Tax Litigation Issues

Our tax system is overwhelmingly dependent on self-reporting. It relies on a healthy mix of taxpayer honesty and fear of the consequences of being caught cheating. Effective and even-handed enforcement of the tax laws is a critical component of this system. Thus, “fair and uniform application” of enforcement mechanisms is one of the Internal Revenue Service’s primary strategic goals following passage of IRS Restructuring and Reform Act of 1998 (the “1998 Act”). But the IRS now finds itself battling the charge that it audits a disproportionately high number of low and middle income taxpayers. A recent article in The New York Times^[1]� details statistical evidence showing that the working poor are more likely to be audited than the wealthy, and highlights many of the obstacles the IRS faces in detecting tax evasion by non wage earners, who tend to be more affluent.

Some of those obstacles were created by Congress, which vilified the IRS in hearings during 1997 and 1998; passed the massive 1998 Act; and decimated the IRS budget leaving the IRS with far less money for audits and criminal enforcement than it had just five years ago. Last year, only about 500 out of a quarter of a billion taxpayers were prosecuted for tax crimes on legally earned income^[2]� – hardly a major disincentive for lucrative tax evasion. Other obstacles to auditing the wealthy stem from the fact that their tax returns tend to be more complex than those of more modest means and that cheating by wage earners is far easier to detect because the IRS computer system is able to match income reported by wage earners with W-2 information provided to the IRS by employers. Despite these limitations, the IRS is taking steps to enhance its enforcement efforts against higher earners. It is launching a program to match partnership K-1 forms with income reported on partners’ individual tax returns. It has also vigorously pursued promoters of tax scams and return preparers in an effort to cut off the source of various tax evasion schemes and has undertaken more coordinated and sophisticated publicity of those enforcement efforts to enhance their deterrent effect.