IRS Is Picking on the Little Guys -- And Losing Money By Doing It

Want to lower your odds of an IRS audit? Try filing as a multibillion-dollar corporation.

The IRS has increased audits of small and midsize businesses, and has decreased its audits of massive corporations, according to a recent study by Transactional Access Records Clearinghouse, a research group at Syracuse University.

Among TRAC's findings: The IRS cut back the hours it spends auditing large companies -- those reporting assets of $250 million or more -- by one-third, even though those corporations have the highest underreported taxable income/assets. TRAC's report suggests that on an hour-by-hour basis, auditors recover $9,354 per hour from large corporations' filing errors, which is eight times higher than tax dollars recovered in audits of small and midsize businesses.

The obvious conclusion? If the IRS were serious about recovering tax revenue -- especially given the ballooning federal deficit -- it would go after the big fish first.

Not Enough Auditors?

Even in the cases of the biggest fish -- corporations with $5 billion or more in assets -- the percentage of audits decreased 17% over the last two years. (The audit rate dropped from 78 per 100 returns filed in 2007 to 64 audits per 100 returns in 2009, according to TRAC data.)

An IRS spokesman wasn't immediately available to comment.

In defense of the IRS, the agency may not have the manpower to audit the more complex filings of massive corporations, especially since it has had to shed some staff. In 2006, for example, well before the financial crisis, the agency planned to lay off 157 of its 345 estate lawyers. A January report from the Treasury Department's inspector general for tax administration found that "insufficient and inexperienced staff could reduce the ability to detect and stop fraudulent refunds." (The report focused on pre-refund fraud detection that was recently transferred from the IRS's Criminal Investigation Division to the Wage and Investment Division.) Various studies over the years have also shown that the IRS is understaffed. The number of permanent employees is significantly lower now than it was in the early 1990s, even as the number of returns has dramatically increased.

Outrage in Seattle

It would be easier to buy that argument, though, if the IRS didn't have a long history of going after the poor and powerless -- perhaps they're the lowest-hanging fruit. A Pulitzer Prize-winning New York Times story published 10 years ago, for example, harped on the fact that the IRS audited 1.36% of all tax returns filed by people who made less than $25,000 per year, compared with 1.15% of returns filed by people who made $100,000 or more.

And in a recent case that stirred outrage in Seattle, Rachel Porcaro, a single mom of two boys who made less than $20,000 working at Supercuts, was audited because her income was too low. The IRS suspected she was making money that wasn't being reported, otherwise she wouldn't be able to afford to live in Seattle. Perhaps if Porcaro had claimed assets of $250 million or more, she could have avoided the whole hassle.