The IRS knows it has a big problem: a tax gap of $450 billion, which is the spread between what the government thinks it should be collecting and what it actually collects. Some cheats fail to report income while others knowingly take write-offs they’re not entitled to. For example, the government pays out billions of dollars annually in refundable earned income tax credits as a result of fraudulent claims. Obviously threats of civil and criminal penalties are not enough to deter some people from cheating, so the IRS employs a number of ways to find these individuals.

Computer data analysis

The IRS uses an Information Returns Processing (IRP) System to match information sent by employers and other third parties to the IRS with what is reported by individuals on their tax returns. The matching is based on information returns submitted to the IRS on W-2s (reporting wages), 1099s (reporting interest, dividends, securities transactions, and nonemployee compensation) and Schedule K-1s (reporting income and expenses from partnerships, S corporations, trusts and estates). The IRS computers then find individuals who received this reported information to make sure it’s been reported on their tax returns. Obviously, some omissions or errors by individuals are simple mistakes; some, however, result from trying to cheat on taxes.

IRS computers are also using filters to find and stop bogus refunds for the earned income tax credit (EITC). The IRS has been able to select 217,000 returns fraudulently claiming $500 million in earned income tax credits for 2013, according to a report from the Treasury Inspector General for Taxation. The report goes on to say that the IRS is using “multi-faceted approaches to stop fraudulent refundable EITC claims.”

IRS computers have become more sophisticated than simply matching and filtering taxpayer information. It is believed that the IRS can track such information as medical records, credit card transactions and other electronic information, and that it is using this added data to find tax cheats. Not surprisingly, the IRS doesn’t share much information about this activity with the public, other than the fact that it’s being done.

Your social media footprint

IRS agents likely are using social media to find tax cheats. (Again, there is little information from the agency about this activity.) Postings on Facebook, Twitter, Instagram and other sites can reveal lifestyles that don’t fit with the amount of income reported on tax returns or with deductions claimed. For example, a claimed deduction for a business trip may be a lie when an individual reveals on social media that the travel was a family vacation.

Of course, without more disclosure from the IRS, how and when social media is used is largely conjecture. However, it’s probable that social media isn’t the audit trigger (the IRS continues to rely on computer matching and other traditional ways to target individuals for audits), but social media may be useful to the IRS once discrepancies are identified to find tax cheats and liars. (See, also, How Do IRS Audits Work?)

The extent of IRS snooping isn’t known.

  • Is the agency looking at private e-mails? Keep in mind that under the Electronic Communications Privacy Act, a federal law enforcement agency can view without a warrant any e-mails stored on a third-party server that have been there more than 180 days as long as they are relevant to an investigation; the e-mails are considered to be abandoned.
  • Is the IRS looking into nonpublic postings on social media? A person can be compelled to reveal postings even when this can be incriminating.

Whistle-blowers

A disgruntled employee or a former spouse may tell the IRS about income that isn’t being reported or other erroneous tax actions that could lead the IRS to recoup taxes. Some whistle-blowers do it for revenge, others because they believe they’re doing the right thing, while others do it for the money. The IRS pays a reward of up to 30% of the government’s recovery for certain whistle-blowing:

  • Mandatory award: 15% to 30% of the amount collected by the government as a result of the informant’s tip. The taxes, interest and penalties in dispute must be more than $2 million. (If an individual is being informed upon, his/her gross income for a year in question must be more than $200,000.) The informant can appeal an award to the Tax Court.
  • Discretionary award: up to 15% of up to $10 million. This award, which can be granted if the conditions of the mandatory award aren’t met, is discretionary and IRS action (or a denial of an award) can’t be appealed.

In the government’s fiscal year ending September 30, 2012, the government paid 128 whistle-blowers. Find out more about whistle-blowing from the IRS. (And see How To Report A Tax Cheat.)

The Bottom Line

Each year, the IRS publicizes some high-profile tax cheats in the hopes that this deters others from doing the same. (Teresa Giudice, who appeared on The Real Housewives of New Jersey, started serving a 15-month prison sentence in January 2015 for tax fraud.) The fact that budget cuts for IRS personnel likely will result in fewer audits of individuals doesn’t mean it will be easier for cheats because IRS computers and whistle-blowers are still doing their thing. (For more, read Five Famous Tax Cheats.)

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