Next Target of IRS Robo-Audits: Small Business

The IRS’s secretive plan for high-tech audits sees small businesses as the biggest tax evaders.

The IRS’s secretive plan for high-tech audits sees small businesses as the biggest tax evaders
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The promise is huge, tax experts say, but so is the threat of failure and abusive practices as a multiyear, $3 billion high-tech upgrade of the U.S. tax system begins to take over more of the Internal Revenue Service's heavy lifting in collecting taxes and forcing compliance.

The IRS is taking in 80 percent of all tax returns electronically, and the agency is beginning to do real-time scoring that selects returns for auditing. So far, the computer-driven processing in so-called "robo-audits" have caught mostly low- to middle-income taxpayers whose returns were frozen, although many were later found to have filed legitimate returns. Meanwhile, the government has cut back drastically on the number of auditors handling compliance cases, forcing it to rely more on computers to ferret out tax evasion.

Small businesses are next up for robo-audits, which will be a complicated task that's already causing widespread concern and confusion among taxpayers and preparers. The IRS is now processing tax returns by checking them against data from third-party records of all credit-card and electronic-payment data providers. It is also using data from social media, email and other online activities. The IRS's own advisory boards have warned that the agency is not prepared for this step, and many problems will likely arise.

The IRS has consistently declined to comment on any of the technology now in use, and tax experts say such secrecy endangers the success of programs that require a high degree of cooperation from the public to succeed.

The agency has denied it will invade personal email without a warrant or that a Facebook post can "trigger" an audit. Once an audit is flagged by other screening methods, however, the use of such material is allowed, and IRS administrative approval is usually all that is needed. Among the things auditors can do: chart and analyze social media such as Facebook, use social media in verifying claims made on tax returns, sort personal data into 32,000 categories, program machines to analyze taxpayer behaviors, analyze relationships based on Social Security and other personal identifiers, track email patterns and Internet addresses, and match returns to credit card payments.

[Read: How the IRS Tracks Your Digital Fingerprints.]

The data fields the agency will track have been revealed in records in which officials disclosed the plans to trade groups or in limited statements to Congress. The plans provide an outline but little detail. Absorbed in its extended budget crisis, Congress has spent little time questioning IRS about how the technology will affect privacy or inconvenience taxpayers caught in the web.

The technology at the IRS's disposal is so comprehensive that it would only take a few steps for the IRS to handle the entire tax-filing process for most Americans electronically. Under proposals already made and tested successfully in trials, anyone filing a simple return with only standard deductions could choose to let the government do all of the work. The IRS would send a check if too much was withheld or a bill for taxes was owed.

Such a "simple return" would place the burden on the IRS to tell taxpayers what they owe. But objections from some members of Congress, some IRS officials and strong opposition from the tax-preparation industry have scuttled those proposals for now. The program offers convenience and savings, but it was stalled by lobbying and Congressional gridlock as more invasive plans to compile personal data for audits won approval when included with emergency-relief measures during the financial crisis.

The agency's expanded powers, including access to all credit-card payment data, came with little debate in the midst of the financial crisis as part of a provision inserted in the Housing Relief Act of 2009. The agency argued it needed the new tools to collect an estimated half-trillion dollars in U.S. taxes that people dodge each year. It has also advocated gaining more technology tools to stamp out the million-plus identity thefts that take place annually, even though it is the Social Security Administration's numbers that are the source of the thefts.