In this economy, folks are very happy to pass judgment about the state of other people’s finances. It has, after all, been conflicting for many (myself included) to watch the government bail out people – and corporations – that have made poor decision after poor decision. As a result, folks are eager to point fingers, wag tongues and make lists explaining how to be a responsible adult. A short one would go something like this:
- Get a job.
- Take care of your children.
- Don’t spend beyond your means.
According to the Seattle Times, Rachel Porcaro did all of these things. A single mom, she took a job at Supercuts in Seattle, Washington to support her two boys (ages 8 and 10). To save on housing, she lived with her parents, paying them a nominal rent. She went without a car.
You’d think she was doing all of the right things.
Except you’re not the IRS.
Porcaro was selected for audit last year. When she asked why she was chosen, the IRS explained that she was too poor.
Yuh-huh. You read that correctly.
The IRS determined, through its handy-dandy database of “what it takes to get by” that her income was too low to support her family. Her income, $18,992, was about half of what the IRS thinks you need to manage a family of three in Seattle. Bells went off – the IRS assumed that she was hiding income (of course).
Even though the IRS eventually found that she wasn’t hiding income – they made some other determinations. The result was that Porcaro owed the IRS a whopping $16,000 in tax for the years 2006 and 2007. That was $16,000 that Porcaro didn’t have – her salary for those two years was just over twice that amount.
What went wrong?
For starters, Porcaro claimed both of her children as dependents on her income tax return. The IRS determined that she wasn’t actually supporting the children and denied her claims to treat them as a dependent; she also lost her right to the earned income tax credit (EITC).
The EITC is a refundable federal income tax credit targeted to low to moderate income working individuals and families. The whole idea behind the EITC was to provide an incentive to work. It helps offset Social Security taxes for taxpayers who work but make a limited amount of earned income during the year; if the EITC exceeds the amount of taxes owed, the result is a credit. To qualify, you must work and file a tax return. Porcaro did both.
To sort out the whole mess, Porcaro did what you’re supposed to do in these situations: she retained the services of a tax professional. The result? The IRS audited Porcaro’s parents.
And again, you read that correctly.
The IRS figured that Porcaro couldn’t possibly be supporting her own children on her salary. To prove that Porcaro wasn’t supporting the children, the IRS wanted to see her parents’ financial and other records.
Porcaro’s parents eventually survived the audit without assessment. They did, however, incur substantial bills in the process. So much for that whole trying to save money bit…
As for Porcaro? She was able to keep her earned income tax credit but failed to prove that her children could be considered dependents. The result was that she owed back taxes plus penalty and interest.
Interestingly, the IRS apparently would not let her parents claim the children as dependents either, which does make me think that there’s a little bit to the story that we don’t know. We don’t know, for example, where the father of the children is or whether he provides any support – that would be a key part of the audit. And we don’t know what kind of medical or child care expenses were incurred – and how those were paid. In the tax world, those kinds of details are important.
But notwithstanding the details, the overall picture is not a good one. As the number of audits ramps up, I’d like to think that targeted audits have more substance to them than comparing a taxpayer to a chart of norms. In the span of a few years, we’ve gone from an overwhelming number of families living in McMansions and driving giant SUVs to those buying smaller houses and relying on SmartCars and scooters (yes, I live in the city). What even constitutes the norm anymore? Is that really the best method to use for a targeted audit?
And let’s straighten out what it is that we want to “solve” when it comes to taxpayer fraud. I know that Congress believes that the EITC is a vehicle for abuse. But honest taxpayers who rely on the EITC shouldn’t fear that the credit makes them more vulnerable to audit by the IRS. If folks in Congress hate the EITC, then they should get rid of it. It’s just that easy. But don’t keep it around just so that there’s something to complain about. We’ve got plenty else that can fill that role.
It would be easy to characterize this story as either an anomaly of “IRS gone wrong” or “that’s exactly what you’d expect from IRS” depending on your view. But I don’t think that either description is completely apt. And I think we’d be missing the bigger lesson here.
This isn’t about Rachel Porcaro. Or the IRS. Or rogue agents. And it’s not about audits.
It’s really about agendas and the economy. As the economy slows, I fully expect more of these horror stories. There is immense pressure at IRS to try and collect more revenue now because the coffers are otherwise empty (trust me, I’ve talked to these folks a lot lately, it’s a different world). And yet, we’re still spending, spending, spending. Middle America simply can’t sustain it. And if our story is that we want people to find a way out of this collective hole that we’ve dug for ourselves, then we need to stop throwing dirt on them.