It’s never a good thing to have a handful of auditors descend upon your business. It’s even worse when you planned to spend the day lobbying City Council to plug holes in your budget.
That’s exactly what happened to the School District of Philadelphia. As noted previously, the embattled district is facing massive shortfalls in its budget for the coming year. Cuts are planned across the board including teacher furloughs and layoffs, staffing cuts, reduced services and elimination of bus and other transportation for students.
Some taxpayers – as well as members of City Council – have raised questions about the School District’s finances. Now, it appears that the IRS has interest, too.
The Philadelphia Inquirer has reported that there are 28 specific areas of inquiry as part of the audit, which focuses on the year 2009. The IRS is apparently most interested in payroll and benefit related matters, inquiring into forms W-2 and 1099 as well as reimbursements for meals and other expenses.
The district has reportedly requested an extension to deal with the requests for information. Spokeswoman Shana Kemp said, about the requests:
We intend to fully comply and answer each of the items. The day that IRS auditors arrived, Tuesday, May 24, the start of the City Council budget hearings, we realized that an oversight had occurred and requested the opportunity to reschedule the meeting with them. They graciously agreed to come back at a later date.
A day after the auditors showed up, the district fired Eileen Pelzer, who was the payroll director at the district. A spokesperson would not comment on the firing.
Most of the information requested from the district appears fairly routine for an audit: cash journal, chart of accounts, checking account information, contracts with employees and contracts with independent contractors and subcontractors.
It’s also clear that the IRS is targeting payroll for purposes of the audit. The IRS is also seeking information related to reimbursement policies for travel and meals and has requested a breakdown of salary, sick and vacation days for employees who left the district (either voluntarily or by being terminated).
Statistically, audits are increasing across the board with the chances of audit traditionally settling in at around 1 in 150 (those odds will likely increase to 1 in 99 for 2011). However, only about 2% of audits are considered chance or random; in most cases, the IRS is engaging in targeted enforcement, meaning that something about your tax return or business activity has triggered interest, usually from a list of hot topics.
For the most recent year, based on statements from IRS, the Treasury and the White House, the IRS intends focus on offshore accounts, real estate losses and worker misclassification (White House budget, downloads as a pdf). The latter might explain why the School District of Philadelphia is under investigation.
It’s been alleged that the district issued forms W-2 and 1099 for the same taxpayer. This definitely raises eyebrows at the IRS because it’s not common to issue both for the same taxpayer – but it’s also not necessarily improper, depending on the scope and types of work being performed (see comments in particular).
It’s also important to keep in mind that an audit in and of itself is not necessarily indicative of wrongdoing. Even if the district is found to have compliance issues, mistakes happen. The magnitude of those mistakes and the degree of willfulness involved will, I think, be key.
As is the case with civil taxpayer matters, the IRS has not issued a public comment.
You can bet, however, that plenty will be said about the audit in taxpayer circles today. In Philadelphia, City Council is debating whether to increase funding for the district this very week, and voting on funding at the state level will begin next week. In terms of timing, it just couldn’t be worse, which, of course, makes one wonder: coincidence?
