IRS Audits 800 on Its Staff Over Suspect Deductions

The Internal Revenue Service is auditing about 800 of its employees after discovering that a handful of the agency’s workers may have cheated on their tax returns.

“I am disappointed that a small but unacceptable number of our employees have generated false business deductions to reduce their taxes,” IRS Commissioner Mark W. Everson said Friday in a statement. “We have a zero-tolerance standard for abuse of the tax laws by employees.”

The probe of IRS employees comes during the agency’s biggest crackdown on tax cheating in more than a decade. Over the last three years, the IRS has been hiring additional agents and examiners while attempting to find more efficient ways to ferret out and prosecute domestic and international tax schemes. That effort has resulted in dozens of lawsuits, indictments and settlements, making the revelation about internal misconduct all the more embarrassing.

“You have to have your own employees in compliance or the average taxpayer is not going to have any confidence in the system,” said Edward M. Robbins, an assistant U.S. attorney in Los Angeles who helps the IRS prosecute tax cheats. “The agency is constantly looking at their own employees. But it’s important to say that this doesn’t indicate that they have 800 tax cheats. They are just looking at 800 people.”

The audits were spurred by a tip from an IRS employee that some agency workers might be filing bogus Schedule C tax forms, which are used to list profit and loss from self-employment or a small business.

After receiving the tip, the Treasury Department’s inspector general for tax administration, which has oversight authority for the IRS, examined 25 IRS employee returns that included Schedule C forms and found that about half of them contained questionable deductions or had other compliance issues.

Several of the employees who submitted the suspect returns have been fired, IRS officials said. Some are still under investigation. The names of the employees and the offices where they worked were not released.

Given the high rate of suspect returns in the sampling reviewed by the inspector general, the IRS decided to conduct a broader investigation into its employees’ tax returns. An electronic screening of returns filed by all 115,000 IRS workers turned up about 800 with suspect Schedule C information, IRS officials said, and these are now being audited.

Pam Gardiner, acting inspector general for tax administration, said she couldn’t comment on the investigation, but said the agency was trying to determine whether the problems were intentional or just honest errors.

The tax returns of IRS employees are subject to considerably more scrutiny than the average taxpayers’. All professional-level IRS employees -- everyone from tax examiners to Commissioner Everson -- are audited when they join the agency. Lower-level employees, such as typists and clerks, face less-aggressive scrutiny. However, all employee returns are tagged so they can be easily sorted and reviewed if necessary, IRS officials said.

Singling out several hundred employee returns for audit on a single issue is rare and hasn’t happened “in recent memory,” if ever, officials said.

Given the scope of the IRS’ effort to crack down on companies and individuals who cheat on their taxes, tax attorneys said it’s appropriate for the agency to go to extra lengths to root out cheating within its own ranks.

“This sends the right message,” said Elliott Kajan, partner at Beverly Hills tax law firm Kajan Mather & Barish. “It says that no one is immune from IRS scrutiny, no matter how low or high on the totem pole. I’m pleased to see that the IRS is continuing to ensure that compliance comes from within, as they expect compliance to be part of the public’s goal as well.”

Everson said he expected that many of the 800 employees who were being audited would be able to substantiate their business deductions.

Among the items that can be claimed on a Schedule C form are such business-related expenses as magazine subscriptions, office equipment, the cost of entertaining clients, wages for other workers and health insurance -- but not the costs of maintaining a home office.

IRS employees are allowed to earn outside income from second jobs and freelance work, as long as the worker has received permission from a manager and the work does not involve preparing or commenting on tax returns, officials said. In addition, some IRS employees are married to self-employed spouses.

Those who cannot substantiate their business deductions will face “appropriate action” depending on the nature and severity of the situation, Everson said.