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Financial firms are less risk for IRS audits { April 11 2005 } Original Source Link: (May no longer be active)
http://www.nytimes.com/2005/04/11/business/11tax.htmlhttp://www.nytimes.com/2005/04/11/business/11tax.html
April 11, 2005
Report Says Financial Firms Are at Less Risk of Tax Audits
By DAVID CAY JOHNSTON
The Internal Revenue Service audits the tax returns of nearly every large company in manufacturing, mining, heavy construction and agriculture, but just a fifth of big banks, insurance companies and brokerage firms, Syracuse University researchers said in a report scheduled for release last night.
The researchers said the disparity in audit rates for the years 2002 through 2004 raised questions about the agency's focus on old-line industrial companies over the returns of financial services concerns, many of which have been central to the proliferation of aggressive tax shelters.
"The very low attention being given to the financial sector by the I.R.S. is particularly surprising in light of the leading role this industry plays in the country's economy, including the level of income subject to federal corporate income taxes," the researchers said in their report.
The I.R.S. said no disparity existed and blamed flaws in its own statistical reporting system.
Among the 11,000 largest companies, the audit rate rose to 38 percent last year, from 29 percent in 2003, according to the report.
A senior I.R.S. executive acknowledged in an interview, however, that some auditors were complaining that the increased numbers might mask a decline in the depth and quality of audits.
The same I.R.S. executive challenged the Syracuse University report, saying I.R.S. corporate audit data was flawed. An audit of a bank or insurance company will be incorrectly reported as a manufacturing industry audit if the examination is done out of a small office, such as Boise, Idaho, that does not have a financial industry specialist, the I.R.S. said. Financial services companies account for 8,000 of the 11,000 largest companies.
"We track audit closures by our organizational structure where the audit was closed," said Deborah Nolan, the I.R.S. commissioner for large- and medium-size businesses.
She said the Syracuse University researchers "tried to oversimplify" the data and "came to the wrong conclusions."
That explanation was disputed by David Burnham, co-director of the Transactional Records Access Clearinghouse, a research unit at Syracuse University that gathers raw government data, organizes it and posts the data and analysis on the Internet at http://www.trac.syr.edu.
"There are indeed flaws in the way the I.R.S. gathers its data," Mr. Burnham said, "but those flaws are nowhere near enough to explain why the audit rates for some industries are five times what the data show for the big banks, insurance companies and brokers. The disparity is just too great for that explanation to hold."
Noting the central role of banks, insurers and brokerage firms in creating and marketing abusive tax shelters, as well as intricate financial derivatives, Mr. Burnham said he found it "truly amazing" that manufacturers would receive more audit scrutiny.
The disparity in audit rates is also a surprise to tax executives at major corporations, said Timothy J. McCormally, executive director for the Tax Executives Institute in Washington.
After talking to some of his members, Mr. McCormally said audit rates for banks might be low because the I.R.S. measured them by deposits, not by assets owned by shareholders. "It could be that it is quite easy to build to a $250 million balance sheet for a bank or insurance company but still not be that big a bank or insurance company," he said.
Ms. Nolan, the I.R.S. executive, said the I.R.S. chose corporations for audit based on its analysis of the risk that the government was being shortchanged, not by industry.
The new data also show that even as the government says that high-level tax cheating is growing, the I.R.S. has cut the rate at which it conducts face-to-face audits of individuals who have business income.
Last year, 45 million of the 130 million individual tax returns showed income from sole proprietorships, also known as Schedule C businesses, or from partnerships, S corporations and other business entities. In 1997, the agency conducted face-to-face audits with 5.6 percent of taxpayers reporting such business income. By 2002, that was down to 2.1 percent, and the next year it slipped to 1.9 percent. Last year the figure fell to 1.7 percent.
Other I.R.S. data show that the audit rates are lowest for partnerships and S corporations, which are favored by investors and professionals such as lawyers. The I.R.S. audit rates are highest for Schedule C businesses, most of which report revenue of less than $50,000.
The I.R.S. has also cut back on assessing penalties for fraud and negligence.
In 2004, 25 negligence penalties were assessed against corporations, a 99 percent decline since 1993. Fraud penalties fell to 132, from 555 in 1993.
Tax returns were filed by 5.3 million corporations last year, but the largest 10,989 accounted for 90 percent of all assets and 87 percent of profits, the data show.
Among the largest companies, the big banks, insurers and other financial services firms collected a quarter of all revenue and earned 61.6 percent of profits to shareholders, but just a third of taxable profits.
Manufacturing was larger, with a third of the revenue. This sector earned just under a quarter of all corporate profits reported to shareholders, but more than 37 percent of all profits subject to tax. Tax rules run counter to the business cycle, pushing up manufacturing profits subject to tax in hard times and pushing it down in good times.
Based on figures reported to shareholders, the financial services firms had a tax rate in 2001 of 15.6 percent because only a little more than half of those profits were subject to tax. The story was the reverse for manufacturing industries, where more money was subject to tax than profits reported to shareholders, resulting in an effective tax rate of 28.8 percent.
Copyright 2005 The New York Times Company
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