WASHINGTON — The Internal Revenue Service is fundamentally shifting its approach to auditing business tax returns, hoping to rapidly expand the number of businesses it audits by shrinking the time and scope of many of those tax examinations.
With corporate tax receipts at record lows, IRS Commissioner Mark W. Everson recently declared that corporate audits, which now take an average of 38 months, should be completed in less than half that time. Everson believes that by hastening the audits, the IRS will collect more taxes because more companies will fear that audits are coming. But others say faster audits will miss major tax fraud and would only embolden corporate tax cheats.
Everson said dramatic change is necessary to overcome the agency’s “scandalous” complacency in a worrisome deterioration in corporate attitudes toward paying taxes. Corporate auditors are still finishing work on tax returns from 1997, or even earlier, he said. The IRS was not even a “player” in uncovering the corporate scandals that erupted in the late 1990s because “we were not even near the year these returns were filed, which is inexcusable,” said Everson, who took control of the agency in May.
“What I’m trying to do is re-center the agency,” said Everson, who spotlighted the corporate auditing problems during his confirmation hearing in March. “Incremental progress in this area is not success. I’m looking for a real rupture in the way we do audits.”
But the architects of the new strategy say Everson has gone too far, too fast, tying the hands of the agency’s best auditors and putting too much power in the hands of potential tax cheats. By declaring that audits should take 15 to 18 months, Everson is virtually guaranteeing that IRS auditors will miss tax dodges, fail to explore suspicious transactions, or even walk away from audits that are on the verge of finding wrongdoing, said B. John Williams Jr., the recently departed IRS chief counsel.
“It’s a bad way to run a railroad,” Williams said.
Larry R. Langdon, the former chief of the IRS’s large and mid-size business division who formulated much of the new auditing approach, agreed. “At one level, I appreciate (Everson’s) energy and enthusiasm,” he said. “At another level, he needs to understand the complexity of the situation. He tends to see these things in black and white when in reality, they’re shades of gray.”
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Tax experts agree that corporate tax avoidance has become a serious problem. Corporate tax receipts — already in a long, steady decline — fell to $132 billion in the fiscal year that ended Sept. 30, the lowest since 1993, even before adjusting for inflation. Expressed as a percentage of total tax receipts or as a share of the economy, corporate tax receipts this year will be at their second-lowest level since the Great Depression. Only 1983’s receipts were lower.
In 1970, corporate tax revenue was 17 percent of the government’s tax take, before it began its long slide. This year, it will be about 7 percent of the total.
For most businesses, the IRS is simply not a factor in deciding whether to comply with the tax code, IRS officials concede. While the nation’s 1,300 largest corporations face constant IRS scrutiny, 148,000 mid-size companies face an audit rate of 4 percent, or perhaps once every 20 years.
“That’s atrocious,” Everson said.
The new audit methods are designed to give businesses with good tax compliance records far more say in what books they will show the IRS and how quickly an audit should end. That way, outgunned corporate auditors could focus on suspected cheats and recognized tax-evasion schemes.
But working auditors, tax lawyers and IRS veterans say that in the push to expand the number of audits, federal tax sleuths will be discouraged to follow the winding money trails that obscure corporate tax cheating.
“There used to be a point of no return, where when you found something wrong, you were there, and you were going to stay there,” said one corporate tax auditor, who spoke only on condition of anonymity out of fear of being fired. “There was no way they were going to get you out, and you had the power of the IRS behind you.
“Now, even if you find the adjustment, find actual fraud, management is still throwing you out of the building,” the auditor said.
Langdon said that when he devised the limited-scope audit process, he envisioned perhaps a quarter of new audits using the procedure. That would cut those audit times in half, he said, but barely dent the overall average audit time. To reach Everson’s time limit, nearly three-fourths of all corporate audits would have to use the procedure, threatening the intention of reserving the limited audits only for taxpayers with good compliance records, Langdon said.
An IRS lawyer, who also spoke on condition on anonymity, said there is already a “strong push to walk away from audits” to prepare for 2003 tax returns that IRS supervisors want to be handled according to Everson’s schedule.
“The exam people were told to clear out their inventory before 18-month cycle begins,” he said. “It’s happening now.”