IRS to mine payment data on mortgages

WASHINGTON -- The Internal Revenue Service will expand a program designed to catch tax cheats that searches for inconsistencies between mortgage payments and income.

After prompting from an IRS auditor, the agency will study whether it should make greater use of data on mortgage-interest payments provided to it by banks. The IRS currently uses such data to send notices to non-filers who it believes should have filed a return.

The data could also be used to target for audits individuals who don't file tax returns, or who report less income than they paid in mortgage interest, according to a letter released Monday by the Treasury inspector general for tax administration.

The IRS move will expand a regional research project on mortgage interest to a nationwide level by December 2011. Such initiatives, called Compliance Initiative Projects, typically involve examination of a small number of tax returns to evaluate new enforcement strategies.

Howard Levy, a tax attorney with the Cincinnati firm Voorhees Levy, said mortgage-interest data might be the best source of information the IRS has on small-business owners, such as roofers or carpenters, who are paid in cash and don't report all their income to the IRS.

"That [IRS Form] 1098 might be one of the few trails IRS could pursue to find out if there is income coming in," Mr. Levy said.

One Republican lawmaker cautioned Monday that the IRS plan could snare taxpayers who have coped with job losses by borrowing or using savings or retirement accounts to make their house payments.

"We shouldn't presume that these struggling families are tax cheats just because they continue to make their mortgage payments despite losing their income," said Rep. Charles Boustany (R., La.), the ranking minority member on the House Oversight Subcommittee.

Highly paid former employees of investment banks who lost their jobs in the financial crisis but who, thanks to their savings, are still making their mortgage payments, could also draw scrutiny under the IRS plan, said Tom Ochsenschlager, vice-president for taxation at the American Institute of Certified Public Accountants.

The Treasury inspector general said in a Monday report that tens of thousands of homeowners who paid more than $20,000 in mortgage interest in 2005 either didn't file a tax return or reported income that appears insufficient to cover their mortgage interest and basic living expenses.

The data for 2005 was the latest tax data available when the Treasury inspector general's office began its audit last year.

Based on a sample of these returns, nonfilers and potential under-reporters identified by the inspector general could have owed a combined total of $1.4 billion in tax, penalties and interest, the auditor said.

Banks report data on mortgage interest paid by individuals to the IRS and to the homeowner, using IRS Form 1098.

Write to Martin Vaughan at martin.vaughan@dowjones.com