New IRS compliance initiatives.

Sixty percent of Americans believe that people are willing to cheat on their taxes and gamble that they will not be audited. Seventeen percent think that it is acceptable to cheat on their taxes (Written Statement Of Commissioner Of Internal Revenue Mark W. Everson Before The Senate Committee On Appropriations Subcommittee On Transportation, Treasury And General Government Hearing On Internal Revenue FY 2005 Budget Request April 7, 2004). Obviously, the IRS is concerned about these statistics on America's view of tax compliance and enforcement and is introducing several new initiatives to encourage compliance and to improve audit coverage. Some of these initiatives will examine executive compensation, employment tax and excess-benefit transactions for exempt organizations.

Initiatives

Over the past eight years, audit coverage, which is the percentage of taxpayers that the IRS selects for audit out of filed returns, has declined (see Exhibit 1 on p. 445). To improve coverage, the IRS is expanding its scope of compliance initiatives by (1) introducing pilot programs, which will help it to learn more about compliance; and (2) standardizing audit procedures for the future. As part of this process, the Service is looking at certain taxpayers and issues that were not a major focus of recent audits.

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Executive compensation initiative:

Last year, the IRS began a compliance initiative for executive compensation. Under a pilot program, it selected 24 corporate returns from inventory already designated for examination by its Large and Mid-Size Business Division; for details, see Neuhauser, Tax Clinic, "Executive Compensation Compliance Initiative," TTA, May 2004, p. 265. These cases were selected because the IRS already had evidence on eight issues:

* Nonqualified deferred compensation;

* Stock-based compensation;

* The $1 million cap on deductible compensation under Sec. 162(m);

* Sec. 280G golden parachutes;

* Split-dollar life insurance;

* Transfers of compensatory options to family limited partnerships;

* Employee leasing asset protection plans; and

* Fringe benefits.

For each of the selected cases, the IRS is also examining Forms 1040, for executives, to determine whether that form is consistent with information reported on Form 1120.

Over the past five to 10 years, executive compensation has generally not been a part of corporate audits. However, lately, revenue agents (RAs) have been frequently requesting Forms 1040 as part of their information document requests.

The IRS will analyze the results of these audits to determine how to properly allocate resources to these types of returns and to issue guidelines and best practice procedures to RAs. As a result, executive compensation audits will likely be more common in the future; the IRS will be better prepared and focused in approaching examinations.

Employment tax: Another area of increasing IRS focus is noncompliance with employment tax withholding. For example, the Service is looking into cash transactions, S corporations and propriety of Forms W-4, Employee's Withholding Allowance Certificate, and W-2. It is considering an up-front validation of Forms W-4 to determine whether a taxpayer's identification number and name are consistent. The IRS is also planning to expand its voluntary tip agreement program in the gaming industry, a program that has been successful in Las Vegas and Atlantic City.

Excess-benefit transactions: Beginning in April 2004, the IRS launched an initiative to examine whether exempt organizations are complying with the Sec. 4958 excess-benefit rules. It will be contacting hundreds of exempt organizations to examine their reporting positions. Private foundations may also be contacted. As part of this initiative, the Service will also revise its procedures on examining excess-benefit transactions and will issue a new section for that in its Internal Revenue Manual. It may also offer a voluntary compliance program for taxpayers to encourage conformity with the Sec. 4958 rules.

Conclusion

In response to the general decline in audit coverage and taxpayers' perception that the chances of being audited ate slim, the IRS hopes that by expanding its scope of initiatives, it will reach more taxpayers. As it continues to look for ways to increase coverage and encourage voluntary compliance, it will focus on reviewing more returns, either through personal contact or correspondence with taxpayers. Thus, taxpayers can expect to see more audits and a greater use of penalty provisions than before to (1) encourage voluntary compliance and (2) increase costs for those who do not comply.

JIM DOUGHERTY, DIRECTOR, AND RONA HUMMEL, MANAGER, TAX CONTROVERSY, DELOITTE & TOUCHE LLP, WASHINGTON, DC