VideoSince taking the helm at the Internal Revenue Service in 2003, commissioner Mark Everson has been threatening to crack down on tax cheats by aiming the agency's biggest guns at large corporate taxpayers and rich individuals.
Now Everson's tough stance is beginning to show results.
The IRS audited one in five of the largest corporate taxpayers — those with assets of more than $10 million — in 2005, twice the rate of 2002. The agency's audits are now faster, more timely, and more targeted. So-called additional recommended taxes — those taxes added after a corporate audit — climbed to $32.2 billion in 2005, the agency says, double the amount posted in 2004. Enforcement revenue from audits of corporations and individuals soared to $17.7 billion in 2005 from $10.7 billion in 2003, reflecting the agency's tough stance on abusive tax shelters. Some 1.2 million individual income-tax returns were audited in the fiscal year ended September 30, up 20 percent over the previous year. All in all, IRS collections from heightened enforcement efforts rose to a record $47.3 billion, up 10 percent from a record $43.1 billion in 2004. Everson says his agency is making progress at closing the $300 billion net tax gap, the shortfall between taxes owed by individuals and corporations and taxes paid. Five years ago, the gap was $350 billion.
Enforcement is likely to intensify even more this year. The IRS budget for 2006 is $10.7 billion, of which $4.7 billion will go to enforcement efforts, an increase of about 7.8 percent over 2005. The IRS may be taking a page from the playbook of state tax authorities, who themselves have emphasized strict enforcement because raising tax rates is so politically difficult. Everson says he is pleased at the success of the crackdown because it ultimately strengthens taxpayer confidence in the overall fairness of the system. "Nobody wants to feel that you can get away with something if you're rich or a big corporation," he says.
Combating abusive tax shelters will remain a top priority for the IRS in 2006, says Everson. The agency's settlement initiatives have been remarkably effective over the past two years. Since 2004, the agency has taken in $5.5 billion under a variety of programs that require full payment of taxes and reduced penalties. Still, Everson says his agency will be watchful of new tax-shelter schemes. "If equity valuations improve and people have big incentives to reduce taxable earnings, there will be more attempts by attorneys and accountants to create these deals," he says. "They'll be different, but we won't let our guard down." In 2006, Everson says, the agency also will focus on illegal uses of tax-exempt bonds and trusts, questionable transfer-pricing practices, offshore accounts, and nontangible charitable donations.
More Backup
The IRS says it made progress this year toward resolving two of the biggest complaints made by corporate taxpayers: that audits were slow and, as a result, costly. For those in the Coordinated Industry Case program (large companies with a team of agents on-site conducting continual audits), the average length of time the team took to complete an audit dropped to 29 months in 2005 from 37 months in 2003. For companies assigned a single agent to oversee filings, called Industry Case companies, the average length of time dropped to 13 months in 2005 from 16 months in 2003.
Enforcement agents are focusing on more-recent tax returns as well. For large companies undergoing continual audit, the IRS says 71 percent of its 2005 audits involved returns filed within the last two tax years — 2003 and 2004. That's up from 63 percent of its 2004 audits. Taxpayers need "to know sooner rather than later if their tax position is consistent with our interpretation of the law," says Deborah Nolan, commissioner of the IRS Large and Medium-Size Business (LMSB) Division.
Corporate tax executives are beginning to see evidence of the agency's new emphasis on speed and efficiency in audits. "There's a real increased pressure to produce documents faster...[and] a much greater sense of urgency from our team leader," says Mike Tilton, vice president of tax at Best Buy Co., the consumer-electronics retailer based in Richfield, Minnesota. Nicholas Anthony, vice president and general tax counsel for American Standard Cos., concurs. "Our auditors are asking us to provide more-detailed backup to support positions we've taken," he says. American Standard, a $10 billion manufacturer of household and automotive products, also has IRS auditors continually posted at its headquarters in Piscataway, New Jersey.
In a recent survey by CFO, 43 percent of the 117 respondents said they think the IRS is more aggressive in enforcement than it was three years ago. Although not a majority, this reflects a growing consensus among executives of small and midsize businesses, those with revenues of up to $500 million. Twenty-nine percent said that the IRS's enforcement efforts are costing them more in federal taxes. Only 25 percent of respondents have adopted more-conservative tax strategies during that time as a result, though, and, of those, most said the biggest factor was stricter corporate governance in the wake of scandals such as Enron and Computer Associates. In any case, CFOs are watching the agency's efforts with a new wariness. "It hasn't changed much of what we're doing," says Bruce Sedlock, tax director for Allegheny Energy Inc., an electric utility in Greensburg, Pennsylvania. "We're just doing it in a more structured manner."
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