Apr 26th 2013
By Jason Bramwell
According to a recent report – Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results – by the Taxpayer Advocate Service (TAS), an independent division within the IRS, some of the nation's largest cities may be hotspots for tax cheats.
Using confidential IRS data, the TAS pinpointed large clusters of potential tax cheats in or around five metropolitan areas: Los Angeles, San Francisco, Houston, Atlanta, and the District of Columbia, according to an April 15 article by the Associated Press (AP).
Many of the communities identified by the study are wealthy, including Beverly Hills and Newport Beach in California. Others are more middle class, such as New Carrollton, Maryland, a suburb of the District of Columbia, and College Park, Georgia, which is home to a section of the massive Hartsfield-Jackson Atlanta International Airport, according to the AP article.
Because the likelihood of an audit increases with income, business owners in Newport Beach are probably targeted because many have high incomes, Steve Rosansky, president and CEO of the Newport Beach Chamber of Commerce, tells AP.
"I imagine it's just a matter of them going where they think the money's at," Rosansky says in an interview. "I guess if I was running the IRS, I'd probably do the same thing."
The TAS also identified small business owners who are most likely to have high or low levels of reporting compliance.
"Identifying how to improve compliance among this segment is particularly important because sole proprietor income is generally not subject to information reporting, is difficult for the IRS to detect, and represents the largest portion of the tax gap," the study states.
According to the IRS, the "net tax gap is defined as the amount of true tax liability that is not paid on time and is not collected subsequently, either voluntarily or as the result of enforcement activities. Thus, the net tax gap represents the amount of tax liability that is never paid." For 2006, that gap was estimated to be $385 billion.
The TAS found that people who own construction companies or real estate rental firms have low levels of reporting compliance compared to business owners in other fields.
"Taxpayers in construction-related and real estate-related industries appeared to be less compliant than those in other industries, as they each comprised 9 percent of the low-compliance group, but only 4 percent of the high-compliance group," the survey states. "By comparison, those in professional and technical service industries appeared to be more compliant, comprising 26 percent of the high-compliance group and 17 percent of the low-compliance group."
Examination Selection Criteria
The IRS will not say much about how agents choose their targets; however, the agency runs every tax return through a confidential computer program to determine the chances of collecting more money from an audit, the AP writes.
"Your return may be selected for examination on the basis of computer scoring," the IRS states in Publication 556, which explains the auditing process. "A computer program called the Discriminant Inventory Function (DIF) system assigns a numeric score to each individual and some corporate tax returns after they have been processed. If your return is selected because of a high score under the DIF system, the potential is high that an examination of your return will result in a change to your income tax liability."
In all, researchers identified clusters of potential tax cheats in more than 350 communities in twenty-four states, mostly cities and towns, but some neighborhoods as well, according to the AP article. About one-third of them were in California.
Across the country in Douglasville, Georgia, accountant Dennis Connally was surprised to hear that tax cheats may be operating small businesses in his community.
"At my office, [we] are very comfortable with the tax returns we prepare [because] we require a lot more third-party support to document all items used on the tax returns," Connally told the Douglas County Sentinel in an interview.
The researchers also looked for areas with high concentrations of small business owners who were very unlikely to cheat on their taxes. According to AP, four communities stood out:
- Aleutian Islands – a chain of seventy-one volcanic islands in Alaska.
- West Somerville, Massachusetts – a neighborhood in Somerville, a suburb of Boston.
- Portersville, Indiana – an unincorporated town in the southern part of the state.
- Mott Haven, New York – a neighborhood in the Bronx, one of New York City's boroughs.
"I'd like to think we're not alone in terms of the civic engagement of businesspeople," Stephen Mackey, president and CEO of the Somerville Chamber of Commerce, told AP in an interview. "But I would say two things: One is they are very close to the community inside and outside their businesses. At the same time, it's not small-town America. It's minutes from downtown Boston."