Tax Prophet Newsletter March, 2006

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The Tax Prophet Newsletter

Issue # 32 March, 2006

REDUCE TAXES! CHECK OUT THE TAX PROPHET'S Action Guides In This Issue: Introduction Evil Congress Patriotic Duty? Self-Reporting No Fear IRS Response Conclusion		IRS -- Too Kind and Gentle? Introduction Is IRS too kind and gentle? Yes, say noted economists, Stephen Dubner and Steven Levitt, authors of "Freakonomics," the widely-acclaimed treatise that uses economic theory to explain human behavior. In a recent New York Times Magazine article, Dubner and Levitt state that contrary to public perception, economic theory suggests that IRS should aggressively audit a much greater percentage of returns to reduce the current $350 billion annual underpayment of taxes (20% of the total taxes actually collected).

Evil Congress		Naturally, taxpayers dislike the tax collector and consider IRS an overbearing agency that rides roughshod over people's lives, even though IRS's job is merely to enforce the tax laws as written. The real culprit is Congress, which passes vague, complex, inequitable and often incomprehensible tax laws, yet fails to provide IRS with the funding needed to ensure compliance, thereby creating ample opportunities for taxpayers to "misreport" income and deductions.
Patriotic Duty?		According to a recent study, over 96% of taxpayers believed they should pay their fair share of taxes (it's their patriotic duty) and 93% claimed that those who cheat should be caught and punished. However, altruism and patriotism aside, 63% of those polled said the fear of being audited caused them to file their taxes honestly.
Self-Reporting		Because of an elaborate and detailed withholding and reporting system, 99% of the taxes from wages and salary are collected. In contrast, only 43% of the income earned by self-employed taxpayers, such as professionals, consultants, home businesses, restaurants or those running a small business, is properly reported. The difference is that these taxpayers self-report their incomes. Unlike wage earners, there is no mandatory tax withholding mechanism in place to compel tax payment from the self-employed and owners of small businesses.
No Fear		According to Dubner and Levitt, the self-employed are no less honest than wages earners. They just have a greater economic incentive to cheat, since the only way of getting caught is by an IRS audit and presently, only 1 in 200 taxpayers are audited. Audits would have to increase substantially to create a genuine incentive to accurately report tax liabilities. Currently, the odds of a partnership, small corporation or limited liability company being audited are about 1 in 400; consequently, a powerful economic incentive exists for these entities to overstate deductions or understate income, with little or no fear of getting caught.
IRS Response		Because IRS is a politically unpopular agency and increasing revenues through additional audits is expensive, it must resort to other means to collect from those who underpay their taxes. One successful tactic involved the requirement of providing social security numbers for dependents listed on tax returns. The result: seven million fewer dependents were claimed. Thus far, the government has received approximately $14 billion in additional revenue. Another technique involves amnesty and settlement programs targeting tax shelters, especially with enhanced reporting imposed on tax-shelter promoters, exposing their participants to scrutiny. IRS claims approximately $5 billion in additional taxes from these efforts. Similarly, an amnesty program aimed at those with unreported foreign bank accounts netted a billion in additional revenues and chased many taxpayers from hiding and back into the system, which means greater future tax revenues.
Conclusion		Unless taxpayers have a genuine fear of being audited, IRS will be forced to catch tax cheats through increased reporting requirements by third parties or through amnesty programs. As Dubner and Levitt conclude, the incentive to understate income or overstate deductions is in proportion to the fear of being audited, and in the end, honesty has relatively little to do with the tax collection process.

Disclaimer under IRS Circular 230: Nothing contained in this message may be used to avoid U.S. federal tax penalties or to promote or market any federal tax transactions.

This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet� is a registered trademark of Robert L. Sommers.