The IRS Says Audit Rates Increase as Income Rises and Offers Data and Explanations (11/8/20)

The IRS offers a web page titled “Audit Rates Increase as Income Rises” (Page Last Reviewed or Updated: 03-Nov-2020), here.  The web page provides tables with data drawn for the years 2013-2015 from the 2019 Databook, Table 17a, showing that the audit rates are significant for the no total positive income returns because of the high rate of refundable EITC errors.  For positive income returns, the audit rates range from less than 1% for $1-$25,000 of positive income and up to 12% in one year and 8% in the other two years for income up to and exceeding $10 million of positive income.  

The web page explains (excerpts):

Despite common misperceptions about IRS examination rates, the reality is that the likelihood of an audit significantly increases as income grows.

Taxpayers with incomes of $10 million and above had substantially higher audit rates than taxpayers in every other income category for each calendar year from 2010 through 2015. Those with incomes above $1 million also had higher exam rates than all other groups earning less.

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The typical audits for higher-income taxpayers involve at least three different tax years, often include related entities, and routinely take years to resolve. The highest income taxpayers face the most significant chance of an examination, and they face the most highly trained and experienced IRS agents and teams utilizing our most sophisticated tools and techniques.

One may ask, whether regardless of the audit rates, should the IRS simply audit fewer lower-income taxpayers receiving EITC? Here’s the challenge with doing that: Error rates on tax returns claiming EITC are around 50%, and the improper payment rate involving EITC claims is more than $17 billion each year. There are several factors behind why the improper payment rate is at that level – some of this is that, despite significant guidance provided by the IRS and others, people (including tax preparers) simply misunderstand the complex EITC rules, and others involve misreporting income. Each year, at the start of the tax filing season, IRS participates in EITC Awareness Day events throughout the country in an effort to increase participation by eligible people and enhance the rate of compliance.

The IRS fully appreciates the importance of the refundable EITC and the significant difference it makes for people. More than 25 million people claim EITC per year, generating more than $63 billion each year to people in need. This program lifts millions of Americans out of poverty, and the IRS is proud to work hard each year to raise awareness about the program since many, many people simply overlook claiming this important refundable credit that they are entitled to.

At the end of the day, the IRS strives to properly serve compliant taxpayers and uphold the nation’s tax laws, ranging from civil side audits and notices to criminal investigations in the most egregious cases. We face tough choices each year as far as where to deploy resources given the breadth of our responsibilities, but our choices are guided by fair and impartial audit plans throughout the process.

Research on Positive Link Between Corporate Audits and Compliance

Jeffrey L. Hoopes, Devan Mescall, and Jeffrey Pittman, Do IRS Audits Deter Corporate Tax Avoidance? (SSRN 11/

The Stephen M. Ross School of Business at the University of Michigan

University of Saskatchewan

Memorial University of Newfoundland (MUN) - Faculty of Business Administration

November 2011

Abstract:    

We extend research on the determinants of corporate tax avoidance to include the role of Internal Revenue Service (IRS) monitoring. Our evidence from large samples implies that U.S. public firms undertake less aggressive tax positions when tax enforcement is stricter. Reflecting its first-order economic impact on firms, our coefficient estimates imply that raising the probability of an IRS audit from 19 percent (the 25th percentile in our data) to 37 percent (the 75th percentile) increases their cash effective tax rates, on average, by nearly 2 percentage points, which amounts to a 7 percent increase in cash effective tax rates. These results are robust to controlling for firm size and time, which determine our primary proxy for IRS enforcement, in different ways; specifying several alternative dependent and test variables; and confronting potential endogeneity with instrumental variables and panel data estimations, among other techniques.

Number of Pages in PDF File: 64

Keywords: tax enforcement, corporate governance, IRS audits, taxes, agency costs

JEL Classification: M40, G34, G32, H25

working papers series

SSRN Link for download here.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1668628

IRS Audits Are Good for Companies; Thanks IRS! (9/13/12)

I always knew that IRS Audits were good for the bottom line -- my bottom line, anyway.  Now, Research says it is good for some taxpayers as well.  Michael Cohn, IRS Audits Keep Companies Honest, Says Research (Accounting Today 9/12/12), here.  Here is the introduction as a teaser for you to link to read the whole article.

The likelihood of being audited by the Internal Revenue Service has its strongest impact on laxly governed companies and fosters corporate truthfulness not just in confidential tax returns, but in public financial reports, according to new research. 

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The study, which appears in the September/October issue of the American Accounting Association’s journal Accounting Review, found that a lesser degree of auditing will translate into significantly less corporate taxes paid to the federal government. 

Less auditing by the IRS is probably not only bad for federal tax coffers but for shareholders as well, according to the study. The paper’s findings, along with those of a related, unpublished study, reveal that the likelihood of being audited has its strongest effect on companies whose governance is lacking. 

“The idea that shareholders benefit from having their companies audited by the IRS may seem strange to some investors,” said Jeffrey Hoopes of the University of Michigan, who co-authored both studies. “Our research, however, suggests that strict tax enforcement promotes good financial reporting and tends to check managers' proclivities to divert corporate resources for their personal use under the guise of saving taxes.”

Click here for the rest of the article.