Out of Control IRS

The IRS seems to think it should vary the population that it audits. Certain commentators, including some from Forbes who think taxpayers should be paid for an audit to make it more appealing, think the IRS should audit many more taxpayers than it currently does. The theory is that most under-report their taxes, so the more audits the IRS does, the more revenue the IRS receives. In fact, the Forbes article says that on average the underpayment in each audit is $19,000, so that is what an audit is worth to the IRS.

Here's Exhibit A for why this is a bad idea. Meet Rachael Porcaro, a 32 year old single mother of two who makes $19K at Supercuts and lives with her parents for $400/month. Her dealings with the IRS were detailed in the Seattle Times.

She was audited over the course of two years for claiming the Earned Income Tax Credit (EITC) for her two children. Why would the IRS audit someone who makes so little money? According to Porcaro, the IRS thought that because she made so little money, she must be hiding income somewhere. Nevermind the fact that there are lots of people living below the poverty line in Seattle, she must be the one person hiding money. According to the IRS, if you are a family of three making less than $36K a year in Seattle, you're stealing or hiding money somewhere. Of course in Porcaro's case, even if she was hiding money, it likely wasn't taxable. She was living with her parents paying rent, but she could still receive $12,500 from each parent each year as a tax-free gift, and the IRS could not do anything about it.

The IRS originally said she could not claim the EITC for 2006 and 2007 nor her children as dependants for those years and assessed her $16,000 in back taxes. Nevermind she only makes $19,000 a year, has no house or car and no real way to pay that assessment. Porcaro's father had to spend $10,000 to hire an accountant to defend Porcaro's tax returns.

The IRS demanded copies of the blueprints of the house Porcaro lives in with her parents, bank statements, and had to prove her children were hers! The IRS decided eventually that she could claim the EITC, but made too little money to claim her children as dependants. So Porcaro had to pay $1500 to the IRS. For someone making $19,000, that probably is not the easiest thing to do, but it likely is easier than having to pay $16,000, or almost a year's salary for her.

What a disaster this situation is. This whole investigation probably cost $25K. The IRS will likely have to pay Porcaro's accountant $8K for his fees because the IRS was wrong to assess Porcaro for the EITC in the first place. So the US government is out about $20K or so to collect $1500. But for those in favor of greating IRS auditing, this is going to happen more and more.

The IRS cannot just audit wealthy people, and the IRS needs to ensure that it does not lose money on these audits, so the IRS will start picking on more and more people who can't afford to defend themselves. Porcaro was lucky in the sense that her parents would pay for an accountant to defend her, but many poor parents of young children do not have families with the income to do such a thing. Those people will have to go before the IRS alone, and the IRS will place liens on everything they have, essentially giving them no hope to ever get out of poverty, and giving poor people another reason to feel the government has it out for them.

The first thing I would do as Porcaro is to tell her parents to claim their grandchildren as a deduction. If the IRS doesn't think Porcaro provides more than half of her children's needs, it almost certainly can't state that her parents don't provide for their grandchildren. Porcaro's parents should file amended returns for all those years claiming their grandchildren as dependants, and dare the IRS to audit them again. Given that Porcaro's parents make more money than Porcaro, the dependent deduction will probably be valuable to them.

If the IRS is going to audit more people, standards need to be in place so that the IRS doesn't use poor people as a piggy bank to make audits worthwhile. Whether you agree or disagree with the EITC, many poor people rely on it, and taking it away years later would be financially crippling to these people. Wealthy people hire armies of attorneys to deal with the IRS because they are ruthless. Poor people don't have that ability, and I'm not saying attorneys should be appointed for them; but the IRS should not be able to increasingly look to poorer people to make audit successes look better.