Overstating of Assets Is Seen to Cost U.S. Billions in Taxes

“The Internal Revenue Service has no effective means to determine the price, known as the basis, paid for an asset that has been sold.

Capital gains and losses are reported on an honor system, unlike the rigorous verification regimes that Congress has imposed for wages, home mortgage interest deductions and tax breaks for parents.

Workers have their wages reported to the I.R.S. by their employer. Banks tell the I.R.S. how much people paid in tax-deductible mortgage interest. Congress requires parents to give a Social Security number for each child claimed as a dependent. The working poor are sometimes required to do much more, like producing report cards from schools and affidavits from landlords, to qualify for the Earned Income Tax credit.

Congress has cut overall financing for audits except for the Earned Income Tax credit for the working poor, which critics have said is rife with fraud. But the estimated $29 billion that is lost because of cheating on capital gains is more than four times the highest estimate cited by Congressional lawmakers for losses in the Earned Income Tax credit, most of which the National Taxpayer Advocate has shown is not related to cheating. Math errors and disputes between estranged parents over who may claim a child for the credit account for most of the disputes, and most of those who challenge denials eventually receive the credit.

Since 1997, Congress has given the I.R.S. additional funds to audit the working poor even as it has cut money for other audits. As a result, according to I.R.S. data, the working poor are about eight times more likely to be audited than investment partnerships.

A verification regime for capital gains would end most cheating, the authors say.

In the case of stocks, the authors say, it would be easy for brokerages to keep records of purchases prices. And Congress can build in practical incentives for such record retention, they argue.

The argument that cheating is rampant comes after Congress has nearly halved the maximum tax on long-term capital gains, to 15 percent today from 28 percent in 1997. The Bush administration has said it believes the proper tax rate on capital gains is zero but has not yet proposed elimination of the tax.

Lower tax rates are usually seen as reducing incentives to cheat. The professors say, however, that in the absence of any effective means to detect inflated prices, and with audits a rarity, there is little to prevent cheating beyond the integrity of individual taxpayers.

Investors, entrepreneurs and landlords annually avoid paying at least $29 billion in taxes by overstating the price of stocks, businesses and real estate, two professors say in an article being published today in Tax Notes, an influential tax policy journal.

Claiming to have paid more than the actual price for a stock, business, apartment building or piece of art results in a smaller profit being reported when the asset is sold, and a lower tax on that profit.…”

http://www.nytimes.com/2005/01/24/business/24tax.html