Demonizing the IRS to Protect Tax Evaders

This article appears in the Summer 2018 issue of The American Prospect magazine. Subscribe here.

For decades, Republicans have pounded the Internal Revenue Service, initially on the advice of pollster Frank Luntz, whose focus group interviews revealed that exploiting popular resentment of taxes and widespread fear of getting tripped up by the worsening complexity of tax law is an easy way to win votes. Taking this advice, the party that claims the mantle of law and order set out to demonize the tax police. At the same time, Congress has enacted bill after bill that makes the Internal Revenue Code ever more maddeningly complex through devices that overwhelmingly benefit the political donor class—which is to say the wealthiest among us, and the corporations they own or control.

Worse, the complicated new Trump tax law pretends to require such companies as Apple, Goldman Sachs, and Microsoft to pay huge tax bills. However, the fine print gives them discounts of up to 70 percent in taxes they avoided paying for years and then allows them to earn huge profits by further delaying their tax payments. Meanwhile, Congress keeps cutting the Internal Revenue Service budget.

Combine demonization of the tax collector with mind-numbing complexity and you provide the perfect political prescription for massive tax evasion with little risk of detection while gathering votes from disaffected ordinary taxpayers.

IF YOU LOOKED JUST AT federal tax and budget data, you might reasonably conclude that tax cheating is a minuscule and dwindling problem based on how Congress funds tax law enforcement. The one exception to Congress’s steady erosion of the IRS enforcement budget—audits of the poor (see below)—reveals just how Machiavellian this devilish strategy is.

AP Photo/Jae C. Hong

For decades, Republicans have pounded the Internal Revenue Service, initially on the advice of pollster Frank Luntz, whose focus group interviews revealed that exploiting popular resentment of taxes and widespread fear of getting tripped up by the worsening complexity of tax law is an easy way to win votes. Here, Luntz moderates a conversation with House Majority Leader Kevin McCarthy in Beverly Hills. 

In the last fiscal year, fewer than about 1,200 prosecutions for tax crimes were initiated, according to government data analyzed by Syracuse University's Transactional Records Access Clearinghouse. From 2010 to 2015, the number of IRS criminal investigators was cut 16 percent to 2,319, while overall the IRS lost a fifth of its workforce.

Americans file about 150 million individual tax returns, corporations another six million. That means the Justice Department obtains about one indictment for every 100,000 tax returns. And many of those cases are where tax law is an easy way to prosecute drug dealers and politicians who took bribes.

While Congress pretends that tax cheating is rare and becoming rarer, we know otherwise, thanks to a variety of sources, including journalists around the world working jointly through the International Consortium of Investigative Journalists. The 11.5 million leaked documents in the Panama Papers in 2016 revealed how a single law firm, Mossack Fonseca, helped cheat taxes in 39 countries.

The leaked documents toppled the government of Iceland, whose prime minister was hiding money, and showed tax tricks used by Vladimir Putin and his gang of oligarchs, the king of Saudi Arabia, the president of Argentina, and British politicians.

Mossack Fonseca is only one of many firms around the world that specialize in cross-border tax-dodging advice. Few of its clients are Americans. However, Mossack Fonseca created thousands of Nevada shell companies to help clients escape taxation. Its actions illustrate how despite all the political blather about high taxes, the United States is a reliable tax haven for wealthy citizens of other countries.

The Paradise Papers in 2017 expanded our knowledge of high-end tax cheating and brought the names of many Americans and major American companies into the open.

The files came from Appleby, a Bermuda law firm, and others it works with. Many prominent Americans were in the Paradise Papers, including Trump cabinet members. Commerce Secretary Wilbur Ross and his Russian connections were among them. There were also files on businesses controlled by Rex Tillerson, Trump's first secretary of state; Gary Cohn, the former Goldman Sachs head who was Trump's first economic adviser; and ten others close to Trump.

Appleby and other firms insist that everything they do is perfectly legal. Assuming that's true, it points to the failure of Congress and the legislatures of other countries to enact disclosure, finance, and tax laws that will hobble and catch tax cheats rather than enable them. And that also requires adequate funding of the IRS.

AT THE CORE OF HIGH-END tax cheating is the ability to use shell companies to hide assets, known as anonymous wealth. Anonymous wealth hidden from tax authorities totals about $36 trillion worldwide. That’s about an eighth of all the net worth on the planet, according to James Henry, an economist and lawyer who has spent four decades exposing corrupt banking and tax cheating. Henry, a colleague at the DCReport news organization, was a Panama Papers project consultant.

You can observe the rapid growth of anonymous wealth in Manhattan real-estate records that Henry and I reviewed. When Trump Tower opened in 1983, it was one of only two high-end residential towers that allowed apartment buyers to conceal their names. The other was Olympia Tower, owned by the Onassis family.

Trump charged premium prices to buyers who hid behind shell companies. Had a buyer called “Snow Inc.” showed up, Trump did not need to inquire whether this was a ski lodge operator or a cocaine importer.

The lucrative profits in allowing anonymous wealth purchases quickly caught on. Today, close to half the value of residential real estate in Manhattan is owned by anonymous wealth, Henry and I concluded after examining city records. It's a good bet that a lot of apartments and buildings owned through anonymous shell companies represent profits hidden from tax authorities domestic and foreign.

There is one area, however, where congressional Republicans have spent billions of dollars to root out tax cheats, a crackdown demanded by Newt Gingrich when he was speaker and acquiesced to by President Bill Clinton. Congress put up money for intense scrutiny of the working poor who apply for the Earned Income Tax Credit. In the late 1990s, you were more likely to be audited if you made less than $25,000 than if you made more than $100,000.

Hearings and press releases asserting massive tax cheating by the working poor are belied by what National Taxpayer Advocate Nina E. Olson found. About 80 percent of people denied the credit were later determined to have been due the credit. Many others had simply committed innocent errors. Olson also noted that Congress funded far more inquiry into pursuing the working poor than small-business owners who deal in unreported cash, tax evasion that she said was at least 11 times larger.

Patricia Marie Knez, married but separated, filed in 2014 as “head of household.” The IRSnot only denied her the Earned Income Tax Credit, it also asserted she could not refile as married filing separately or jointly after reuniting with her husband. Knez represented herself through the IRSappeals processand ultimately before a U.S. Tax Court judge, who took 11 pages to detail the case before ruling in her favor.

Or consider the case of Rafael Barajas, who cared for his sick mother and two younger siblings, supporting them by working part-time as a machinist earning about $1,200 per month. The IRS denied Barajas the credit, asserting that he “did not care for any of his siblings as if that sibling were his own child.” Like Knez, Barajas represented himself all the way to the Tax Court, where a judge held that “under difficult circumstances” Barajas had “satisfied the requirements” to receive the Earned Income Tax Credit.

Divorced mothers have told me how their ex filed for the credit and IRS agents then demanded extensive proof that their children resided with them. One mother in Queens, who asked that her name not be used, told me, in tears, about an IRS agent losing her documents twice, then demanding she appear in person, only to tell her that her children's report cards and a utility bill did not prove that her children resided with her. Her boss threatened to fire her if she took time off to go to the IRS again to hand-deliver a notarized statement from her building superintendent, which an IRSagent rejected as inadequate, but a supervisor accepted.

Greater scrutiny of the poor continues today, though at lower levels because Congress has been cutting IRS funding, down more than a third per tax return since the turn of the 21st century.

Congress also perpetuates draconian penalties for the working poor, including a ten-year ban on receiving the Earned Income Tax Credit if misconduct is found.

No pile of massive funding was provided, however, to pursue the sham tax shelters promoted by the major accounting firms with help from big banks, especially Deutsche Bank and a host of Swiss and British banks. While a few high-profile court victories got a lot of attention in the news, little was done in terms of revising tax laws to make them clear and rigorous or providing enough tax police to discourage cheats.

Poorly drafted tax laws combined with fewer tax police is a formula for encouraging tax evasion by those at the top. In more than four decades of attending tax trials, I have watched prosecutors make incredibly detailed arguments that jurors later told me left them utterly confused.

Consider the prosecution of an Illinois car dealer who claimed to be a resident of the Virgin Islands to take advantage of a targeted tax ploy allowed by Congress. The core of the case was easy. To get the credit you had to be a bona fide resident, but the car dealer had rented out his condo to the federal government.

But instead of presenting a lean case focused on that fact, Justice Department prosecutors presented more than 118 hours of tape recordings and 6,000 documents. That fits with a pattern I have observed in federal tax trials going back more than 40 years. In the 2008 prosecution of actor Wesley Snipes, the prosecutor spent hours summing up his case instead of just holding up a 600-page manifesto that Snipes sent the government asserting that no law requires paying income taxes.

Jurors in both the car dealer's and Snipes's case, as well as some others I covered, acquitted the defendants despite overwhelming evidence of willful misconduct. (Snipes was convicted on a minor charge.)

AP Photo/Mark Lennihan, File

The complicated new Trump tax law pretends to require such companies as Apple, Goldman Sachs, and Microsoft to pay huge tax bills. However, the fine print gives them discounts of up to 70 percent in taxes they avoided paying for years and then allows them to earn huge profits by further delaying their tax payments.

Michael Minns, a Houston criminal defense lawyer who went to law school at night, uses the complexity of the tax code to help clients. In one typical case, his Michigan clients used complex trusts to make taxable income vanish, though they were at best sloppy in applying the techniques. The government's star witness was a veteran IRS auditor. Prosecutors droned on and on with detailed questions about the many transactions.

Minns conducted a brief cross-examination that roughly went like this:

How many advanced degrees in tax law and accounting do you have?

Two.

How many years have you studied and worked with the tax code?

More than 20.

Have you, after all that study and practice, mastered the tax code?

No.

If I told you that because of the extreme complexity of the tax law your audit contains errors would you be surprised?

No.

Little surprise that the jury in that case found reasonable doubt and acquitted the defendants. That Minns smiled and said good morning to jurors every day while the prosecutor looked stern and stiff also helped.

In the Swiss and other offshore bank cases, where Americans hid billions of dollars from the tax collector, official data analyzed by tax lawyer Jack Townsend shows the average fine was just $49,356.

Of 58 people who confessed, only 27 went to prison with an average sentence of just five months. All 58 owed a combined $118 million, but only 14 made any restitution. Add up all the restitution and it comes to just 4 cents on the dollar of tax evaded, assuming the IRS found all the evasion, which of course it didn't.

Going to trial was riskier, but 14 tax cheats were tried, 12 of them convicted. Their average sentence came to more than seven years. And average restitution among those convicted after trial was more than the tax evaded by almost $1 million.

The government made an effort to go after corporate tax shelters, too, but with similarly weak results. In general, companies that exploited a disconnect between different parts of the tax code got away with it so long as they made sure to follow the exact path laid out by tax lawyers. Some of those lawyers charged $1 million for an opinion letter stating that the tax strategy would survive an audit, though the opinions were rife with caveats.

Demonizing the IRS has also helped tax cheats by making juries distrust our tax police.

That encourages dishonesty in self-reporting income and deductions.

It also made believable a fabricated scandal ginned up five years ago by Representative Darrell Issa and his Republican colleagues on the House Oversight and Government Reform Committee. Issa and friends asked the Treasury inspector general for tax administration to investigate whether the IRS “targeted” groups seeking tax-exempt status as 501(c)(4) organizations in 2010 and beyond so they could not participate in elections.

The Republicans asked for a report only about conservative groups, not all groups. When House Democrats asked for more information, it turned out that liberal and progressive applicants got similar scrutiny. But by then President Obama had foolishly stepped into the issue, announcing on national television along with the Treasury secretary that the IRS commissioner had been fired.

The real story was that a low-level IRS manager, who volunteered to Issa's investigators that he is a conservative Republican, learned that many 501(c)(4) applications declared plans to engage in promoting politicians in partisan races. Congress says that's not allowed. His actions were like those of a building inspector who is shown plans for a building that he concludes will collapse if built and orders additional scrutiny.

Today, virtually every American who has heard about the issue now believes that the IRS withheld approval of tax-exempt status for conservative groups who sought it. Indeed, The Wall Street Journal recently ran an op-ed stating as fact that the IRS had deliberately and maliciously targeted conservative applicants for tax-exempt status.

The net result of adopting Frank Luntz's advice to attack the IRS, the budget cuts, the adoption of ever more complex laws, and sucking the inspector general into a one-sided audit has been to lay the groundwork for a major transformation of the tax system.

MOST AMERICANS HAVE their income (and Social Security and Medicare) taxes withheld from their paychecks before they collect the balance. That system is mostly automated so IRS budget cuts have little effect on them.

But for Americans who control their finances, it's another story. Business owners, especially those operating on an international scale, self-report. Unless they are thoroughly and frequently audited, they can understate their income and overstate their deductions.

One of the most blatant examples of this is in small real-estate partnerships. When each deal ends with sale of a property, they are supposed to pay back the income taxes they saved while depreciating the nominal value of the building usually after 20 years (the actual value typically increases—this gimmick is another legal tax fiction that benefits the rich).

Jerry Curnutt won awards a quarter-century ago as the IR Schief partnership specialist for identifying this type of cheating and how to easily and efficiently identify it. The IRS sent him all over the country to teach the technique to IRS and state income tax auditors.

There was just one problem. His audit technique was never put to use, except when Pennsylvania hired him as a consultant. Even though Pennsylvania is just about the worst state to find such cheating because of peculiar aspects of its tax law, Curnutt quickly found some big-time cheats, contesting audit findings in court.

We could catch lots of tax cheats with simple changes to tax law and computer software that identifies patterns. Congress vowed in 1998 to get the IRS new computers with just such a capability. But Congress has never funded the software needed to identify more cheats.

WITH THE GROUNDWORK laid for distrust of our tax police, the new tax law signaled another major shift in American tax policy, a shift that has received little attention in the news. You may have read that because of the Republican Tax Act, multinational companies are now repatriating about $2.6 trillion of profits held offshore. That was supposed to mean more capital investment at home, creating jobs and resulting in higher wages. None of that has happened, but something much more sinister from the point of view of average taxpayers is in that law, something incredibly costly.

Many of those untaxed “offshore” profits were actually earned in the United States. The companies used a five-word section of the 1986 Tax Reform Act to convert those taxable profits into tax-deductible expenses paid to offshore subsidiaries. For example, every time Pfizer sells a Viagra tablet, it pays a royalty to a Swiss subsidiary, which passes the money on to a Liechtenstein entity known in tax argot as a “see nothing” because it is invisible to IRS auditors.

These companies will also benefit from severe cuts in corporate audits. In 2017, the IRS audited just 331 of the 616 giant corporations, compared with near universal audits of the biggest companies up until 2013.

More troubling, the IRS audited only 331 big companies in 2017, which is 100 fewer than in 2010, and spent 49 percent less time on these audits. That means that many of these audits were not thorough, known in an unflattering comparison to low-calorie beer as “audit lite.”

These and other provisions of the old and new tax law, together with demonizing the tax police so the public is suspicious of the IRS, constitute a huge new program of welfare for the rich. By shifting the burden of taxes down the income ladder—did you get a 57 percent discount and an eight-year zero-interest loan from Washington?—the rich can get ever richer without taking risks investing their money in productive assets that create jobs in America.

On the surface, our tax law is progressive, meaning that the more you make, the larger the share of your income you pay in federal income taxes. But for people who know how to exploit the weaknesses, are willing to take the minimal risks of buying into illegal tax shelters, and who can arrange to delay paying their taxes years into the future, the Republican changes in the tax law make life even easier.

SWEET DEAL FOR APPLE

Apple announced it would pay $38 billion in taxes because of the 2017 Tax Act. Technically, that's true. It's also a gross distortion of what the Tax Act does. That $38 billion will be paid in installments from this year through 2025. And the installments are backloaded, just 8 percent annually for five years and a quarter of the money due on the last day of 2025.

That means Congress loaned Apple $38 billion at zero interest. As the accompanying chart shows, if Apple continues to earn its current rate of return on shareholder equity, the company will make $68.7 billion in pre-tax profit because its tax payments are delayed.

Apple actually hinted at the deferred tax payments in its press release, boasting that it expected to make the largest tax payment in history. Apple said it “anticipates repatriation tax payments of approximately $38 billion as required by recent changes to the tax law. A payment of that size would likely be the largest of its kind ever made.”

No mention that Apple will pay $38 billion, but through discounts and investing, its deferred taxes earn what I calculate is about $113 billion in added profit.

Trump and the Republicans gave Apple a 57 percent discount on its taxes, saving it about $42 billion. The Trump tax law gives a 70 percent discount to companies that invested their untaxed offshore profits in offshore factories.