October 10, 1999

I.R.S. Is Allowing More Delinquents to Avoid Tax Bills

By DAVID CAY JOHNSTON

Understaffed and caught in a set of mixed signals from Congress, the Internal Revenue Service for more than a year has let many tax delinquents go without paying tax bills that total billions of dollars.

Those owing back taxes include wealthy individuals, as well as employers that have withheld payroll taxes but not turned the money over to the Federal Government, according to I.R.S. tax collectors who spoke on the condition of anonymity for fear of retaliation by supervisors.

Instead of working cases, tax collectors, whose numbers are dwindling, have spent much of the year in training on complex new rules imposed by Congress. In addition, the I.R.S. interprets the new rules as requiring an all-or-nothing stance on back taxes. Rather than reach negotiated settlements and work out payment schedules, as was customary in the past, the I.R.S. is demanding full payment. If the taxpayer is unable or unwilling to comply, the agency is setting the cases aside as temporarily uncollectible. Then, calculating that the agency is unlikely to act before the 10-year statute of limitations runs out, many big tax delinquents are opting to take their chances and pay nothing.

“I have clients who owe taxes in six figures and could pay 60 percent, 70 percent, and the I.R.S. is collecting nothing,” said Steve Kassel, a tax preparer in Daly City, Calif., who specializes in tax collection cases. “The I.R.S. is leaving a ton of money on the table.”

Two years ago, the I.R.S. collected $30 billion from delinquent taxpayers. An I.R.S. official said there was no updated tally of the money going uncollected, but that it amounted to billions of dollars.

Charles O. Rossotti, the tax commissioner, said the number of collection cases languishing in I.R.S. files is growing, particularly cases involving taxes withheld from paychecks and then not turned over to the Treasury by small businesses. “Our case inventory is building up because we are not working as many cases,” he said.

Tax consultants say some wealthy taxpayers are also shielding assets from the I.R.S. by putting them into homes, fully aware that the Government — which used to seize as many as 1,000 houses in a year for nonpayment of taxes — has not seized one in more than 14 months.

Though some tax advisers say it remains risky to dodge tax debts, even some high-level I.R.S. officials acknowledge that the latest ploys may be successful. They blame antiquated computer systems, the shortage of collectors and complex new regulations that taxpayers can manipulate to delay collection.

“We don’t have the resources anymore to do hand-to-hand combat” with recalcitrant taxpayers, said Harry Manaka, the I.R.S. chief of collection practices.

Since 1990, the number of tax returns filed has increased 13 percent, to 226 million this year, but Congress has cut the number of tax collectors 19 percent, to about 6,800. Meanwhile, restrictions imposed by Congress to protect people from overzealous I.R.S. officials mean tax collectors handle far fewer cases.

Some of the new rules were imposed after Senate Finance Committee hearings in 1997 and 1998 during which armed raids, bullying tactics and other abuses of taxpayers were described. While some of the testimony has since been discredited, Senator William V. Roth Jr., the Delaware Republican who was chairman of the hearings, said that they nonetheless showed that the I.R.S. was out of control and needed to change its ways. Senator Roth said that the problems in collections “are like growing pains” and that the new protections for taxpayers “were never intended to allow tax cheats to escape the consequences of their lawless behavior.” Once the new policies are fully in place, he added, if the I.R.S. “for some unintended reason lacks the authority and resources necessary to pursue individuals who break the law, I can assure you we’ll revisit the issue.”

Still, the new strictures on the agency have had unintended consequences — most notably the de facto all-or-nothing policy on tax debts.

The policy stems from a requirement by Congress that the I.R.S. negotiate all terms of a tax-collection agreement up front. In the past, the agency would often collect what it could from a taxpayer, and then — as the period for collection was about to end — threaten action such as seizing a house to persuade the debtor to pay the balance or extend the collection period, sometimes for decades. Now, according to tax professionals, if a taxpayer does not agree to pay in full, collectors are quick to designate the debt “currently noncollectible,” which, for the purposes of performance reviews, effectively closes a case.

“Revenue officers are no longer judged by the dollars they collect, but by the efficiency with which they close cases,” said Mike Wellman, a tax accountant in Longview, Tex., with numerous clients who he says could pay more than half of their back taxes but are paying nothing.

Rossotti said he now limits extensions of the statute of limitations on collecting back taxes to an extra five years. And if the taxpayer will not grant an extension — or if regular payments would not cover 100 percent of the debt even with the extended pay period — the I.R.S. is refusing to accept an installment agreement and suspending its collection efforts. If the statute of limitations expires without I.R.S. action, the taxpayer successfully avoids paying the debt.

The danger, explained Manaka, the I.R.S. collections executive, is that the agency could revive the case within the allotted time — and seek penalties and interest. “Tax professionals who advise clients to do this are taking a risky approach,” he said.

Manaka acknowledged that the chance of a case being revived is small, provided the taxpayer continues to file annual tax returns and there is no evidence of a sharp increase in income.

Adjusted gross income would have to rise between 25 percent and 200 percent, depending on the taxpayer’s income level, before I.R.S. computers would flag the case for review, tax professionals and former tax collectors said.

Kassel, the California tax preparer, said that for taxpayers with a stream of income sufficient to pay part of their back taxes, but no significant assets, there was no incentive to grant the I.R.S. an extended collections period, let alone pay delinquent taxes.

One of his clients, Louis, a Connecticut taxpayer who insisted his last name not be used, said the I.R.S. initially told him it would accept payments that would total $66,000 of the $90,000 of back taxes owed on his family’s failed food business. Six months later, another I.R.S. official said the payment agreement could not be accepted, because it would not cover the full tax bill.

Because his income may rise, and so expose him to renewed attention from the I.R.S., Louis said he was negotiating to settle his tax debt with a lump sum payment — a payment that may be as little as 22 percent of what he would have paid in installments. He called the I.R.S. policy “crazy.”

Rossotti said the all-or-nothing policy shows that “there are some combinations of circumstances that we still need to work on.”

In the meantime, many tax professionals say that they have clients who should be made to pay, but who are facing no I.R.S. enforcement.

Rick Oelerich, an accountant in Davenport, Iowa, said that until recently he represented an Illinois doctor who owes millions of dollars in Federal income taxes, but has not faced any collection attempts by the I.R.S. — even though he has a substantial income and substantial equity in his home.

“The doctor’s conduct was flagrant up and down the line,” said Oelerich, who serves on a national board that advises Rossotti. “I was not happy that I had taken the case, because the farther I got into it, the more I could see that there was no doubt that this taxpayer was abusing the system. The revenue officer had dotted his i’s and crossed his t’s, and yet nothing is being done to collect, and it stinks.”

“As a taxpayer I am outraged,” Olerich said, adding that he has two other clients who also could, and should, pay back taxes, but whom the I.R.S. is ignoring.

Marc Albaum, a Manhattan tax accountant who works on collection cases, said he would advise most clients against counting on the I.R.S. to ignore their tax debt, especially if they had most of their assets in their home. Knowing that the Government might seize your house, he said, “is a terrible way to live.”

Still, he said, “there is no question the I.R.S. is going to lose a lot of cases because the statute of limitations will expire.”

Rossotti acknowledged that it is widely believed within the I.R.S. that he has an unwritten policy against seizing homes to pay back taxes, except in cases involving major drug dealers or people who make their living claiming that the income tax is a Government hoax.

“That is absolutely not true,” he said. “We have heard that some managers have said, ‘Don’t ever, ever send a home seizure case to me,’ and we’re working to get over that. The fact is that we do have the power to seize homes, and we will.” Seizures will resume, he said, once collection officers are fully trained in the new rules governing their conduct.

Every significant tax delinquency will be pursued, he said.

By far the Government’s biggest source of tax dollars is withholding from paychecks. Yet in interviews, tax collectors said thousands of cases of withheld taxes not being paid over to the I.R.S. by employers were simply being recorded in computer files, with little or no action to collect the money.

In some I.R.S. offices, tax collectors said, managers have coped with a shortage of tax collectors by simply raising the threshold for when prompt action is required, in some cases to more than $100,000.

“Some of these cases are so old that by the time we go out, the business will be gone and we’ll never see a dime,” said one tax collector in San Francisco.

Rossotti acknowledged that there had been a significant increase in instances of small businesses failing to turn over withheld taxes. His staff said it had no current figures, however. He wants the I.R.S. to adopt the same collection practices as private industry, with an emphasis on contacting taxpayers within days after a payment becomes overdue.

But tax collectors say it takes weeks, and sometimes months, before the service’s ancient computers flag cases.

Rossotti characterized the collection problems as transitory while collectors are trained.