Why the IRS Goes After the “Minnows” and Ignores the “Whales”

The intrepid bureaucrats at the Internal Revenue Service have done a superb job of making us fear them. We dutifully file our 1040s, FBARs, and all manner of other forms, consent to having our wages withheld from our paychecks, and suffer indignities on a daily basis at which our forefathers would have blanched.

But it’s never enough. I have seen many examples in my years of experience as a consultant. One client was pursued for 18 months for an underpayment of a few dollars and wound up paying more than $1,000 in penalties to make the IRS go away. Another client filed an offshore trust reporting form one day late and the IRS tried to collect a 35% penalty on a $1 million transfer to the trust.

But I don’t have a large collection of horror stories involving the big Fortune 500 companies. Sure, the IRS took down Swiss banking giant UBS as part of its ongoing vendetta against all things offshore. But these cases are few and far between.

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I’ve often wondered if the IRS has a formal policy for ignoring tax evasion and fraud by “whales” (Fortune 500 companies) and instead focusing on “minnows” (you and me).

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It turns out such a policy does exist. It may not be formal, but nonetheless, it is real, according to several insider sources, including two high-level attorneys working at the IRS (although perhaps not for long) and one former IRS attorney.

Jane Kim is an attorney in the IRS Office of the Chief Counsel. She recently wrote a letter that accused IRS executives of “deliberately” not pursuing cases of multibillion-dollar tax frauds. Kim accuses top officials at the IRS of intentionally undermining the IRS Whistleblower Office to avoid taking action “in cases involving billions in corporate taxes due.”

She also says the IRS has a policy of not enforcing the tax laws that pertain to “large corporate taxpayers,” resulting in the loss of additional billions in tax. On the other hand, Kim says the IRS applies tax laws with “draconian strictness to small business, the self-employed, and wage-earning individuals.” Kim’s letter contained numerous examples of cases the IRS declined to pursue that resulted in nearly $15 billion in lost tax revenues.

Bill Henck is another IRS attorney in the Office of the Chief Counsel. According to Henck, since 2003, the IRS has opted not to pursue a series of corporate tax scams, which has resulted in more than $50 billion in unclaimed taxes. Henck also says he has “personally witnessed” the “bullying of elderly taxpayers” in cases that should never have been brought.

One anonymous ex-IRS attorney says:

Almost every large firm or corporation has a person inside the IRS. It’s a revolving door, with the top two or three management layers all from big accounting and law firms, and this is why they won’t work big billion-dollar cases criminally. Private bar attorneys are, in effect, controlling the IRS. It’s a type of corruption – that’s the word used by one IRS agent I’m in touch with whose case was shut down by higher ups without cause.

Now, don’t get me wrong. Personally, I think income taxes should be much lower – or even abolished altogether – and replaced with value-added taxes or even tariffs on imports. I don’t get hot and bothered over big corporations and their complicated tax-avoidance schemes because I view taxes as just another cost of doing business. And, like any other cost, keeping tax payments to the minimum necessary is just a prudent business practice. Indeed, public companies have a fiduciary duty to their shareholders to keep tax payments as low as possible.

But as long as we have a tax system that imposes income tax, I think the least we can expect is for the agency responsible for collecting it to treat everyone equally. The evidence is overwhelming that it doesn’t work that way.

Plain and simple, the IRS plays favorites. If you’re the CEO of a Fortune 500 company with a former executive sitting in a top position at the agency, the tax-avoidance strategies your lawyers come up with won’t be challenged. But if you’re an ordinary taxpayer, the “sword of Damocles” is ever present.

I don’t see this changing anytime soon, if ever. The Republicans are in bed with big business; they’re perfectly happy having the Fortune 500 call the shots. The Democrats are so obsessed with “fairness” and “equality” that they miss the obvious: if tax rates were reduced, the incentive to cheat or invent sophisticated means of avoidance would be reduced as well.

Until that happens – and I’m not holding my breath – there are only a couple of things you can do if you’re a US taxpayer. One is to physically relocate abroad and work as a US national overseas. If you do, you can legally exclude up to $99,200 of earned income each year from the clutches of the IRS. But this is hardly a perfect solution, because you still have to file tax and reporting returns with the IRS, and if you make even a minor mistake, the penalties the IRS can impose are nothing short of horrifying.

The other option is to get out of Dodge – permanently – by giving up your US citizenship and passport (after, of course, you acquire another one).

A radical solution? You bet. But if you’re tired of dealing with the intrinsically corrupt tax system administered by the IRS, that’s the only choice.

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