Taxing Days Ahead for Everyone in IRS Scandal

The IRS faces a massive audit, and the cost will be paid by taxpayers.

The conference was called “lavish” and “shameless.” Could it pass an IRS audit? Here’s what experts say.
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Few taxpayers will be upset to see the unloved Internal Revenue Service going through its worst crisis in decades ­– although tax experts and lawyers say they probably should be.

The agency runs on the trust and cooperation of taxpayers in raising revenue for the U.S. government, and its widening scandal and use of invasive tactics is undermining that role at a critical time as budget concerns mount. A prolonged political battle over what to do about the agency could be a costly problem. And taxpayers will foot the bill.

"We all know what's going on with the IRS today. How can we trust an entity like that?" said Rep. Charles Boustany, the Louisiana Republican who heads the House Ways and Means subcommittee that oversees the IRS, in a hearing committee comment reported by The Wall Street Journal.

"We have to trust them," says Edward Zelinsky, a tax law expert and professor at Benjamin N. Cardozo School of Law and Yale Law School who has handled federal tax appeals. "Their ability to do their work depends on public trust and confidence, and they have violated it. The secretive way they have gone about their work is the most disturbing part of this. It's certain to undermine them in their mission, and that hurts all taxpayers."

[Read: How IRS High-Tech Tools Track Your Digital Footprints.]

There will also be direct costs related to lawsuits and the many investigations already launched. The Internal Revenue Service Restructuring and Reform Act of 1998 lets taxpayers sue for up to $1 million over tax grievances. Already, a number of groups from the loosely affiliated wings of the Tea Party have said they will.

Congress is also likely to take a much harder look at how the IRS uses technology and automatic screening of returns as it identifies possible audits, a critical cost-saver aimed at collecting more of the estimated $400 billion in tax dodges missed each year. The agency has declined numerous requests from U.S. News to explain how it uses technology to screen tax returns, and denied suggestions that such screenings were used inappropriately to target any groups. The IRS's lack of openness in providing guidelines has made the agency "their own worst enemy," says Zelinsky.

Investigators are now looking into the use of keywords to review an estimated 60,000 applications for tax-exempt status by a small staff of workers in Cincinnati, the hub for reviewing nonprofits. Initial government reports do not disclose how technology may have been used, but the agency did automate such filings over the past five years to simplify the process of screening.

"There is going to be a lot more digging to see how this happened," says tax attorney and former IRS revenue officer Elizabeth Atkinson of LeClairRyan in Virginia Beach, Va. "The lack of transparency and guidance is the fundamental problem at the root of this scandal. As they move into data mining, it shows the dangers. You just cannot run an agency with such an important role off the cuff like this."

U.S. Treasury Inspector General for Tax Administration J. Russell George, in a report on the alleged abuses, said the agency failed in its stated mission to help Americans "understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." In hearings Friday, the Associated Press quoted House Ways and Means Committee Chairman David Camp, (R-Mich.), as saying, "This is a problem of the IRS being too large, too powerful, too intrusive and too abusive of honest, hardworking taxpayers."

The Republican-controlled Ways and Means committee blames the Obama administration for the abuses. But the inspector general's report blamed "ineffective management" and lack of proper oversight, not political pressure. The Cincinnati group screening the applications was told at numerous points to stop using explicit search terms like "Tea Party" and "patriot" that profiled a group's political beliefs, according to the report.

Instead, the group quickly substituted more vague terms to circumvent restrictions on specifying political groups, replacing it with "limiting government" and "educating on the Constitution and Bill of Rights," according to the report, which notes the groups did not seek higher approval for the change.