spoken Scotch economist is difficult, it also is critical to the well-being of the United States. Smith's words made good sense then and they make even more sense today.