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

Following the trend of business. In making its case for more sophisticated technology, the agency said it is simply using many of the same tools private businesses already employ, such as browser "cookies" and data-mining tools used in marketing, hiring and other industries. The difference is that the IRS, as one of the most powerful government agencies, also has rights to use personal data, health information and private communications that go far beyond a corporate researcher's data set and sometimes surpass those of the Federal Bureau of Investigation or police.

"Tax returns have been guided by the legal concept of exceptionalism, outside the legal norms," says Paul Schwartz, University of California law professor and co-director of the Berkeley Center for Law & Technology. "The IRS is working under guidelines that go back to 1960 and the tax return is filed under legal compulsion. But there is so much information on everyone now it makes it harder for people to comply if the IRS uses data not in your return. It can get you into trouble." In other words, people might incriminate themselves with a careless online post, he says.

[Read: What Does the IRS Know About You?]

The agency has claimed steady success in tracking tax cheats. So far, however, its technological upgrade has shown incremental gains in tax collection. It has also created big snags in the system and a huge spike in complaints. Millions of tax returns have been frozen and delayed by the computer-generated processing, hitting mostly low- to middle-income taxpayers. The so-called "tax gap" of uncollected taxes is widening and the number of audits held in backlog has increased.

Meanwhile, there are growing concerns in Congress and oversight agencies about the unintended effects of the new data tools. IRS National Taxpayer Advocate Nina Olson has been a consistent critic about the lack of disclosure in what data is being used, and the burden robo-audits put on lower-income taxpayers. Last month, Sen. Charles Grassley, R-Iowa, called on the IRS to explain "abuse intrusions of privacy" in its data mining. The IRS has responded that it protects people's privacy and adheres to the law.

"Things that were not feasible in the past because there were financial barriers are possible now, and might be legal – but they are not necessarily what you want, and they should only be implemented with full transparency and awareness of people affected by the changes," says Harry Surden, a University of Colorado–Boulder School of Law associate professor and former fellow at Stanford's Center for Computers and the Law. "Technology has changed things very quickly and not just by degrees, so they become something entirely different."

Even some of the toughest critics of the IRS say the agency needs to rise to the challenge of a high-tech global economy by using more technology tools. Tax evaders use sophisticated tools to avoid detection.

"The bigger people will figure it out," says tax attorney and former IRS revenue officer Elizabeth Atkinson of LeClairRyan in Virginia Beach, Va. "For small business, I'm afraid it's going to be a disaster." Virtual currencies like bitcoins can make it easier for tax evaders to send cash to secret offshore accounts. "Zappers" are used by some retailers to blank out data on sales receipts. "Phantom-ware" is a kind of software used to conceal sales and other computer records from outside detection. With each technology innovation the IRS introduces, serious tax evaders come up with a way around it.

When the IRS does go after offshore tax dodges, the target is usually money laundering aimed at concealment, she says. Most of the offshore accounts held by wealthy Americans are legal, and the IRS does not see them as a significant source of new revenue. Nor do wage earners, whose income is reported on W2 forms, make up a large portion of the IRS's estimated tax gap. Corporations account for just 10 percent of tax dodges or underpayment, the IRS says.