IRS Spending More Hours on Non-Revenue Corporate Audits

IRS revenue agents are now spending substantially more of their time on corporate audits that produce no revenue for the government than they did in the recent past, according to agency data obtained under the Freedom of Information Act by the Transactional Records Access Clearinghouse (TRAC).

The year-to-year growth in nonproductive audit time — defined by the IRS as face-to-face examination hours that produced what it calls "no change" results — occurred for corporations in every asset class.

The forty percent increase in the number of corporate audit hours that bore no fruit is troubling primarily because the misdirection of the agency's enforcement resources ultimately could weaken the long term interest of corporations in paying their taxes.

But IRS data tracking the outcomes by corporate size raise more focused concerns. One key finding was that the relative growth in these unproductive hours tended to rise as the size of the corporations increased. In the last five years, for example, the nonproductive audit time for the largest corporations — those with assets of $250 million or above — has more than doubled.

Although audit dollar recommendations for the largest corporations increased substantially from fiscal years 2001 to 2005, they declined by about 15 percent, from $30.1 billion in 2005 to $25.5 billion last year, a drop of $4.6 billion in potential audit revenue. See Table 1. It should be recalled that historically the largest corporations produce the lion's share of all audit dollars.The pattern of nonproductive auditor time increasing with the larger corporations is also puzzling. This is because the bigger the institution the more likely that the sheer volume and complexity of its business transactions will result in misreporting errors.

Explaining the Changes
The data presented in this analysis are not available in the IRS's annual report and the information about the across-the-board growth in the agency's nonproductive corporate audits has not been publicly discussed by the agency or Commissioner Mark W. Everson.

Instead, Everson has repeatedly emphasized his interest in effectively marshalling the powers of the IRS to assure that all American taxpayers, including corporations, pay their fair share of federal taxes. During a March 20 hearing before the House Ways and Means Oversight Subcommittee, for example, the commissioner said that improving corporate compliance is "a top priority of mine...." And, talking from his position as the head of one of America's largest enforcement agencies, he added that "we are doing our level best to improve compliance here."

As part of his prepared testimony during that same subcommittee hearing, the commissioner reported that "IRS enforcement efforts have increased in virtually every area." Concerning the agency's specific programs regarding corporations, Everson emphasized how the number of these audits have substantially increased and did not touch on the quality questions that have emerged from the internal administrative data analyzed by TRAC.

But the quality of the corporate audits has become an issue for the IRS in the last few months. In a meeting with the American Institute of Certified Public Accountants last fall, Deborah Nolan, Commissioner of the IRS's Large and Mid-Size Business Division, defended the agency's audit policies. According to Tax Notes, a leading trade publication, Nolan told the accountants that the service's emphasis on speeding up the audits — what she called the "currency and cycle time" effort — had been done "in a smart way, and all of our statistical indicators indicate that our agents made very sound decisions."

Some within the ranks of the IRS disagree with this judgment. On March 20, for example, The New York Times published an article which said that more than a dozen revenue agents — all speaking anonymously — had told the reporter that they had been pressured by their managers to close cases too quickly and that this could result in the loss of billions of dollars in unpaid taxes.

And in March 29 testimony before the House Appropriations Committee on Financial Services and General Government, Colleen M. Kelley, President of the National Treasury Employees Union, agreed. She said the pressure on the auditors that had been reported by the Times was not new, going back to a 2002 IRS policy called the Limited Issue Focused Examination (LIFE) process.

Kelley told the subcommittee that the union had "heard directly from a number of our members about the detrimental effect this policy has had not just on efforts to ensure corporations are in full compliance, but also how this misguided policy is damaging employee morale."

The goal of improving the effectiveness and fairness of the IRS is an extraordinarily challenging job and measuring the extent to which these efforts are achieved is difficult. On the efficiency side, for example, the commissioner has claimed many times that the increase in enforcement revenues collected by the IRS between FY 2002 and FY 2006 is one of the "most obvious measures" supporting his assessment about the agency's improving enforcement effort. But the Government Accountability Office, in its April report on the IRS, was less confident. The GAO acknowledged the recent increases in revenue collected as a result of the agency's enforcement programs. It added, however, that "enforcement continues to be included on our list of high-risk federal programs." The reason, according to the GAO, is the massive and persistent gap between federal taxes owed and federal taxes paid. According to the latest official estimate this so called "tax gap" is estimated to be over $300 billion.

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