Weaponizing the IRS could be every politician’s dream fantasy. Two senior former FBI officers who were fired by then-President Trump were both the targets of an unusual kind of IRS audit, according to a New York Times report from last week. Later headlines from prominent media publications suggested that the reason former FBI Directors James Comey and Andrew McCabe were chosen for these audits was because they enraged the previous president. The situation’s public relations consequences were so severe that IRS Commissioner Charles Rettig almost immediately sent the case for inquiry to the Treasury Inspector General for Tax Administration (TIGTA). TIGTA is a department of the U.S. Department of Treasury that offers impartial review of IRS operations. However, the rest of the nation makes assumptions as TIGTA investigates. It’s crucial to take into account the information that is available in addition to the headlines that capture your attention if you’re one of those who speculates.
Two Forms of Audits
Most people envision an audit as something they may refer to as a “prove it” audit. To choose income tax returns for these kinds of audits, the IRS use a mechanism known as a DIF score. In essence, the DIF score informs the IRS when specific items on a tax return don’t fit within predetermined limits. The parameters used by the IRS to assess various forms of income and deductions, as well as how they are calculated, are closely guarded secrets. A tax return may not always be chosen for audit even though it has a high DIF score. Simply said, the DIF score is a method the IRS uses to determine which returns to audit.
When a return has been chosen for audit based on the DIF score and other variables, the taxpayer is frequently contacted to provide documentation supporting the deductions they claimed on the return. Deductions are a matter of “legislative grace,” as the courts have made plain since since the case of New Colonial Ice Co. v. Helvering (who was serving as the Internal Revenue Commissioner at the time). In addition, if the taxpayer’s return is scrutinized, the IRS is within its legal rights to demand that taxpayers verify (or prove) that they are entitled to a deduction (audited). The IRS may also examine the taxpayer’s bank statements and other financial records to determine whether deposits are taxable income or something else (e.g., gifts, non-taxable inheritances).
Audits by the National Research Program (NRP) did, however, focus on Directors Comey and McCabe. These audits are extremely seldom and rigorous. Some people view them as being overly detailed. In fact, the 2021 “Purple Book” of legislative proposals from the National Person Advocate recommended paying taxpayers who were the target of these audits unless the audit led to changes that compelled the taxpayer to pay more. Previously known as the Taxpayer Compliance Measurement Program (TCMP), these audits are used, among other things, to determine the tax gap. The tax gap is the discrepancy between the amount of tax that is due for a particular year and the amount that the IRS actually collects. Commissioner Rettig pegged the annual tax gap as high as $1 trillion.
NRP audits choose taxpayers at random using an algorithm, in contrast to “prove it” audits, where suspicious (or deviant) items on a tax return lead to a high DIF score. However, the algorithm itself is made to assist the IRS in calculating the tax gap and has nothing to do with whether or not the IRS believes a particular taxpayer is engaging in tax evasion or fraud. Instead, the IRS creates (and improves) the algorithm to increase the precision with which it determines the tax gap. This allows the algorithm to be modified to concentrate on particular groups or categories of taxpayers who are more accountable for the tax gap.
The tax gap typically arises when a person’s income comes from places other than the employers who issue W2s. People are substantially less likely to fail to declare taxable income if their income is additionally reported to the IRS by a third party than if it isn’t (or is only partially) reported on forms provided by third parties. People who file a Schedule C (Profit or Loss from Business) and/or a Schedule E (Supplemental Income and Loss, which includes rent and royalty income) frequently fail to disclose all of their taxable income and are therefore accountable for a sizable portion of the tax gap. Because of this, it makes likely that the IRS would modify the algorithm that chooses returns for an NRP audit on groups of returns that contain a Schedule C and/or a Schedule E.
Since the middle of the 1990s, Enrolled Agent Robert Kerr has worked on tax administration issues for the IRS Research Division, the tax business, and his own customers. He says that NRP audits “need to encompass a variety of income strata, locations, and return types.” He asserts that while it is improbable that the IRS has a stratum for “FBI leaders,” it most likely does have one for taxpayers in particular ZIP codes who file Schedule C and/or Schedule E and have annual incomes of exceeding $250,000.
Even though it is undoubtedly a strange coincidence that two former FBI agents who crossed the former president were chosen for these arbitrary audits, it isn’t quite as significant a statistical outlier as it might initially appear to be. The chances of Comey and McCabe being chosen for an NPR audit (even in different tax years) seem astronomical or even lottery-like when taking into account a truly random pool of audit candidates, but within the NPR algorithm’s targeted sample group, perhaps they aren’t quite that high. That is, it would be highly improbable for an algorithm to choose Comey and McCabe from a pool of regular taxpayers. It would still be odd that both of these men were chosen, but statistically it wouldn’t be quite as unlikely if the algorithm was looking for taxpayers above a certain income threshold, with above a certain amount of Schedule C or Schedule E income, and within a given geographic region. Unlike the pool of potential auditees, the taxpayers chosen for audit are chosen at random.
Targeting? maybe programming?
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After they were sacked, the tax returns of Comey and McCabe were also chosen for audit. Alternatively put, once they stopped receiving a W2. It’s possible that the former president didn’t specifically ask the IRS Commissioner to perform him a favor because he was enraged with them. The source of their money might have been the only (and most likely) factor.
2019 will see an NRP audit of Comey’s 2017 tax return. He received additional money from paid speaking engagements in 2017 in addition to a seven-figure book contract. Both Schedule C and Schedule E, for book royalties, are commonly used to report these sorts of income. An NRP audit of McCabe’s 2019 tax return was chosen for that year. After leaving the FBI, he worked as an on-air law enforcement commentator for CNN, which would have qualified him as a self-employed consultant (Schedule C with a 1099) rather than a CNN employee for tax purposes (W2).
