The matter of the “tax gap” (i.e., the difference between what is owed, and what is paid) has gotten a lot of attention lately. This past week, six public accounting firms weighed in on the tax gap, and their recommendations included trying to learn more about the reasons for noncompliance in certain areas. (BNA Daily Tax Report Subscribers can find this story in the June 8 issue.) The IRS is already on the case, however. In a News Release issued earlier this past week, the Service announced that it would be selecting 13,000 2006 individual income tax returns for audit in a special program. The purpose of these audits is to focus on areas of the tax return that are not otherwise subject to verification by third parties.
Though we have a tax system that is nominally based on voluntary compliance, the government uses the Ronald Reagan approach whenever possible: “Trust, but Verify.” (I’ll attribute that to the Gipper, as I believe he used it in missile negotiations with the Soviets.) The W-2s, 1099’s, and other accountability mechanisms help people ensure that they get the right information for their tax returns, but more importantly they also provide a means of verification. If the IRS doesn’t see an entry on your return for the matching W-2 or 1099, they know to come looking. But not all areas are covered like this, and herein lies the potential for underreporting of income and overreporting of deductions.
These 13,000 unlucky souls will endure this audit for the purpose of helping the IRS figure out where the big areas for underreporting/overdeducting are there days, so that they can better target the tax gap. I support efforts to improve compliance, as it is a way of respecting those who follow the law (i.e., you are not a chump who pays while your neighbors and friends cheat). However, this kind of an audit can impose costs on individuals, which are incurred for a public benefit. As a matter of equity, there should be some efforts to provide taxpayers with reimbursement for costs and attorney’s fees, particularly if the audit produces only trivial changes or possibly a refund.