IRS continues audit trend away from large corporations and toward smaller businesses

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The Internal Revenue Service (IRS) has reduced the number of hours agents spend auditing corporations with assets of $250 million or more by one-third since 2005 and increased the number of hours spent on audits of companies with assets of less than $10 million by 30 percent, according to a report bythe Transactional Records Access Clearinghouse (TRAC), a nonpartisan research group affiliated with Syracuse University.

This trend in IRS priorities will not yield greater revenue gains. Data show that audits of larger corporations produce significantly higher returns per audit hour – $9,354, for audits of large corporations compared to $1,025 for small to mid-size companies. Revenue per audit hour for large companies increased from $6,594 in the five-year period revenue from audits of small to mid-size companies actually decreased in 2009 from the $1,294 reported for 2005.

IRS statistics show 94 percent of tax underreporting comes from large companies, with only 6 percent coming from small companies, the study reports.

The authors of the study, TRAC co-directors Susan Long and David Burnham, find that that the current political context makes this shift even more puzzling. "The dramatic collapse in the auditing of those corporations with assets of $250 million or more has occurred during a period of increasing national concerns about growing federal deficits, growing public distrust of big business, and intense worry about the extent of white collar crime personified by executives like the investment adviser, Bernard Madoff."

Other statistics based on data provided to TRAC confirm the trend. The number of large corporate audits has fallen from 4,693 in 2005 to 3,675 in 2009. The audit rate of these companies has also fallen, from 43 percent of all returns in 2005 to 25 percent in 2009. While the total number of returns filed by large corporations has increased from 11,027 to 14,683 since 2005, the number of large company returns filed but not audited has decreased significantly, from 57 percent of returns not audited in 2005 to 75 percent of returns not audited in 2009.

Susan Long, co-director of TRAC and faculty member at Syracuse University's Whitman School of Management told AccountingWEB that that the trend could not be explained by a shortage of resources, because the IRS was hiring more staff during the period. "The IRS also was not responding to return growth, since where returns were growing fastest -- larger corporations -- they were cutting back the most, and where returns were declining -- smaller corporations -- they were expanding their audit hours."

"Then we found a pattern to the audits that was related to the organizational structure and the individual division monthly performance targets", according to Long. Within each division the data indicate declines in auditor time spent on the more time consuming returns of large corporations, and increases auditor time for smaller-sized firms. For example, for the corporations handled by the Large &Mid-sized Business (LMSB) Division, the audit hours for mid-size firms increased by 13 percent in the last five years while the hours devoted to the large companies went the other way, declining by 33 percent.

Audit data for Small Business Self Employed Division (SBSE) show a similar pattern. Hours devoted to examining smaller firms with assets of up to $5 million grew by 34 percent since fiscal year 2005, while the auditor hours spent on the top bracket of small companies (assets from $5 to $10 million) shrank by 11 percent during this period.

"Although a direct causal relationship between the well-documented quota systems and the audits by corporation income class has not been established, choosing to audit the smaller rather than the larger businesses would on its face help the individual agents meet their performance targets in the two divisions", Long and Burnham write.

As described in IRS documents obtained by TRAC",Each of the agency's divisions routinely establish 'goals' or quotas for the aggregate number of audits they expect their revenue agents to complete each month." Both the Large & Mid-Size Business (LMSB) Division, and the Small Business/Self Employed (SBSE) Division have annual quotas broken down into monthly performance targets for businesses that are a part of their responsibilities. "And for both divisions, those businesses with fewer assets typically take less time to audit than those with more assets."

"These quota pressures may well influence revenue agents and their managers when making their decisions about which business will be audited and which will not."

TRAC's role is to try to paint the broadest and most complete picture of the activities of the federal agency", Long told AccountingWEB. "We want to make information from the federal government more accessible to the public."

Long became involved in the TRAC project when as a graduate student, she decided to track IRS statistics under the Freedom of Information Act, and found that even the number of audits was classified At that time she initiated a series of successful lawsuits against the IRS, asking for information. After receiving a series of court orders requiring IRS to turn over this information, for some years the IRS was very cooperative, but recently Long has had to return to court to make the IRS comply with these long standing court orders. Litigation continues as the IRS has continued to redact anonymous statistics, refused to provide the geographic locale covered by area offices, and claimed that because of a new system key statistics can no longer be located.

Access to IRS statistics is guaranteed by law, and transparency is really important, Long says. "We want our tax system to work well. It runs on trust and it's important that people feel that it is fair."

Commenting on the TRAC report in his column in Forbes magazine, Dean Zerbe also expresses concern for taxpayer rights and the rights of small business owners.

"The shifting of IRS enforcement and the burden of additional scrutiny onto small and medium businesses has an impact beyond just the IRS's compliance numbers. Congress tries to stimulate job creation and various types of investments--for example, in hiring new workers and in research and development – with various tax credits", Zerbe writes. "But already, some small and medium businesses don't take advantage of these tax incentives and credits in part because they fear their use of the credits will be subject to audit."

"The IRS's increased audit focus on small businesses and their owners only underscores the importance of Congress enacting improved taxpayer rights and protections for small business."

Zerbe sees the trend in audits of small businesses as harming the economy overall, writing",Politicians in Washington love to give speeches touting how small businesses are the engines for job growth. Revving up IRS audits of small business is like putting sugar in the gas tank."

TRAC reports are based on computerized data obtained under the Freedom of Information Act from the Justice Department, the Internal Revenue Service, and the United States Office of Personnel Management. These data were supplemented by interviews with current and former government officials, tax attorneys, and agency data processing specialists.

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