HOW THE IRS TARGETS YOU If you live in Las Vegas, you're seven times more likely to get audited than in Milwaukee. That's disparate treatment. It's unfair. It violates IRS policy. And it's rampant nationwide.
(MONEY Magazine) – JOHN DROBISH AND KIM VIELMA ARE about as different as two taxpayers can be. Drobish (shown on the preceding page) is a 66-year-old horse breeder from Lake Forest, Calif. Vielma, 52, is a Las Vegas travel agent. Yet they have three things in common: Both were audited by the Internal Revenue Service. Both easily settled their cases with one IRS district office. And both were subsequently assailed over the original audit issues by a different IRS office. Why? It's simple: Both had moved. Drobish and Vielma are now well schooled in a fundamental fact of life about the IRS that's worth considering as roughly 1 million audit notices for the '93 tax year start showing up in mailboxes next month. Your zip code partly determines not only your chance of being audited but how you would be treated after the audit. To learn how the IRS deals with similar taxpayers differently, we analyzed more than 3,000 pages of confidential IRS documents covering audits and other IRS policing ! activities from 1991 to 1993. The result is MONEY's exclusive IRS target town ranking of all 63 IRS district offices according to how tough they are on taxpayers (see page 135). (There is one district in each state, except for California, which has five; New York, four; Texas, three; and Florida, Illinois, Ohio and Pennsylvania, two each.) Our chief finding: The Las Vegas district, which covers residents of Nevada, riddles taxpayers more than any other district, while the Milwaukee office, serving residents of Wisconsin, shows the most gentleness. Other highlights: -- People living in the 10 toughest target districts, on average, face double the risk of being audited as taxpayers in the other 53 districts. They are also 14% more likely to see the IRS reject their offers to settle for less than the full tax and are 21% more likely to have the IRS seize their property. Westerners are targeted the most: Eight of the 10 strictest offices are west of the Mississippi.
-- While the toughest target district of all, Las Vegas, audited 1.76% of its taxpayers in fiscal 1993 -- 2 1/2 times the national average of 0.7% -- the easiest, Milwaukee, zapped only 0.24%. (MONEY uses the 0.7% national rate, sanctioned by the watchdog General Accounting Office; the IRS' own 0.92% rate is inflated with such extraneous items as returns for nonfilers.) -- Audited taxpayers in the top 10 target districts are, on average, 13% more likely to be victims of pointless IRS interrogations that end up concluding the taxpayers owe no extra taxes after all. -- Over the past two years, the relatively kindly IRS office in Helena, Mont. accepted 78% of taxpayer offers to settle their bills for less than the full amount; by contrast the Boston office, for example, okayed only 27%. The national average is 50%. Furthermore, the IRS office in Hartford collected an average of $35 per $100 owed, but the San Francisco office settled for a big- hearted $9 per $100. The national average is $22. Such disparate treatment of taxpayers conflicts with the IRS' pledge to inspire "the highest degree of public confidence in our integrity, efficiency and fairness," to quote the agency's 10-year-old mission statement, which hangs framed on IRS office walls across the country. IRS commissioner Margaret Richardson, who took office 15 months ago, adds that her own policy is to provide "fair, courteous, consistent tax treatment." Unfortunately, however, dissimilar treatment has prevailed at the agency for more than 30 years. Says Don Alexander, IRS commissioner under Presidents Nixon, Ford and Carter and now a tax partner with the Washington, D.C. law firm Akin Gump Strauss Hauer & Feld: "Disparate treatment by the IRS, especially with audits, surely was and still is a serious problem. It's chronic." Adds Thomas Ochsenschlager, a tax partner at the accounting firm of Grant Thornton in Washington, D.C.: "Some IRS offices come on like sheriffs with both guns blazing, while other offices act like kindly crossing guards shepherding taxpayers through the system." (The box on page 139 tells you how to fight back when you've been audited by one of those IRS sheriffs.) Why are some taxpayers targeted over others? Commissioner Richardson, who asked MONEY to submit written questions and then responded in writing, argues: "Any perceived 'geographic' variations result from differences in compliance levels, taxpayer behavior, and economic and business trends." But that's only part of the story. MONEY interviews with more than 20 IRS officials and outside experts over five months reveal three intersecting reasons for the unfair treatment that have more to do with the workings of the agency itself. First, the IRS is so decentralized that local bosses can decide whether to go easy on residents or use a sledgehammer. An October 1990 internal report criticized the IRS' highly decentralized administration as "insufficient to assure the uniform, fair and equitable treatment of taxpayers across the country." IRS watchers continue to echo that charge today. "There is a little king mentality at these IRS offices," says Alexander. "Suppose a taxpayer has a tax obligation that he is unable to pay. Do you seize his property, or do you give the taxpayer a great, big break and let him work out a payment plan or compromise? It depends on the local office." Second, IRS offices often blindly follow local traditions. For instance, Las Vegas' cash economy and history of criminal activities have influenced the local office to adopt a hard-nosed compliance policy that often results in rough treatment of ordinary taxpayers. "We're tough in Las Vegas," admits Richard Flakus, who has been Las Vegas' chief of collections since 1987. "We'd like our audit rate to be four times the national average." In Milwaukee, by contrast, Midwesterners' traditional sense of probity has inspired the office to present a friendlier face to taxpayers; but that gentleness, in turn, may allow area cheats to fly freely under the IRS' radar. "We can't unequivocally prove that taxpayers here are more compliant than ((those)) elsewhere," says Robert McDonnell, Milwaukee's IRS chief of examinations. Third, the most aggressive IRS offices are rewarded with fatter budgets and bigger staffs. Therefore, the tougher they are, the more likely they are to get the resources to push even harder. By contrast, merciful IRS offices tend to end up without the staffs needed to scrutinize their population. Since the top 10 target districts last year, on average, audited 1.23% of taxpayers in their purview and assessed $852 million in additional taxes and penalties, they were rewarded with an aggregate budget of $419 million. However, the bottom 10 districts, which audited only 0.44% and brought in $493 million, got just $351 million to spend. Also, despite their lower budgets, those bottom 10 offices serve about 5 million more taxpayers than the top 10 target offices do -- 19 million to 14 million. The price of such massive imbalance comes high. By sponsoring a system that enables some districts to be far more zealous than others, the agency denies evenhanded tax justice to many. Moreover, by following a flawed audit- selection process, the IRS continuously audits tens of thousands of innocent citizens needlessly while letting cheats slip by. Here are the details:
YOUR ODDS OF GETTING AUDITED BY THE IRS DEPEND ON WHERE YOU LIVE In 1989, Kim Vielma thought she had left her IRS troubles behind when she moved from Bellevue, Wash. to be with her new husband in Las Vegas. Back in Washington State, the IRS had audited her in 1985 and disallowed a $2,000 tax shelter write-off that she had taken on her '84 return for a $6,000 investment in a partnership that distributed cassette tapes. After Vielma underwent a double mastectomy and a hysterectomy in 1987, the IRS' Seattle office, which ranks a relatively benign No. 35 out of 63 in our table, classified her as a hardship case. In 1988, while she was recovering, it approved an open-ended installment plan allowing her to pay down her resulting $6,000 bill. Once she got to Las Vegas, however, the tough local office yanked the agreement and billed her $21,300 for taxes, interest and penalties. It then seized two $300 paychecks and a $300 bank account, refused her $2,000 offer to settle, and after two years finally drove her into bankruptcy. The officer "said he came after me partly because I moved," recalls Vielma. "The whole experience was very upsetting." She has since settled her case with the IRS. Californian John Drobish entered a similar IRS twilight zone in 1992 when he moved from Homeland, in Southern California's Riverside County, to Roseville, near Sacramento. Before he moved, the IRS office in Laguna Niguel notified him that it planned to audit his 1989 and 1990 returns because of what it called questionable business deductions for his horse-breeding business in Oregon. He tried to convince the IRS to let its Sacramento office audit both his 1989 and 1990 return but was granted only half his request. The Sacramento office audited his 1989 return, found nothing wrong with his $24,000 in write-offs and let him go. But the Laguna Niguel office disallowed $18,300 of the same type of deductions on his '90 return and handed him a $6,973 bill for back taxes, interest and penalties. After a two-year fight, the IRS in Laguna Niguel finally concluded in March that Drobish's '90 deductions were okay after all. Says Drobish: "I still don't understand why Laguna Niguel tried so hard to disallow my business write-offs." As Drobish and Vielma can attest, some IRS districts are much tougher than others about auditing people, even those who earn identical incomes. IRS assistant commissioner of examinations John Monaco says flatly: "We audit taxpayers who make the same amount of money at the same rate no matter where they live." But his claim just ain't so. San Francisco, for instance, is the toughest office for incomes of $50,000 to $99,000 (audit rate: 2.11%) vs. the gentlest, Philadelphia (0.37%). Yet John Scholz, a political science professor and IRS expert at the State University of New York at Stony Brook, calls the $50,000-to-$99,000 income class a "fairly homogeneous group no matter where they reside." Last year, though, the IRS' Manhattan office sank its audit hooks into 11 of every 1,000 local taxpayers in that income group, while just a subway ride away, only seven of 1,000 Brooklynites with the same earnings were hit by the IRS office. Do Manhattan's middle-class taxpayers cheat more than Brooklyn's? "In general, no," says Scholz. Flakus of the Las Vegas IRS office concedes that "all districts should be auditing the same percentage of returns. But they're not." The problem begins when IRS computers evaluate your return. Using a top-secret set of formulas, the computers measure the probability that you may owe more tax, based on ! reported income and deductions, and give you what's known as a DIF (discriminant function) score. If it's high, an IRS auditor assesses whether your return is in fact audit bait. If so, you're mailed an audit notice. However, each IRS office does not audit the same percentage of high-scoring DIF returns. That's because a year before those high-DIF returns are even filed, IRS top brass and the 63 district directors draw up a battle plan for the agency's 18,000 audit troops to follow. According to confidential IRS audit plans obtained by MONEY, the agency calls in advance for widely differing rates of audits from district to district. There are two reasons. First, to keep the audit stick in full public view, each office has wide discretion in deciding how many taxpayers to audit in each income class. Second, as mentioned above, the local IRS chieftains whose audits bring in the most are rewarded with even bigger budgets and staff. As a result, last year the top 10 target districts in our ranking had 519 auditors, while the bottom 10 offices had about half that number, 279. Lowest- ranked Milwaukee has seen its audit troops dwindle from 77 to 24 over the past 20 years, as its audit rate has sunk from 5.16% to a puny 0.24%, roughly a third of the U.S. average. "If we had more auditors we would do more audits. That's just a given," says Milwaukee IRS audit chief Robert McDonnell.
YOUR ODDS OF GETTING NEEDLESSLY AUDITED ALSO DEPEND ON WHERE YOU LIVE Classical composer Sorrel Hays, 53, of Manhattan (shown on page 134) couldn't have been more annoyed. After enduring two years of abusive phone calls from an agent and $700 in audit expenses, she was informed by the IRS that her audited 1990 tax return was just fine in the first place. Says Hays: "My IRS agent was unnecessarily tough on me." Last year, in Hays' Manhattan district, 15% of the people who got audited ended up owing no extra taxes. That's the national average. However, 32% of those audited in the Las Vegas district, 26% in Indianapolis and 25% in Jackson, Miss. ended up not owing any money. That's not just unfair; it's expensive for taxpayers. "Rates of 15% or more set off alarms around here," says assistant commissioner Monaco. One chilling estimate of the cost of such IRS goofs: The American Institute of Certified Public Accountants figures that if all 550,000 of the taxpayers audited needlessly since 1988 -- roughly 15% of the 4 million who were audited -- had wisely hired a tax professional to ! represent them at a typical fee of $1,000 per audit, they would have spent more than $500 million to do so. (There are no reliable estimates of the number of taxpayers who use pros to represent them at audits.) Why are there so many unnecessary IRS audits? A 1992 IRS report blames "job fatigue" as one key reason. Since decisions on whether or not to audit are left up to 180 service center auditors who must each screen roughly 120 returns a day, judging a return must be accomplished in an average of four minutes. Another reason: low morale. "Picking returns for audit is a dreary, tedious job," says Ed Campbell, a Cambridge, Mass. computer contractor working with the IRS to fix this problem. For its part, the IRS insists that a new computer system, which will be completed in 1996, will take over the wearisome task and greatly reduce the agency's misfire rate.
IF YOU OWE THE IRS MONEY, HOW YOU'RE TREATED ALSO DEPENDS ON YOUR ZIP CODE Robert McWaters, now 39, was in a bind in 1984. His check-guarantee business in Meridian, Idaho, which covered bounced checks for local retailers, had just gone bankrupt, and he had injured himself seriously in a head-on collision. For the next eight years, he failed to file his tax returns. "Back then, I was running from my problems," he says. When McWaters finally filed his 1991 return, the IRS nailed him with a $30,000 tax bill, which he reduced to $16,222 by paying his back taxes. But with his $9,000 annual household income -- almost 50% below the poverty line -- he could barely take care of his wife and three young boys, much less handle a huge tax bill. So in July 1993, his C.P.A., Cheryl Curtis, asked the Boise IRS office to let her client pay off less than the amount owed; she presented two so-called offers in compromise -- one for his personal returns, one for his business returns -- totaling $1,000. Since 1992, the IRS has made it easier to get such deals. McWaters lucked out: The IRS accepted his 6 cents-on-the-dollar offer. He says: "I really feel the IRS was fair with me." Meanwhile, over the state line in Wyoming, the IRS office there was dragging James Simmons (shown on page 137) and his wife Darline through tax hell over similar problems. When the oil industry dried up in 1984, so did the Simmonses' $63,000-a-year income from their oil-well servicing company. By 1987, James, now 41, and Darline, 32, owed the IRS $38,000. The couple say they couldn't afford to pay their '84 to '86 income taxes, in part owing to high medical bills for their one-year-old daughter Carmeleda. After James filed for bankruptcy in 1987, the couple tried to whittle down the $38,000 in taxes, interest and penalties with a $50-a-month installment plan, but to no avail. By 1993 the IRS tab had ballooned to an untenable $80,000. Last year, the Simmonses decided to offer the IRS $6,000 plus half of any income they earned annually over $50,000 from 1993 to 1997. Two C.P.A.s, who called the Cheyenne office "extremely tough," warned them to expect a rejection. Sure enough, their Cheyenne revenue officer "took about five seconds to stamp our offer reject," says Darline. (The Cheyenne IRS office did not return repeated calls from MONEY.) Since December 1993 the Simmonses have been praying that the IRS will approve their renewed offer of $6,000, which is only 8 cents on the dollar of what they owe but all they say they can afford. "If my life were in such disarray because the local IRS office was rejecting my offer, I would seriously consider moving just to get some relief," says David Keating, executive vice president of the National Taxpayers Union, a nonprofit advocacy group in Washington, D.C. As the Simmons and McWaters cases indicate -- and our district ranking table illustrates -- approval rates for offers in compromise vary sharply. Our table shows that it's no surprise the Simmonses are having trouble in Cheyenne. It's No. 3 of 63 in our overall IRS target ranking, partly because it accepts a mere 29% of the offers it gets. Boise, the McWaterses' district, grants 71%. Why the different treatment of deals? IRS spokesman Henry Holmes offers one reason: "In areas where there is a low acceptance rate, we found taxpayers could afford to pay more." Yet one GAO study points back to the telltale twins of decentralization and local culture. The December 1993 GAO report on offers in compromise fingers "differences in district managers' attitudes," with some district directors viewing the offer in compromise as "a giveaway program." For those shackled by an audit, the pain can get much worse than rejected compromise offers. If you live in a tough target district such as Providence or Phoenix and owe the IRS money, you face far higher odds of the IRS seizing your bank account or even your car than taxpayers elsewhere. The IRS levied, or seized, assets from 3.3 million taxpayers in 1992 in anything but an evenhanded manner. For example, while only about half of delinquent taxpayers are levied nationwide, the Anchorage office, the toughest tax collector of all, levied an astonishing 959 of every 1,000 delinquents in 1991. By contrast, Atlanta and Columbia, S.C. are at the bottom of the pack, slapping just 23% of delinquent taxpayers with levies. What makes Anchorage so aggressive? Michael Graetz, a former Treasury deputy assistant secretary, points to the local culture: "Alaska has always been a rough-and-ready kind of place with a high number of self-employed individuals." Scholz notes that the IRS is deeply suspicious of such independent souls because they often get much of their income in cash. Unsurprisingly, uneven staffing results in disparate treatment of taxpayers who owe the IRS money, according to a May 1993 GAO report. On average, the 10 toughest IRS offices have 184 collectors, each with a caseload of 137 taxpayers, whereas the 151 officers in each of the bottom 10 offices must track far more taxpayers, 153 apiece. In the future, taxpayers can look forward to far fewer mistaken audits, but a massive increase in audits overall and a whole new different kind of targeting. By 1996 the IRS' $22 billion computer modernization program is supposed to eliminate tax auditors who select returns for audit. That would banish human error. The computers then would be able to pick for audit as many as 288,000 individual returns daily, more than 13 times the current number. What's more, the IRS is planning a major shift in audit emphasis away from grouping taxpayers for audit according to the type of return they filed and their income level, and toward a new "market segment" program targeting taxpayers by occupation (like lawyers, doctors, musicians), businesses (coin- operated laundries, bed and breakfasts, gas stations) and tax issues (passive activity losses). The changes promise to yield big revenue increases. Listen to IRS officials, and it's easy to conclude that disparate treatment is here to stay. According to the agency's assistant commissioner Monaco, the reason is "human judgment, which we can't control." Perhaps. Though as Greg Holloway, director of civil audits at the GAO, says: "Life may be unfair, but that doesn't change the IRS' obligation -- and goal -- to treat taxpayers fairly."
BOX: Top targets by income
Contrast the rates below against these national averages: 0.54% for $25,000 to $49,999, 0.98% for $50,000 to $99,999 and 3.66% over $100,000.
IRS DISTRICT AUDIT RATE FOR $25,000 TO $49,999 Anchorage 1.92% Las Vegas 1.18 Fargo, N.D. 1.15 Los Angeles 1.09 Boise, Idaho 1.03
IRS DISTRICT AUDIT RATE FOR $50,000 TO $99,999 San Francisco 2.11% Helena, Mont. 2.00 Los Angeles 1.93 Anchorage 1.88 Las Vegas 1.81
IRS DISTRICT AUDIT RATE FOR OVER $100,000 Helena, Mont. 12.69% Fargo, N.D. 7.95 New Orleans 7.12 Oklahoma City 6.61 Cheyenne 6.53