Return of the 'Audits From Hell'

Insight ^ | 7/4/02 | John Berlau

[Jean S]

When he was confirmed in 1997 as President Bill Clinton's second commissioner of the IRS, Charles Rossotti promised a new agency that would emphasize service and uphold taxpayer rights. Speaking to the Senate Finance Committee right after it had held hearings on gross abuses of taxpayer liberties at the agency, the new commissioner told the senators that "the IRS must do a far better job of serving taxpayers."

Rossotti, who cofounded the Fairfax, Va.-based information-technology company American Management Systems after serving a stint at the Pentagon as one of Robert McNamara's "Whiz Kids," emphasized how he would reform the IRS with private-sector principles of customer service. "At an absolute minimum," he said, "we must not allow the kind of unacceptable treatment of taxpayers that was described by the taxpayers at your hearings several weeks ago. But I think we should aspire to something far more than the minimum," he insisted. "We know that the vast majority of taxpayers file their returns and do their best to pay the taxes they owe, and I just think we owe these taxpayers first-rate service in return."

Nearly five years later this Clinton appointee still is serving in the Bush administration. And he has gone so far as to bring back the old IRS practice of subjecting thousands of innocent taxpayers to audits for "research" purposes, one of the practices that spurred the congressional hearings.

At the time of his confirmation the Senate Finance Committee's then-chairman William Roth (R-Del.) believed Rossotti would become a champion of taxpayer rights. But Rossotti recently told the Joint Committee on Taxation that he wants to "begin a dialogue with Congress about certain changes" to provisions of Roth's 1998 IRS Restructuring and Reform Act that was designed to protect taxpayers from agency abuses. Rossotti and other IRS officials say provisions of the Roth reform are hurting the agency's ability to collect revenue. Among these are termination of IRS employees who intentionally violate taxpayer rights, assurance of due process for taxpayers before their assets can be seized and protection for the "innocent spouses" of derelict taxpayers.

Rossotti ultimately is a "computer guy" who cares little about taxpayer rights, says Daniel J. Pilla, president of the Tax Freedom Institute, an association of tax professionals, and in the mid-1990s a consultant to the congressionally created National Commission on Restructuring the IRS. Pilla and other civil libertarians particularly are concerned about the intrusions of the so-called National Research Program, which the IRS has announced it will begin this fall with 50,000 random audits of individual taxpayers to build a database to better target its audits.

"This approach will give us the tools we need to help ensure the fairness of the American tax system," Rossotti declared in an IRS press release. "Ultimately, this project will help all taxpayers by giving the agency timely, accurate information about tax compliance." The IRS claims that this new data ultimately could result in fewer audits of innocent taxpayers ? once it knows where the tax cheats are. The press release noted that "the IRS has not conducted updated research on the distribution of errors in returns for more than 13 years, a period when the economy and the tax law have changed dramatically."

But there was good reason why those fishing expeditions were stopped, say critics, who call them invasive and grueling for taxpayers and say they did not yield nearly as much useful information as promised. In 1988, the last year such audits were performed under the old Taxpayer Compliance Measurement Program (TCMP), 54,000 taxpayers were subjected to exhaustive "line-by-line" audits wherein they had to prove each item in their tax returns was accurate. These often were called "audits from hell," and the IRS frequently required those subjected to them to produce highly personal documents, including marriage papers and birth certificates for their children.

In 1995, the IRS wanted vastly to expand this program to audit some 153,000 citizens and businesses but was slapped down by the newly elected Republican Congress. The House speaker at that time, Newt Gingrich (R-Ga.), compared the TCMP audits to the Spanish Inquisition and noted the frequent IRS error rate concerning how much people owed. Fred Goldberg, U.S. commissioner of internal revenue under President George H.W. Bush, testified that the TCMP had proved "intrusive, burdensome and expensive." After Congress cut the 1996 budget for the IRS by almost $1 billion, the agency got the message and "postponed indefinitely" the TCMP audits.

But now there's a different atmosphere on Capitol Hill, and the IRS is taking advantage. The war on terror has muted criticism of law-enforcement agencies, and the IRS likely will get a 5 percent budget increase next year for a total of almost $10 billion. Recalling that the IRS was able to nab Al Capone and other criminals on tax-fraud charges when other agencies failed to put them behind bars, many hope the agency can be used to go after terrorists and their nonprofit fronts.

But they are likely to be disappointed, say close observers. A January 2001 IRS "strategic plan" states that the agency's Criminal Investigation Division, which traditionally has handled such cases, will focus its energies away from illegal activity such as drug dealing and money laundering, and toward prosecuting "legal income cases." Pilla says that even after the events of Sept. 11, the IRS is going ahead with this change in direction for its criminal division. "The war on terror has clearly given the IRS a clear go-ahead, but it's not going to lead to the IRS going after terrorists," Pilla says. "It's going to turn the IRS loose to harass Joe and Jane American."

Tom Fitton, president of the nonpartisan public-interest law firm Judicial Watch, has criticized Rossotti's IRS for going after Clinton's enemies while seemingly leaving alone nonprofits with links to terror. Fitton says, "The IRS likes easy targets. It's the bully mentality. They don't want to go after anyone who can fight back, so they go after people who won't put up a fight." When the scrappy Judicial Watch itself became an audit target, the IRS allegedly asked it for all details on seven years of returns and demanded the political affiliations of founder Larry Klayman.

Fitton says the IRS should not be conducting "research" audits of innocent taxpayers. As he puts it: "Innocent taxpayers should not be forced to serve as lab rats for IRS bureaucrats."

IRS director of research Mark Mazur insists the agency's new National Research Program audits will be "less excruciating" than the TCMP audits. "It's a conscious decision by the IRS to shift the burden for verifying items to the IRS as much as possible," Mazur tells Insight. He emphasizes that of the 50,000 people selected for audits, about 8,000 probably won't know they're being audited because the IRS will verify their information through third-party sources. Another 9,000 taxpayers simply will correspond with the IRS through the mail. Another 32,000 of the innocents will have face-to face audits with the IRS and, of these, 2,000 will be "calibration audits" in which, as with the TCMP, every line must be verified.

Mazur adds that these numbers "are guesses and estimates," and could end up being more or less dependent on what the IRS finds. He contends that even the line-by-line audits will not be as burdensome because the IRS will try to verify income with third-party institutions such as employers and banks before asking the taxpayer for proof. "It's not the type of thing where, if you were a wage-earner, you'd have to go hire an accountant or anything like that," Mazur says. "This time the IRS will have a W2 [filed to the IRS by the employer]. Each line will be looked at, but they won't be asking you for evidence on each line." Mazur says taxpayers will be told they are being audited as part of the research study, but "we haven't decided on the exact language yet."

But William Stevenson, chairman of the Federal Taxation Committee of the National Society of Accountants, an Alexandria, Va.-based group that represents independent tax practitioners, points out that the audits will be the same for those of known tax cheats. He argues that it is unfair to subject taxpayers to audits without probable cause that their returns are inaccurate. Furthermore, he worries about overzealous IRS auditors in the field who are desperate to find something on every taxpayer. "They don't have any control over the field, even though they think they do," Stevenson tells Insight. "You may have some field people doing these audits ? the old TCMP guard ? and saying, 'Yeah, we're going to go back to those days.'"

Stevenson is convinced the "research" audits will not give the IRS the data it wants about tax cheats. He notes the IRS already has reduced the potential for cheating by matching tax returns through computers with W2s from employers, 1099s from customers of independent contractors and data from banks for the mortgage-interest deduction. Other deductions were reduced in the Tax Reform Act of 1986.

The self-employed will be the biggest targets, Stevenson says, but the audits will do little to identify those who underreport cash income. He says he thinks the data will be flawed because "participants" in the study will be intimidated by the IRS, and as with the TCMP the agency probably will not include the results of taxpayer appeals in its final results.

David Keating, a counselor to the National Taxpayers Union and former member of the congressionally created IRS restructuring commission, thinks the research project as proposed may be okay, but that those who get stuck with defending themselves in a line-by-line audit ought to be compensated for expenses such as hiring an accountant. "If you're going to subject someone to a ridiculously excruciating research project, I think they should be paid," Keating tells Insight. "Certainly the 2,000 should be paid, and perhaps some of the others should as well."

But Mazur says the IRS has decided not to reimburse anybody for anything. "That's an idea that's been considered but pretty much rejected by the Internal Revenue Service," he tells Insight. "The reason is that we don't expect these audits to be more burdensome than a regular audit." Stevenson counters that many of the unlucky taxpayers subject to the line-by-line "research" audits will need to employ an accountant at a cost of between $500 and $1,000.

How far the IRS goes with this scheme may depend upon Sen. Charles Grassley of Iowa, the ranking Republican on the Senate Finance Committee. Grassley was a staunch opponent of the old TCMP and a major proponent of the congressional changes in 1998 to protect taxpayer rights. Grassley now tells Insight that "the IRS has been responsive to my concerns and has made many changes ? that will significantly reduce the burden on taxpayers and protect taxpayers' rights." His spokeswoman, Jill Gerber, says the senator believes protecting taxpayers' rights should be paramount.

Pilla says the fact that Rossotti is asking Congress to weaken taxpayer protections at the same time the agency is launching these random "research" audits is discomforting. "The IRS takes the position that no burden for taxpayers is too great," he says, "but that any responsibility it shoulders on its own is onerous."

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Rossotti Still Hasn't Cut All Ties to AMS

Last December IRS Commissioner Charles Rossotti announced that he and his wife were divesting themselves of all their stock in American Management Systems (AMS), the information-technology company he cofounded in 1970 and where he was longtime chief executive officer.

The announcement came after a series of articles appeared in Insight highlighting the potential conflicts of interest that the IRS commissioner owned millions of dollars worth of stock in a company that had millions of dollars worth of contracts with the agency he headed [see "A Taxing Dilemma," April 23, 2001; "IRS Boss Snagged Clinton Waiver," May 7, 2001; "How Can Rossotti Reform the IRS?" May 21, 2001; and "Rossotti's Hires Raise Red Flags," Sept. 10, 2001].

The reason Rossotti gave for his decision was that he was honoring his agreement with the Senate Finance Committee to sell his stock if AMS bid for work at the IRS beyond existing or successor contracts. Never mind that some had contended he already had broken this agreement because of the company's hugely lucrative "add-on" contracts with the agency.

But in June, when Insight finally was given access to Rossotti's annual financial-disclosure form filed this year, it became clear that he and his wife still had financial ties to AMS. Between $1,000,001 and $5 million in AMS stock was listed as an asset in an irrevocable trust for a "nondependent adult child."

Although there was a note saying Rossotti had resigned from the trust in February 2002, his wife, Barbara, still is shown as a trustee. A partner at the law firm of Shaw Pittman, she also had done legal work for the company while her husband was commissioner.

IRS spokesman Frank Keith says Rossotti kept his word to the Senate Finance Committee in his confirmation hearings. "He made two promises: He would divest his personal holdings in AMS and resign as trustee over irrevocable trusts that held AMS should there be a triggering event," Keith tells Insight. Having his wife also resign from trusts that held AMS was "not part of his agreement with the Senate Finance Committee," Keith says. The committee had not responded to inquiries on this point by press time.

But ethics experts were disturbed that Rossotti and his wife hadn't severed all ties to the company, especially since AMS was seeking more business with the IRS.

"He still pretty much has a tie to this company," Charles Lewis, executive director of the Washington-based Center for Public Integrity, tells Insight. "He didn't really relinquish control. It sounds like a little bit of a two-step there."

Larry Noble, executive director of the Washington-based ethics watchdog group the Center for Responsive Politics, agrees. "Given his previous connection with AMS, and given AMS' connection with the IRS, you would really hope he would distance himself as much as possible; you'd really hope he'd completely distance himself from AMS," Noble tells Insight. "The part that gives one pause and concern is the idea that he seems to be keeping connections with AMS. He seems to have this problem in totally separating himself from a company that does business with the IRS."

Larry Klayman, chairman of Judicial Watch, the nonpartisan public-interest legal group that filed complaints against Rossotti with the Justice and Treasury departments and the Office of Government Ethics, says, "It sounds slick. It's confirmation of his lack of honesty."

John Berlau is a writer for Insight magazine.

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