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As thousands of taxpayers rush to the post office to pay Uncle Sam by midnight, thousands of their fellow Americans are content to stay home and not pay taxes at all.

And the IRS can't do much about it.

Indeed, with 12 percent of Americans saying it's OK to cheat on taxes and the “tax gap'' — the amount of taxes owed but not paid each year — ballooning to as much as $353 billion, the IRS has fewer tax cops than a decade ago and a lower overall audit rate, less than 1 percent, than at that time.

Critics call the tax gap a “surtax” on honest taxpayers worth $2,695 per return. That's $353 billion in uncollected taxes divided by the 131 million individual tax returns filed last year.

Put another way, that $353 billion could pay the costs of Medicaid for one year. Or nearly make up the $390 billion federal budget deficit projected for fiscal 2006. Or put a big dent in the Defense Department's $417 billion bill this year.

So why isn't the IRS cracking down more on tax scofflaws? Because, for one thing, the IRS is smaller and spread more thinly than it used to be.

IRS Commissioner Mark Everson insisted recently that the agency is starting to make a comeback after congressional hearings into alleged IRS abuses led to plummeting audits and collections. Congress restructured the agency in 1998, significantly reducing its size. But while the IRS has been rebuilding, it still has a long way to go.

Consider:

• The IRS enforcement staff — revenue agents, auditors and collectors — dropped from 25,000 in 1996 to 16,000 by 2003.

• The IRS audits topped 1 million last year for the first time in five years — but that's still only half the audits it conducted in 1996.

• The IRS had 111,000 employees to handle 116 million returns in 1996. Last year there were 131 million returns filed, but only 99,000 employees.

“There aren't enough IRS employees,” said Colleen Kelley, president of the National Treasury Employees Union, which represents most IRS workers. “The agency needs to be given the funding to do its job and close the tax gap.”

It's not just the union calling for a beefed up IRS. The IRS Oversight Board, appointed by President Bush and headed by Ray Wagner, a former Missouri Department of Revenue director, came to the same conclusion last month in its 2006 IRS budget recommendations.

“The IRS is currently trying to rebalance itself between enforcement and customer service,” he said.

His panel advocated bolstering the IRS as the revenue-producing arm of government it is, not just another agency competing for limited tax dollars.

Everson made that same point in a speech to the National Press Club in March, when he said IRS tax enforcers produced $43 billion in revenue — more than four times the agency's $10 billion budget. Audits of high-income taxpayers more than doubled between 2001 and 2004, he said. Corporation audits also are up.

However, measured against the total number of returns filed, the IRS's overall audit rate remains on the decline, according to the Transactional Records Access Clearing-ghouse (TRAC), a nonprofit research office at Syracuse University that analyzes IRS data. If audits of low-income taxpayers, known as correspondence audits, are included, the audit rate is up only slightly since 2000, TRAC said.

In the meantime, the tax gap is growing, now representing about 16 percent of federal income taxes owed each year. And that's just legal income.

The IRS doesn't even try to estimate taxes due on illegal activity. That level of compliance is slightly worse than in 1988, the last time the IRS measured the gap.

So who isn't paying their taxes?

The biggest culprits, the IRS says, are small-business owners and other self-employed persons. As a group, the self-employed pay only about 36 percent of the taxes they owe, the government estimates.

Unreported and underreported business income on individual income-tax returns accounts for as much as $99 billion of the tax gap, the agency estimates, based on an audit of 46,000 individual tax returns in 2001.

“There's a ton of money out there that's going unreported,” says Gary Rohrs, an Independence tax accountant and chairman of the IRS Service Advisory Council.

New businesses and those that are struggling are most likely to get into tax troubles, Rohrs and other accountants said.

In tough economic times, business owners may be tempted to pay bills rather than send in payroll taxes withheld from employees, Rohrs said. The IRS levies a hefty 25 percent fine for failing to pay those taxes. Faced with mounting tax debt, the business owner may decide simply to not file a return, Rohrs and other accountants said.

“We get people in here who every year who haven't filed a tax return in 12 or 15 years,” said Peter Newman, a CPA and host of KMBZ radio's “Moneyline” show. “People say, I got behind one year and I got worried the IRS was going to put me in jail.”

Newman, like many tax professionals, blames a big part of the tax gap on the complexity of the U.S. Tax Code — 18,500 pages long and counting. “There are some people who've just said, ‘I give up,' ” he said.

The cash economy also plays a big role, tax professionals said, such as the handyman who gives you a lower price if you pay in cash and a higher one if you pay by check.

“That money just goes out the door and never gets collected,” Rohrs said. “They're openly evading taxes. … Everybody seems to feel it's OK to pay in cash. Well, why would you help somebody not pay their taxes? You're having to pick up for what he doesn't pay.”

High tax rates also breed tax dodgers, said Dan Mitchell, a senior tax researcher at the Heritage Foundation. It's a cost-benefit analysis, especially if you're a small-business entrepreneur and the government's going to take half your money if you fully comply,” Mitchell argued. “Of course they're going to try to cheat.”

Lower tax rates have been shown to increase compliance, even without tax simplification, he noted.

The public's sense of whether taxation is fairly applied also plays a role in compliance, said John O. Fox, who teaches tax policy at Mount Holyoke College and has written two books on the subject.

“It's the exception rather than the rule that two households of the same size and income pay the same taxes,” Fox said.

But Wagner credits the IRS with some recent improvements, citing an annual taxpayer attitudes survey his board conducts.

In the national survey, the number of Americans who think it's all right to cheat on their taxes “a little here or there” or even “as much as possible” held steady at about 12 percent from 1999 to 2002. In 2003, it spiked to 17 percent.

“One in five taxpayers now believes that it's acceptable to cheat on their taxes,” the board wrote in its 2004 report. “Their ranks are growing, especially among younger taxpayers.”

In last year's survey, however, the number shrank to pre-2003 levels.

“I really do think that has a therapeutic effect on people's willingness to pay all the taxes that they owe,” Wagner said.

Meanwhile, Everson, the IRS commissioner, has said the agency is making great strides, such as improving its telephone service. More than half of all individual returns will be e-filed this year. And the IRS Web site is becoming popular, surpassed recently only by Web pages of celebrities such as Paris Hilton, Clay Aiken, Pamela Anderson, Britney Spears and a poker game.

The tax agency's new mantra, Everson said, is “service plus enforcement equals compliance.”

But if you're one of those tax scofflaws, you'll probably want to avoid the IRS's enforcement side, advised Robert McQuain, a Kansas City tax attorney.

Once the agency has you in its sights, you're in trouble, McQuain said. The IRS can take your house, your car, your bank account and most of your paycheck — all without ever asking a judge.

“No other creditor in the world can do that,” he pointed out.

The IRS also has 10 years to collect its debt from you. After 8½ years, he said, it will begin its final push, garnisheeing your wages and leaving you as little as $254 a week.

“In terms of a creditor, they are the toughest there is,” he said.

by Gregory S. Reeves, (816) 234-4366 or greeves@kcstar.com.
The Kansas City Star www.kansascity.com
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