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Does Proximity to an IRS Office Increase Audit Risk?

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Apr 11th 2017
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In an intriguing catch-22, a recent study reveals that public companies are more likely to avoid taxes if they are located near an IRS office but also are more likely to be audited.

But that tax avoidance lessens if the corporate chieftains know that an IRS industry specialist familiar with their type of business works nearby.

The study of public company tax records from fiscal years 1996 to 2012 was published recently in the Journal of Accounting and Economics. The authors are Thomas Kubick, assistant accounting professor at the University of Kansas; Brandon Lockhart, assistant finance professor at Clemson University; Lillian Mills, business professor at the University of Texas; and John Robinson, agricultural economics professor at Texas A&M University.

They gleaned their information from public sources identified in local newspapers and from the IRS under a confidentiality agreement with one of the authors, the study states.

What it indicates is that taxpayers believe proximity to the IRS gives them an information advantage. While the study doesn’t go so far as to state that somebody is leaking information on either side, one of the authors alludes to just that.

“The intuition is that when two parties operate in close proximity, there is more information on both sides,” Kubick said in a prepared statement. “I know more about you. We may not have met, but we have mutual friends. And people I know may have dealt with you.”

After all, other regulators and analysts, investors, and independent auditors benefit from geographic proximity, so why not the IRS, too?

“The IRS may know more about the operations and developments in nearby firms because of direct past experience or via indirect connections, such as local media coverage,” the study states.

How tight a budget the IRS is operating under also affects audits.

Companies located close to an IRS office face more audit adjustments in additional taxes owed per agent hours spent on the exam. But in tight budget years, the IRS assesses lower tax deficiencies and has a higher rate of no-change audits of nearby companies. When auditing companies farther away, however, the agency collects more per hour during constrained budget years.

“We conjecture a resource-constrained IRS prefers to pursue distant taxpayers only when they assess higher ex-ante risk of noncompliance,” the study states.

According to Kubick, that indicates a greater level of care, “perhaps due to the greater cost associated with auditing more distant companies.”

In addition, the authors state that their evidence that nearby industry specialists constrain tax avoidance “suggests that the recent emphasis by the IRS’s Large Business and International (LB&I) Division toward industry issues, and away from geographic lines of organization, will be more effective when specialists are near taxpayers.”

So, where are these industry specialists and their territorial offices? The LB&I Division is broken into these five industry groups:

  • Communications, Technology, and Media, Oakland, CA
  • Financial Services, New York City
  • Heavy Manufacturing and Pharmaceuticals, Iselin, NJ
  • Natural Resources and Construction, Houston
  • Retailers, Food, Transportation, and Healthcare, Downers Grove, IL

(A sixth, Global High Wealth, was not included in the study.)

In turn, the LB&I Division’s territorial managers are located in:

  • Fayetteville, AR
  • Phoenix, AZ
  • Glendale, CA
  • Laguna Niguel, CA
  • San Francisco, CA
  • San Jose, CA
  • Denver, CO
  • New Haven, CT
  • Maitland, FL
  • Plantation, FL
  • Marietta, GA
  • Chicago, IL
  • Downers Grove, IL
  • Fairview Heights, IL
  • Schiller Park, IL
  • Louisville, KY
  • Stoneham, MA
  • Clinton Township, MI
  • Troy, MI
  • Bloomington, MN
  • Iselin, NJ
  • Buffalo, NY
  • New York, NY
  • Akron, OH
  • Cincinnati, OH
  • Oklahoma City, OK
  • King of Prussia, PA
  • Nashville, TN
  • Farmers Branch, TX
  • Houston, TX
  • Norfolk, VA
  • Seattle, WA
  • Milwaukee, WI
  • Wheeling, WV

The authors believe their findings could help the IRS in its “strategic deployment” of employees. They state that their study is the first to directly link audit results and tax deficiencies to proximity. That, they say, should assist policymakers in determining budget priorities.

Related article:

What Are Your Chances of Being Audited? IRS Data Book Provides Some Clues

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