IRS Audits Aren't as Scary as They Really Ought to Be

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Few things inspire more fear among Americans than the threat of an audit from the Internal Revenue Service. Indeed, many taxpayers choose not to take deductions or credits that they're legally entitled to because they think that claiming those tax breaks will raise red flags that could inspire an audit.

Yet a new report from the Treasury inspector general for tax administration threw cold water on the idea that an IRS audit is such a terrifying prospect. According to the report, the IRS is extremely bad at collecting outstanding taxes from taxpayers, and it often declares outstanding tax debts uncollectible rather than taking the extra steps necessary to bring the money into federal coffers.

What the Treasury's IRS-Audit Report Said

The report centered on cases that the IRS declared as currently not collectible because it was unable to contact or locate the delinquent taxpayer. During the government's 2012 fiscal year, the IRS closed more than 482,000 cases because it couldn't find the taxpayers who owed money. Those cases involved about $6.7 billion in taxes that the IRS chose not to collect as a result of its actions.

The investigators found that the IRS did a poor job of following its own procedures in running down delinquent taxpayers. In 57 percent of the sample of cases that the Treasury inspector general examined, the IRS didn't complete all the appropriate research necessary, such as tracing mail, looking at motor vehicle records, examining deeds and court records governing property, and interacting with state and local licensing agencies to track down business owners. Extrapolating that sample, the report concluded that collections on roughly $1.9 billion in unpaid taxes could have proceeded had the IRS followed its procedures more closely rather than closing the cases prematurely.

More than half of the cases had no more than three steps missing in the IRS research process. But, given that some of those steps are relatively simple, missing even one could have led to the closure of a case on which the IRS could otherwise have collected taxes due.

In addition to the findings about the research process, the report found that in 7 percent of the cases, the IRS didn't include notice of the filing of a federal tax lien for the tax years in question. Failing to file a lien means that those performing credit checks of a delinquent taxpayer won't necessarily find out about outstanding taxes owed, which can potentially lead to uninformed decisions to extend credit from subsequent lenders that could prove disastrous.

Will the IRS Get Even Scarier Now?

Some believe that, in the wake of this criticism for its lack of diligence in pursuing outstanding taxes, the IRS will respond with more extensive and intensive audits. For its part, the IRS admitted that most of the Treasury inspector general's recommendations were appropriate, and the chief of the IRS division that covers small businesses and self-employed individuals said that the IRS has developed a new checklist to ensure better compliance with its procedures in the future.

More broadly, though, the IRS is continuing to work in other ways to soften its perceived harshness toward taxpayers in financial trouble. For instance, over the years, the IRS has refined its offer-in-compromise program, which allows some taxpayers to request partial reductions of their tax liability as well as the option of repaying delinquent taxes in installments over longer periods.

The IRS has a duty to treat all taxpayers fairly, and giving some delinquent taxpayers an unfair break by failing to properly track them down both penalizes and discourages the vast majority of Americans who pay their taxes promptly and in full. Even if the IRS makes audits more grueling, most taxpayers will appreciate the effort if it results in fewer deadbeats getting away with not paying the taxes they owe.

You can follow Motley Fool contributorDan Caplingeron Twitter@DanCaplingeror onGoogle+. To read about our favorite high-yielding dividend stocks for any investor, check outour free report.

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