The IRS called the complicated tax plans offered by international accounting and law firms to their wealthy clients in the late 1990s and early 2000s "tax shelters". The IRS shut down that type of planning through aggressive enforcement and a revamping of the requirements for written tax advice. Since those "tax shelters" are long gone, it is disturbing that in March of 2016, IRS Commissioner Koskinen has admitted defeat to a $5 billion a year tax revenue loss. CPAs and tax lawyers all around the country know why. Unprecedented numbers of taxpayers and a small group of unscrupulous "tax practitioners" have taken advantage of the perception of an almost complete absence of tax enforcement by the IRS.
Everyday ordinary average taxpayers know one thing - no-one is minding the store. What happens when the IRS is not there to keep taxpayers in line? The answer is simple - human nature takes over. What begins as just a little fudging on a tax return turns into much more aggressive behavior when folks think they can get away with it. How many times have you seen the driver in front of you run the "yellow" traffic light when there is no red light camera. On the other hand, how many times have you seen the driver in front of you slam on the brakes when the light first changes from green to yellow when there is a red light camera.
Non-compliance can be placed into four categories:
First, the “everybody does it” group of folks. his group always manages to decrease income (even entire sources) and increase deductions. The methods are limitless but the "tax reduction" effect is the same.
Second, taxpayers who implement a tax plan that appears legitimate but won't stand up to modern scrutiny. These are so damaging because the taxpayers who engage in this planning have no clue and no reason to know that the planning is defective. When the IRS and the courts apply a “too good to be true” test to these plans, which appear 100% legitimate to the taxpayer, the result is the imposition. Penalties are not appropriate for this group of taxpayers fooled by the dishonest "tax professional" charlatans.
Third, the group of people who just can't figure out how to correctly comply. This group simply can't get it right despite their best good faith efforts. Unfortunately, this group can and does get so frustrated that some throw up their hands and give up on trying to get it right.
Fourth, organized criminals attacking IRS systems with false refund claims. These criminals believe, incorrectly in some cases, that criminal sentences are less than other types of non-white-collar criminal violations. Also, the aggrieved parties of ID theft are less likely to respond with gunfire than other aggrieved parties in a non-white-collar criminal context.
How did we get here? The answer is the predictable result of constant IRS criticism that members of Congress have reacted to with annual IRS budget cuts. On the bright side, the IRS has been quite ingenious in continuing civil examinations and criminal investigations on a shoestring budget. For example, the IRS can now identify a missed employment tax deposit within 48-72 hours. Also, the IRS is working on an algorithm to identify if a specific tax violator will respond to merely a letter, a call or needs the personal touch of a visit from an IRS employee.
Unfortunately, IRS is failing ordinary taxpayers constantly by failing to retain and replace qualified individuals who do make the system work. Would you rather have an agent who knows within half a day that the potential multi-million dollar adjustment is not appropriate or would you instead want to spend half a year on it only to have to elevate the exam to IRS Counsel or IRS Appeals for resolution?
Errors resolved in days or weeks in the good old days now can easily take months. Examiners are stretched thin and communication can be a challenge as the time of qualified examiners is being competed for within the IRS. Appeals Officers are fewer in number and are under pressure to close cases. The lack of walk-in Taxpayer Assistance Centers is terribly damaging to low income taxpayers. Taxpayers without representation are fortunate if they can have a problem solved. Otherwise, these types of problems literally ruin fragile financial lives. Even taxpayers who are well represented are still not guaranteed a timely and fair resolution.
Taxpayers deserve a fully funded IRS. Continuing at the current pace is perilous. Honest taxpayers are very frustrated with the lack of service. Even worse, a growing group of taxpayers are slowly giving into temptation while no one is watching the store. The IRS is addressing tax non-compliance with less and less agents. The not unanticipated result is that too many taxpayers are taking a chance and successfully playing the "audit lottery". Will we look back one day and note that Commissioner Koskinen wasn't crying wolf but actually underestimated the lost revenue when it exceeds $5 billion per year? Perception becomes reality. The perception is that the IRS is losing the ability to do its job thanks to congressional budget cuts. The real losers are all of us as the hordes of non-compliant taxpayers continue to grow.