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FOR A FEW YEARS early in my career, I was an internal revenue agent for the IRS. I audited the tax returns of small businessmen, drug dealers, doctors, lawyers, a professional basketball player and everybody in between.
That was 43 years ago, when the IRS was much bigger relative to the population. One result: A larger percentage of the population were subjected to audits.
I saw and heard a lot. Some people would put dogs, cats or imaginary children on their tax returns, and claim an exemption for them. That was when you weren’t required to list Social Security numbers for dependents.
I remember one guy who gave his girlfriend thousands of dollars and had her sign promissory notes, which he promptly wrote off as bad business debts. This also kept his wife from knowing what he was doing.
Another guy started a little business out of his house that never generated any real money. But he wrote off everything as business expenses, including his house, meals out, cars and vacations.
One small businessman didn’t report, in today’s dollars, $310,000 of income. In addition, he paid all his employees in cash, which meant more unreported income. The boss also benefited by not paying the employer’s share of Social Security payroll taxes on their wages. One of the employees got mad at the boss and told on him.
There were more sophisticated tax scams. For instance, at that time, there was a widespread art donation scam and a master song recording scam. I won’t bother you with all the details. But it involved thousands and thousands of dollars just on the one case that I dealt with, which consisted of bogus charitable contributions, along with bogus business tax credits and deductions. This resulted in refunds going to the perpetrators of a well-oiled tax scam machine. Everybody involved benefited at the expense of other taxpayers.
You hear every now and then about the IRS beating up on some “poor” taxpayer in court. When I was an agent, the IRS wouldn’t go to court unless it was 99.9% certain of a conviction. If the IRS was actually taking you to court, you were in big trouble. It had decided it had a slam-dunk case and wanted to make an example of you to others planning the same thing. I imagine it’s the same today. The folks I audited took the wiser course: They paid the tax and maybe a civil penalty.
Court cases sometimes involved tax law that was so ambiguously written by Congress that it could be interpreted in many different ways. The IRS chose one way, the taxpayer another and the courts had to sort it out.
Audits not only catch tax cheats and honest mistakes, but also serve another purpose. Those being audited were a warning to others that the government was indeed at work collecting taxes. This included where the big tax money is—and, by that, I mean large corporations.
My strangest experience came long after I left the IRS. A successful and devoutly religious small businessman started “confessing” to me that he had been blatantly cheating the government out of large amounts of taxes, and had been involving his family. One result was that these family members were eligible for government welfare programs because they appeared to have low incomes.
Why was he telling me all this? I think he wanted me to tell him that it was “okay” and his sins were “forgiven.” I didn’t.
The IRS has been a favorite whipping boy of politicians for decades, resulting in inadequate funding. One result is there are now fewer audits as a percentage of all taxpayers. It sends the message that the politicians don’t care if you fail to pay your taxes. That means a lot of folks—the types I used to audit—are getting away with tax murder. You can’t find tax cheats if you don’t audit them. They’re emboldened, thinking they can do what they want without getting caught.
You should want a strong and well-funded IRS to help drive down national deficits by enforcing the tax laws passed by Congress. A good rule of thumb is that, for every dollar spent on the IRS, we get back $10 in taxes collected.
Ken Begley has worked for the IRS and as an accountant, a college director of student financial aid and a newspaper columnist, and he also spent 42 years on active and reserve service with the U.S. Navy and Army. Now retired, Ken likes to spend his time with his family, especially his grandchildren, and as a volunteer with Kentucky’s Marion County Veterans Honor Guard performing last rites at military funerals. Check out Ken’s earlier articles.
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Count me in the Club also!
I agree with R Quinn, small business owners and unreported tips. Anything where cash is involved. I’ve been an AARP Tax Aide volunteer for 20 years, the IRS gets copies of W2s and 1099s, so that income can’t be underreported without the IRS knowing.
Great piece and I cheered all the way through as a fellow ex-Government auditor working for a highly political agency (in another sector). I knew someone who was quite proud to the family’s small hotel business and playing games with the amount of declared income-they justified it by other unfair taxes and government programs.
I’m guessing AI will improve so it can identify tax return ‘errors’ and automate letters to the taxpayers. This should improve productivity and also identify returns that should be audited (best cases to collect revenue).
Yeah, but knowing the federal government it may take the decades longer to institute AI than private business, thus losing out on billions in income.
From an article on CNN’s website:
”Starting around late 2022, the Treasury Department began using enhanced fraud-detection methods powered by AI to spot fraud.
Uncle Sam’s AI-fueled crackdown on fraud appears to be paying off.
Treasury’s AI-powered fraud detection recovered $375 million in fiscal 2023 alone.”
My humble apology to the IRS.
Perhaps they could contract it out to someone like Elon Musk?
It amazes me that people who consider themselves honest and trustworthy cheat on their taxes. One, it’s morally wrong, but it’s also stupid. Risking large fines, even jail time, for what probably isn’t even life changing amounts of money? I appreciate your service for honest taxpayers.
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There are so Many ways for the self employed to cheat on their taxes that only the threat of an audit keeps most people honest.
No argument with paying what’s due, “fair share”, etc, but having spent a large chunk of time in the first 2 months of retirement planning around a complex tax code and navigating the complexities of ACA ,and soon Medicare, I will note that the complexity is a waste of human time, energy and money. I had plans to volunteer in places that benefited others (kids, etc), but so far, I’ve had a full time job thanks to circumstances and the complexity.
https://reason.com/2024/02/28/congress-continues-to-make-the-tax-code-ridiculously-hard-to-understand/
Excellent article Ken. You’ve seen a lot in your time. The owner of an iconic pizza shop in our beach town pled guilty to tax evasion a decade ago. The shop had always been a cash only establishment. The servers took orders by memory, and verbally gave the amount due. No paper trail. This went on for at least 4 decades. The owner pled guilty to underreporting his income by almost $300K, and evading about $92K in taxes. He regularly deposited cash in the local bank, but always under $10K so the bank didn’t have to file a currency transaction report. The bank eventually realized what was going on and notified the authorities. The owner was sentenced to 24 months and fined. His wife got probation and a fine. The business now has modern cash registers, provides receipts, and takes credit cards. They are as busy as ever and have expanded to a new modern location. An 18 inch pie is $26! Talk about theft.
Thank you. I have noticed that when I suggest that the uber-wealthy are paying less than their share, and that taxation is requirement for a civil society, I get down-voted. I would prefer not to live in Hobbes’ dystopian universe, and that requires looking out for the other members of your society. All of them.
I’ve always done my own taxes, first manually, and then over time I converted to TurboTax. Over the years I’ve received several audits by mail where I was asked to defend certain entries. In all but one I successfully defended my decisions and/or entries. The one I lost was due to my misunderstanding of self-employment rules. I paid what was owed along with a small penalty and received closure, and never made that mistake again.
Our finances and current investments are very simple. I know many people take their information to tax preparers, but I don’t understood why that is necessary for us.
I’ve used the H&R Block software for many years. Our finances aren’t that complicated, and I’ve learned the ropes. I’ve occasionally gotten those letters from the IRS with errors usually in small amounts, sometimes even in our favor, and I either pay the difference or accept the refund.
The biggest problem I ever had was back in 2020 after we’d sold our home of over 20 years in 2019 at a big profit—that was still under the capital gains limit. I filled out the worksheet on the software with our original purchase price, our sales price, and our sales costs, which showed that we were under the limit. But I realized when I heard from the IRS that somehow the program hadn’t submitted the worksheet with our return (and I’d failed to catch it when filing), so the IRS thought we owed a lot of capital gains taxes on our sale. Thankfully, I’d kept good records of that paperwork and was able to mail in hard copies of the proof we needed, and the IRS said “OK, good,” and we were fine. But it was a good lesson that if we file something new or unusual to us, we need to check and double-check.
I don’t why, but some people are terrified of doing their own taxes. But there is one thing that DIYers often miss. In some states (Ohio for example), it might make sense for marrieds to file separately. You need to compare the net tax liability of both the federal and state together. If on Medicare you also have to watch out for IRMMA. Otherwise, the Turbo Taxes of the world do a good job so long as you answer the interview questions correctly.
I’ve used H&R (whatever it was called back then), accounting firm$ and now TT. Software works just fine for most everything but you really need to recheck details of entries that are downloaded, from brokerages, for example. I’ve experienced several nuances as I have been adjusting holdings, combining accounts, conversions etc. in these early years of retirement.
I calculate and pay estimated taxes quarterly due to uneven income through the year so I have a pretty good idea what my end game numbers will be to avoid underpayment penalties. I’m not a tax expert but one category you may need to pay close attention to are equities purchased prior to 2012 and sold later. Prior to 2012, investors had to track basis and sell prices and report accordingly. Since then, brokerages were responsible for tracking and reporting these figures to the IRS and the account holder. I had to make several such checks and updates for our 2022 taxes. Not hard to do but kind of a PITR. The problem is, if you’re not aware of such things, it would be very easy to simply accept what the software summary states and hit the e-file button.
If you have such pre-2012 purchases and later sales, Box E on one (or more) of your 1099-B will be checked (versus say Box D) on long term gains/losses. This means your basis was not reported to the IRS. Long story short, it is critical that you check each transaction here to assure the basis is reported accurately. Just finished loading all my inputs into TT Premium yesterday and the refunds amounts were off by thousands (lower) than what I calculated in early January. After an overnight brain reset, I walked thru the downloaded entries and noted that one account was loaded twice thus doubling up on the capital gain from that account and throws off many categories such as taxable SS benefits. This MAY have to do with the integration/transition from E*TRADE to Morgan Stanley in mid 2023, as they forewarned, but this was not quite the same thing. I’ll be getting into more details on the capital gains transactions today to complete my overview and get these returns filed!
Good news is that I only have a few “old timer” equity purchases left and they aren’t going anywhere soon. “Apple been very good to me”, but Mr. Cook needs to get some new menu items out of the R&D kitchen. Pun intended,
If anything above needs correcting, please share it. Just trying to be helpful.
Very interesting article and seasoned perspective, Ken. What you say makes a lot of sense. I’ve no doubt cheating on taxes has gotten much more widespread since the days when you were on the beat. There have also been cases where the IRS has been used as a political weapon. I’m guessing that was less prevalent in your era.
I don’t know if it’s still true today, but in the past the IRS stated that there would be no “tax gap”, (the difference between tax revenue and federal spending) if the self employed filed honest tax returns.
Employees and retirees should have no fear of audits; the IRS knows who they need to go after.
Regarding wait staff, I’ve never had anyone ever claim their cash tips. By not doing so they are cheating themselves out of a larger future Social Security benefit, even though they are often people who will need SS the most.
Always interesting to hear about how some try to get over on the government.
Politicians’ railing against the IRS proves their stupidity. The Service is the organization that collects the money Congress love to spend.
If it were up to me I’d double the number of auditors. I’ve seen a lot of BS…
A crime is a crime. But I couldn’t help laughing about the Husband who effectively wrote off the costs of having a girlfriend, via promissory notes. After laughing, I recovered my sense of outrage at a bad husband and a tax cheat.
And yet politicians like to rant that it’s the millionaires and billionaires who are the tax cheats. I read once the most tax cheats are small businesses dealing in cash followed by restaurant servers not reporting tips although new reporting rules cut that.
I have no data, just suspicions. I don’t know what percentage of people who file returns cheat, but suspect it is similar across the income spectrum. It also seems likely that the larger the income, the larger the tax fraud, in general. So it should not be surprising that the IRS recovers more money per audit on average, after accounting for the cost from higher earners, as discussed in the paper referenced by parkslope. Perhaps a similar proportion of cheaters can be found at all income levels, but the amount of money involved is larger among those with the higher incomes?
What I do have trouble grasping is why anyone with an income which places them in the top 1% or higher is tempted to risk civil penalties, and even prison, for trying to weasel out of paying the taxes they owe!
Take a look at who took PPP loans in your area and zip code. Another area ripe for abuse and potential audit.
“On average, $1 in audit spending raises $2.17 in initial revenue. Audits of high-income taxpayers are more costly, but the additional revenue raised more than offsets the costs. Audits of the 99-99.9th percentile have a 3.2:1 return; audits of the top 0.1% return 6.3:1.”
https://www.nber.org/system/files/working_papers/w31376/w31376.pdf
Ken, I now know who’s the lone member of the IRS fan club. 😁
I was once taking a patient’s history who said she worked for Treasury. I paused to consider her statement, then asked if she meant the IRS. She said “Yes, but I don’t like to tell it.”
Thanks for a very interesting article.
Make that at least 3 fans. Great piece, found myself cheering all the way through.
There are at least 2 fans in that club. I have no regard for unethical people.