The IRS gets tougher on the wealthy

The federal tax collector is cracking down on illegal tax shelters.

As Americans file their federal tax returns, they may find comfort in knowing that the Internal Revenue Service is seriously attempting to close illegal tax shelters used by many corporations and some of the rich. As a result, more big tax cheats are being caught.

Many middle-income Americans may also be pleased that the Democrat–led Congress is trying to shrink some of the tax breaks President Bush and previous Republican-led Congresses have provided the well-to-do since 2001. If Congress made all the Bush tax cuts permanent, which is unlikely, the top 1 percent of households would receive more than $1 trillion in tax benefits over the next decade.

The squeeze on tax cheaters could have sizable fiscal significance, too. The so-called "fiscal gap," the difference between what individuals and businesses legally owe in taxes and what they actually pay Uncle Sam, is huge. It's about $450 billion, estimates Donald Alexander, IRS Commissioner under presidents Nixon, Ford, and, briefly, Carter. The Office of Management and Budget, the White House bean counter, estimates the gap is smaller – about $345 billion.

If tax collectors can close the gap somewhat, the extra revenue could pay for a few months of the Iraq war. That war has cost about $500 billion so far.

"The IRS, under the most conservative administration we have had in my lifetime – maybe since Warren Harding [president, 1921-23] – is doing a very good job in letting the IRS enforce the tax law," says Mr. Alexander, now with the Washington law firm of Akin, Gump, Strauss, Hauer, & Feld.

In terms of fiscal policy, the Bush administration has not been "conservative." It has overseen a rapid increase in federal spending and in budget deficits.

After the late Senator William Roth Jr. (R) of Delaware attacked the IRS in lengthy hearings in the mid-1990s, the agency was "put out of the enforcement business," recalls Alexander. But present IRS commissioner Mark Everson emphasizes the need for compliance with tax law. He has spoken of a "culture of greed" that was "allowing large numbers of taxpayers to believe they really need not pay their full share."

Since 2004, the IRS has shifted more of its overall spending to enforcement. The IRS would like to boost enforcement spending for fiscal 2008 to $7.2 billion, a 6.5 percent increase.

A study by the Transactional Records Access Clearinghouse (TRAC), a research group at Syracuse University (N.Y.) that tracks the IRS, finds a shift in IRS enforcement strategy. Five years ago, 61 percent of IRS audits conducted by correspondence (rather than in-person) targeted taxpayers making $25,000 or less. Last year, only 15 percent of such audits focused on that income group. As a result, audit revenues are way up – $4.5 billion extra came from correspondence audits of those with incomes of more than $100,000. IRS audits of corporations, however, have not been very efficient in bringing in new revenues, the TRAC study finds.

Nonetheless, Alexander is impressed by IRS efforts to close improper tax shelters. He notes that one 56-year-old national law firm based in Dallas, Jenkens & Gilchrist, indicated last month it will close its doors after admitting to developing and marketing fraudulent tax shelters that caused major revenue losses to the government. The firm paid $76 million as a civil penalty. The firm's customers have been socked with tens of millions of dollars in IRS settlements.

Alexander suspects the Bush administration of being devious in its motives for the crackdown on illegal tax shelters. Mr. Bush, he charges, hopes to raise revenues sharply so that he can claim his tax cuts worked to boost the economy and thus federal revenues.

Most polls find that a plurality or a majority of taxpayers regard taxes as too high. They specially dislike property taxes and the estate tax.

In fact, the federal tax burden for most income groups, including middle-income households, is at its lowest level in decades, says the Center on Budget and Policy Priorities, a Washington think tank. The middle one-fifth of the income spectrum paid an average of 13.9 percent of their income in federal taxes in 2004, the lowest since 1979.

To prevent that percentage from rising for middle-income taxpayers, Congress may pass a bill this year shielding all but the wealthiest taxpayers from the alternative minimum tax (AMT), a tax created in 1969 to prevent millionaires from using loopholes to avoid all federal income taxes, tax experts figure. Without such a "patch," the AMT could boost the tax bill for tens of millions of middle-income Americans as early as next year.

Robert McIntyre, director of Citizens for Tax Justice, another Washington think tank, suspects Congress may also try to close some tax loopholes, perhaps limiting offshore tax havens, to provide extra revenues to offset the AMT patch or cover the cost of other programs.

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