IRS data sharing may increase state revenue

AUGUSTA – For the first time, Maine tax officials have received electronic copies of partnership tax returns filed with the Internal Revenue Service, which could mean “significant” additional revenue for the state.

The state has received paper copies of the so-called K-1 forms in the past, but complicated returns can be lengthy and relatively few have been scrutinized in the past, according to Tony Neves, executive director of Maine Revenue Services.

Receiving the information electronically, however, will allow the documents to be analyzed by computers, he said. “We will be able to automatically generate letters based on the federal returns, and we will certainly have more leads to follow.”

Neves said he could not estimate how much money will be realized by having electronic access to the federal returns, but it could be “significant.” How significant will depend on a number of factors, including whether the department has the staff to follow up on all potential leads generated by the computer analysis.

“We only have so many auditors and we have to put them on the cases that are most likely to prove productive,” Neves said. “Two sessions ago we convinced the Legislature to give us three positions to audit these returns. We estimate each auditor has generated an average of $750,000 a year in revenue.”

There are 14 types of partnership income, such as rents, royalties and capital gains. The electronic data from the IRS will allow each federal return to be examined and compared to state returns through computer matches. For example, four individuals who each own one-quarter of an office building that generates a net income of $100,000 each should be reporting $25,000 of income on his tax returns to both the federal and state governments.

Computer matching also will allow complex partnerships with foreign partners to be scrutinized. Tax experts say such partnerships sometimes are created to avoid paying taxes. But at least one tax expert isn’t convinced the electronic data will benefit the state that much. “I don’t think you will find many foreign partnerships in Maine,” said Peter Chandler, a partner with Baker Newman & Noyes, a Portland-based accounting and consulting firm. “I am just not sure the state will be getting all that much more [revenue] as a result of this. They have been scrutinizing partnerships for some time; it’s not like this is a whole new area.”

He did say one area that might prove productive for the state involves finding partners who live in other states but have income from that partnership that was earned in Maine. He said if the out-of-state partners have not reported their income in Maine, they could face a significant tax bill with penalties and interest. “People will always seek a way to get around the law,” said University of Maine professor of investment education and finance Robert Strong. “Oftentimes they set up a partnership to pay less tax, and there is nothing wrong with avoiding taxes. Evading taxes is illegal; avoiding taxes is certainly not.”

He said lawmakers at the state and federal levels often believe they have established tax laws that do one thing, only to find out somebody has found a way to “get around” that tax policy. He said the whole tax consulting industry is built around finding ways for people to pay less in taxes.

“I think this will mean more revenue for all those states that tax partnership income,” Strong said.

Just how much in state income tax is being avoided is uncertain. In testimony to Congress, IRS Commissioner Charles Rossotti, said as much as 20 percent of partnership income is not being reported on federal returns. He said tougher enforcement could yield billions of dollars in overdue taxes, penalties and interest, and that would benefit the states as well as the federal treasury.

Both the federal government and states such as Maine were surprised by lower than expected capital gains tax revenues for 2001, but capital gains are only a portion of the earnings reported through partnerships. There is broad agreement among tax officials that not all partnership income is being reported.

“We really don’t know what it is in Maine,” Neves said, “but we are sure it is not all being reported. We know that from the audits we have done using the paper returns.”

Neves said his agency collects as much as $40 million a year as a result of all its audit efforts. He said as the IRS has shared more computer data with the state, the amounts collected from audits has increased.

According to IRS data, fewer than 7,000 partnership returns were filed by Mainers in 2001 out of the more than 600,000 individual tax returns. But those few taxpayers could be among the wealthiest Mainers. IRS data indicates that 75 percent of partnership income flows to people who report a total income of $200,000 or more, the richest 2 percent of all Americans.