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TIGTA Audits the IRS’ SMB/Closely-Held-Corp Auditors

This morning, the Treasury Inspector General for Tax Administration (TIGTA) released the results of its review of the IRS Small Business/Self Employed Division (the SB/SED also audits closely-held corporations).  TIGTA acknowledges that its review was based on a nonstatistically significant sample (performed in a single Maryland-based tax office, and that it only reviewed audits that resulted in a “no change” status) but goes on to report that it found “quality concerns” in 19 of the 51 audits reviewed.

(NOTE:  When I last viewed this document, it had “junk” text on pages 6-7.  I called TIGTA about this, hopefully their document will be fixed by the time you review it.)

I’m not going to address the obvious flaws in TIGTA’s methodology.  But because the TIGTA published the report, it is in the public eye, and will possibly (likely) get IRS Management’s attention, so thought I’d give you the highlights . . .

In its report, TIGTA indicated that two measures of productivity from the audits are (1) amount of additional taxes recommended for each return audited, and (2) amount of additional taxes recommended for each hour examiners apply to an audit.  I am skeptical of the use of these items as “productivity measures” they are biased toward the  assumption that all tax returns audited are erroneous and incent the auditor to find error (possibly even when none exists) and “recommend additional taxes.”  After all, if your productivity is being measured by the number of additional taxes you recommend, and that measurement likely impacts your job performance reviews, potential for raises, and job security, wouldn’t you be inclined to “find” additional tax revenue wherever you could?  The only thing that remotely redeems these measures is that they are looking for “recommended,” and not actual, additional taxes.  (As I’m assuming—perhaps naively—that someone else, not incented by generating additional tax revenue, has final say in whether the recommended taxes are valid.)

All that aside, TIGTA expressed concern at the number of audits closed as “no change,” and made the following observations:

  • During FY 2010 the SB/SED audited about 17% of all returns filed between 2006-09, the audits resulted in @$381 million in recommended additional tax revenue
  • The amount of recommended additional taxes per return has increased about 58% from FY 2006 ($16,576) to FY 2010 ($26,222)*
  • At the same time, FY 2006 – FY 2010, the “No Change” rate has dropped from 37% to 28%*
  • Between FY 2006-FY2010, 32% of corporate returns audited by SB/SED were closed as “no change”

*These changes may be a result of a change in how the IRS selects returns to audit, see the page 4 of the paper for more detail

Despite the increase in recommended tax revenue, the TIGTA found that the IRS could improve by enhancing the way it selects returns for audit and improving the quality of the audits themselves (hmmmm . . . perhaps making those dubious recommended-additional- tax-based productivity measures are more important).  TIGTA recommended the following changes:

  • Use the results of a planned NRP study (see note below) to improve how returns are selected for audit (so basically no attention to or recommendation for this prong of TIGTA’s “solution”)
  • Use already existing automated checks to enhance the quality of the investigations auditors perform in three main areas:
    • significant ($40,000 or more) differences between the amount of labor costs deducted in the return and the amounts reflected on the associated employment tax returns (looking for overstating, etc.)
    • differences between corporate returns with individual shareholder returns (looking for areas where dividends are misclassified, etc.); and
    • large, unusual, or questionable items.

Although the IRS is not required to act on TIGTA recommendations, without addressing specifics, the IRS stated that it agreed with TIGTA’s recommendations and that it would provide a guidance “memo” to first-line managers to improve performance in required filing checks.

NOTE:  The report mentioned an upcoming National Research Program Study that is designed to evaluate the extent to which corporations and shareholders comply with tax laws.  The study will be based on @2,500 FY 2010 tax returns  from corporations with less than $250,000 in assets.  I’ll keep an eye out for the results.

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