Small Business Taxes & Management

Special Report


TIGTA Review of IRS's Selection Process of High-Income Taxpayers for Audit

 

Small Business Taxes & ManagementTM--Copyright 2015, A/N Group, Inc.

 

The Treasury Inspector General for Tax Administration (TIGTA) has released an audit report on the IRS's approach to auditing high-income taxpayers. TIGTA noted that the IRS has taken steps to improve its audit coverage of high-income taxpayers. The IRS adopted a High-Income and High-Wealth strategy focused on auditing more tax returns related to high-income individuals. As a result, audit coverage of high-income taxpayers has improved. However, the IRS should reevaluate whether the threshold for its High-Icvnome and High-Wealth strategy, set at $200,000 results in an efficient allocation of examination resources.

Additionally, as part of this strategy, the Large Business and International (LB&I) Division established the Global High Wealth (GHW) Industry to specifically address tax compliance issues of high-income taxpayers. The GHW Industry takes a comprehensive approach to auditing high-income taxpayers by extending the audits beyond the individual income tax return to include examining the entities that thee taxpayers control.

High-income taxpayers are frequently involved in complex entities and financial arrangements, including trusts, real estate investments, foundations, privately held companies, partnerships and international activities, all of which can increase the risk of noncompliance with the tax laws.

TIGTA also found that the complexity of the financial affairs of many high-income taxpayers and thelimitations of the IRS's audit information systems prevent the IRS from systemically quantifying GHW Industry audit performance. Further, the LB&I Division has not taken a number of steps to ensure that the GHW Industry evolves into a mature industry. For example, the GHW Industry has not implemented a quality review process for its audits.

TIGTA broke high-income taxpayers into seven strata and computed the audit coverage for each group. The table below shows the audit coverage for fiscal year 2014 by TPI (where TPI is total positive income):

TPI Range Returns Filed Audits Closed Coverage Average Dollars Dollars/Hour $200,000 to $399,999 4,111,527 62,159 1.5% $7,064 $605 $400,000 to $599,999 828,622 20,245 2.4% $9,520 $789 $600,000 to $799,999 334,678 10,523 3.1% $13,351 $1,058 $800,000 to $999,999 174,408 6,470 3.7% $18,051 $1,339 $1,000,000 to $1,999,999 284,055 14,230 5.0% $20,381 $976 $2,000,000 to $4,999,999 125,758 9,117 7.2% $34,453 $1,729 $5,000,000 plus 52,078 6,309 12.1% $139,437 $4,545
Notes.
1. Average dollars represents the average dollar amount recommended as an adjustment on audit.
2. Dollars/hour represent the average dollar amount recommended as an adjustment divided by the number of hours spent on the audits.

Using information from the IRS Data Books for Fiscal Years 2010 through 2014, shows a comparison of 2010, 2013 and 2014 to illustrate the trend in audits (the table uses different breakpoints than above):

Adjusted Gross Income Audit Coverage Percentage 2010 2013 2014 No Adjusted Gross Income 3.19% 6.04% 5.26% $1 to $24,999 1.18% 1.00% 0.93% $25,000 to $49,999 0.73% 0.62% 0.54% $50,000 to $74,000 0.78% 0.60% 0.53% $75,000 to $99,999 0.64% 0.58% 0.52% $100,000 to $199,999 0.71% 0.77% 0.65% $200,000 to $499,999 1.92% 2.06% 1.75% $500,000 to $999,999 3.37% 3.79% 3.62% $1,000,000 to $4,999,999 6.67% 9.02% 6.21% $5,000,000 to $9,999,999 11.55% 15.98% 10.53% $10,000,000 or more 18.38% 24.16% 16.22% All Returns 1.11% 0.96% 0.86%

Note. The high audit rate in the No Adjusted Gross Income group is misleading. Taxpayers in that group could have negative income as a result of net operating losses, passthrough losses from partnerships or S corporations, or other items that could increase their audit potential.

TIGTA noted that during the risk assessment process, additional internal and external research is performed to identify large, unusual, or questionable items to determine the reasons for a low effective tax rate. Risk assessors may create a flowcharge of a particular return to identify where the gains/losses originated (e.g., from a passthrough entity). Often that requiresd the risk assessors to also select for audit the tax returns for the related entities with which a taxpayer is associated.

TIGTA noted the decision of where to set the high-income TPI threshold has a significant bearing on how IRS audit resources are used. Because there are more taxpayers in the $200,000 to $399,999 range than in higher income ranges, it appears that the IRS is spending mosdt of its audit resources on auditing tax returns with potentially lower productivity. IRS management told us that decisions on resources allocation cannot be made solely on the basis of productivity measures alond (e.g., Recommended Dollars per Hour). However, given the decreasing budgets that the IRS is working under, it is critical for the IRS to determine the best use of its limited resources. While coverage of different taxpayer groups remains important, the IRS should reevaluate the appropriate income thresholds for its High-Income and High-Wealth strategy and reassess its case selection methodology to determine if more emphasis should be given to auditing taxpayers with higher TPIs to address the higher potential productivity shown for those TPI levels.

Among other things, TIGTA recommended that the IRS reevaluate the income thresholds in the High-Income High-Wealth strategy and use the results of the evaluation to ensure that audit resources are being applied to the appropriate taxpayer income levels. The IRS agreed with this recommendation and will conduct an analysis of the existing income thresholds for high-income taxpayers to determine what adjustments are needed and will make the necessary adjustments

To see the complete report go to www.treasury.gov/tigta/auditreports/2015reports/201530078fr.pdf

 


Copyright 2015 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536


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--Last Update 11/27/15