Originally published on Forbes.com May 19th, 2014
The recent TIGTA report on IRS alimony matching is a scandal of epic proportions that dwarfs Teapartygate in its significance. Response so far has been underwhelming.
Why Alimonygate Is A Much Bigger Deal?
There are some complications about the tax effects of alimony, but there is something that is very simple. If one taxpayer is deducting alimony, some other taxpayer should be recognizing the exact same amount as income. There could be a bit of a lapping problem if in late December Robin mails a check to Terry who does not receive it until early January (Robin and Terry are a couple of indeterminate gender and sexual orientation who were invented to help me with awkward pronoun problems), but you will expect that to pretty well balance out after the first year and almost entirely cancel out when large numbers of taxpayers are considered.
The IRS is able to keep track of this because Robin has to put Terry’s social security number next to the line with the alimony deduction. And, it turns out, the IRS actually does that matching and in quite a few cases investigates the discrepancy. According to the TIGTA report when the IRS looks into a discrepancy, it finds that Robin’s return has to be adjusted about 56% of the time and that when Robin turns out to be right and they take the next logical step Terry gets hit with an adjustment about 83% of the time. So what is the scandal?
The scandal is that, on a percentage basis, very few discrepancies get investigated. In 2010 there were 567,887 returns deducting a total of $10 billion in alimony. Nearly half of the corresponding returns of the recipients did not match. The net difference was $2.3 billion. Of the 266,190 unmatched returns, the IRS opened examinations on 10,870. This led to further examinations of recipients in just over 2,000 cases.
Think about this. For 2010 there were over a quarter-million pairs of tax returns with one of the pair almost certain to be blatantly wrong and the IRS did something about it in just 4% of the cases.
Why Can’t The Computer Take Care Of It?
Alimony is a frequent topic in the Tax Court, probably a couple of cases a month – clearly, we now know those cases are not even the tip of the iceberg, barely a snowflake on the tip of the iceberg. What the cases often concern are ambiguous agreements. The payment arguably qualifies as deductible alimony and it also arguably does not.
I haven’t gone back and counted, but one of the most common things is a lack of provision that payments terminate on the death of the recipient. If payments don’t terminate on death it is more or a property division rather than alimony. The quirk is that just because the agreement does not say that payments terminate on death does not mean that the payments continue after death. That will depend on state law and will not be readily apparent.
So the IRS computer picks up that Robin deducted $24,000 paid to Terry and Terry reported nothing. Who is right? They can’t both be right, but they might each have a plausible argument and it will take a real live person to try to sort it out. If the agent decides that Robin is wrong. Robin can appeal the decision within the IRS, go to Tax Court. If the Tax Court decides that Robin owes the money, Robin can then ask for a collection due process hearing, which can also be appealed to Tax Court. And maybe the Tax Court will decide that Robin was right and it is now too late to chase Terry.
The IRS has over 90,000 people, but only about 20,000 of them are enforcement people, mostly Revenue Agents. You’ve got 20,000 people and there are 266,190 of these cases. My first managing partner, Herb Cohan, would just drop 13 or 14 of them on each agent’s desk, tell them to take care of it and not let it interfere with anything else they might be doing, but you can’t expect that from the IRS. They’ve got a union.
A Crisis Of Conscience For Tax Advisers
Normally, as an adviser, I want things to be clear. On the other hand, I work for the taxpayer. Preparing somebody’s return, I will take the position that is most favorable to them while pointing out possible risks. The AICPA ethics requirements for tax work forbid us from playing audit lottery. Still, people do tend to ask how likely it is that something will be caught. I tend to discount most comments that people make on that topic because they tend not to be based on any facts.
Still, I can say with pretty good confidence that if you don’t report interest and dividends you get a 1099 for, that will very likely get caught. If you claim payments to the IRS that you did not actually make, that will certainly be caught. I also would have said that if you don’t pick up alimony that your ex deducted, that will most likely be caught. Turns out that I was right, but what I did not realize was that most likely the IRS will not be able to do anything about it, which is, as a practical matter, as good as it not getting caught.
The reason that I find this so disturbing is the effect that it will have on the tax profession. Most of us want to both do things right and also do what is best for our clients. Doing things right has a certain degree of elasticity to it, since it is close to impossible to be perfectly compliant, but it is generally not that hard to avoid things that are in your face blatantly wrong like not picking up alimony that somebody else is deducting. If I had a situation in which I was doing planning for a splitting couple, my natural impulse would be to advise that the agreement be unambiguous from a tax viewpoint, but then I think about this hypothetical situation.
Terry comes to me to prepare a 1040. Terry is getting $2,000 per month from Robin. The agreement says that Robin can deduct the payments and Terry should pick them up as income. The agreement also says that the payments stop when their child Ashley graduates from high school. Attorneys who draft agreements like that are either incompetent or devilishly clever. Even though the agreement says that Robin gets to deduct and Terry should pick up the income, the graduation contingency disqualifies the alimony payment.
So I explain this to Terry. The argument for Terry not picking up the income is very strong. Terry is worried though that the IRS will go after Robin, if the IRS discovers the discrepancy. I have to tell Terry that the IRS will notice the discrepancy, but the odds are 25 to 1 that they won’t do anything about it.
TIGTA has recommended that the IRS should send out “soft notices” letting people know that maybe they need to amend their returns. An example is on Page 23 of the report. If they go that route and Terry gets a soft notice, I’ll ask Terry whether there is some reason to rattle Robin’s cage. If not, I’ll tell Terry not to worry. Prior to this TIGTA report, I might have strongly recommended that Terry be proactive in getting the agreement fixed so that it produces the result was intended.
The bottom line is that I used to believe that when I was telling people to do the right thing, I was also telling them to do the smart thing – that the risk of non-compliance outweighs the benefits. That confidence has been eroding in me for some time with respect to people who just want to maximize their lifestyle and are not too worried about their credit rating, but knowing now that something so blatantly wrong will more than likely slide by, not because the IRS can’t find it, but just because they lack the resources to look into it is very disturbing.
This One Falls Squarely On Congress
The way the law is written, alimony mismatches cannot be cleared up without people and Congress is refusing to provide them.
I am likely to get some comments to the effect that if we had some simpler system and abolished the IRS, there would not be any problems. I also read a lot of state cases and there are compliance problems with some relatively simple systems like sales tax and meals tax. I think the primary reason that people don’t pay taxes is that they would rather keep the money themselves and they think they can get away with it. Your simplified system will not change that and there will be a requirement for actual people to enforce the law. If there are not enough of them compliance will erode.
You can follow me on twitter @peterreillycpa.