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Posted 4/8/2002

Are You a Tax Chump or a Tax Cheat? Big companies pay nothing and the superrich have their dodges. Why more folks are getting aggressive By Daniel McGinn NEWSWEEK

			SHE’S WRITING OFF her husband’s birthday trip from their Dallas home to San Francisco (she had breakfast with a publisher, and she may write about wine country), and she’s deducting the groceries and liquor for a party she threw for other writers after a book reading. “I think it works—who knows?” she says. Cynthia Smith Freed, an interior designer, has started obsessing over receipts, mileage and every $1.50 phone call—”all the small things that I previously thought weren’t worth the hassle,” she says. Freed’s war on taxes is fueled by stories about how companies like Enron have dodged taxes. “We’re paying taxes and they’re not?” she says. “It makes me feel like I’m getting screwed.”
			As tax season enters the homestretch, more Americans appear to be taking aggressive steps to shrink their checks to Uncle Sam. Federal data on tax compliance are spotty and out of date, but in interviews with NEWSWEEK, a score of tax experts say that self-employed and high-income folks appear increasingly emboldened. They’re aware of the small odds they’ll be audited, the pros say, so they’re more likely to inflate deductions. A recent survey shows the number of people who say they believe in being totally honest on their taxes declined from 87 percent in 1999 to 76 percent last year. There’s also evidence of more outright evasion. Last month the IRS estimated that 2 million Americans are using offshore accounts to evade taxes. And in seminars and on the Internet, a group of tax revolutionaries are teaching people to stop paying taxes altogether. They could be in for a surprise: after years of complacency, the IRS is poised for a crackdown. But as headlines publicize the growing number of tax cheats, honest taxpayers are left feeling like chumps. “If there’s a sense that no one else is paying their taxes,” says William G. Gale of the Brookings Institution, “people might naturally feel ‘Why should I?’ ”
			COSTLY NONCOMPLIANCE        It’s difficult to quantify exactly how much that thought is crossing people’s minds as they sit down to do their taxes. The IRS estimates the “tax gap”—the difference between what people should pay and what they do pay—was $278 billion in 1998, so every emotion that drives noncompliance is costly. Academic research shows that taxpayers’ perception of enforcement (will I get caught if I cheat?) is the major factor when they decide to fudge or not. Other data suggest that people who use professionals to do their taxes are more apt to inflate deductions. But people’s sense of whether other taxpayers are paying their fair share is an influence, too, according to researchers. That means all the headlines about tax evasion could have a trickle-down effect. If you’d asked University of Michigan tax expert Joel Slemrod last fall how current events might influence taxpayer compliance, he’d have said that the patriotism inspired by September 11 might reduce cheating. But with tax evasion now getting daily publicity, the mix is murkier. Surely some people are thinking ” ‘if everybody else is doing it, if big companies are doing it, I want to do it too’,” he says.
			Tax Tools From MSN •  Tax Estimator •  Deduction Finder •  Tax Glossary        Even in a world with few auditors, the IRS has ways to keep most taxpayers in line. The average family’s income comes mostly from wages, interest and dividends, and the IRS can match those numbers with reports from employers, banks and brokerages. Likewise, many middle income taxpayers don’t itemize deductions, limiting their ability to embellish. That means most tax tricks are available only to richer taxpayers, and it leaves out folks like Margaret and Dave Collette. Emptying their tax records onto their kitchen table, they show how they owe $9,836 in taxes on their income of $79,844 (he’s an exterminator, she’s an ultrasound technician). They say their finances are too straightforward for shenanigans. “Creative accounting is for people with a lot more money than us,” says Dave. The Tax-Free Bermuda Getaway         Thurston Bell has a suggestion for him: just tell the IRS you had no income. Bell is a self-proclaimed tax expert who, like other promoters of the “tax honesty movement,” has parsed the tax code and concluded that key portions are vague and unenforceable; he says the IRS is powerless to stop people who use his convoluted arguments to claim taxes don’t apply to them. Experts disagree. “A lot of these people are trotting out old arguments that have been repudiated by the courts,” says Mark Luscombe, federal tax analyst at CCH Inc., a tax-guide publisher. In fact, Bell is facing a Justice Department lawsuit, but people still buy his system of filing “zero income” returns and answering IRS inquiries with carefully crafted letters. Bill, a United Airlines pilot, says it’s no more unethical than when companies relocate to Bermuda to avoid U.S. taxes. “My whole focus is, how can I take home more money to provide for myself and my family,” he says. “Look, if there’s no law that makes you liable, there’s no penalty,” says Marc Yarborough, a truckdriver who stopped paying taxes 10 years ago. The IRS has taken him to court, Yarborough says, but it hasn’t prevailed yet. “Now I’ve got $12,000 more a year in my pocket.”
			A BELEAGUERED AGENCY        These stories almost make you feel sympathy for the IRS. Clearly it’s a beleaguered agency. During the last decade, the number of employees has dropped 17 percent, while the workload has increased 20 percent. Since 1998, when Congress investigated IRS agents’ abusive behavior, the agency has been focused on customer service, and in 2000 it examined just one in 232 returns, down from one in 79 in the 1988. “For the last couple of years nothing seems to have raised a red flag,” says Jan Zobel, a tax expert in Oakland, Calif. “I’m feeling not quite as cautious.” The agency hopes to change those attitudes soon, hiring new auditors and has announced a National Research Program, which will mark the first comprehensive random audits since 1988. “We’re trying to do more,” says Larry Levitan, chairman of the IRS Oversight Board. “There is no question we’ve got to stop this slowdown in enforcement activity.”
			Until then, many filers will be constrained only by their own consciences and their preparers’ arched eyebrows. Maryland tax expert Connie Kurtz knows this expression well. When her clients present her with suspiciously high deductions, she tries to encourage honesty. “I ask if they have their deductions documented, they say yes, and we go forward,” she says. She doesn’t approve, but she’s resigned to it. Chances are they won’t get caught: Kurtz hasn’t had a client audited in years. But even if Uncle Sam isn’t watching, she makes a subtle appeal that some higher authority might be. “Behind my desk there’s a picture of heaven and hell,” she says. Until the IRS ends its era of laxity, many people will be praying Saint Peter doesn’t ask to see their 1040s.         T. Trent Gegax, Ellise Pierce, Joan Raymond, Tara Weingarten and Rich Thomas

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