Academic journal article Journal of Accountancy

Improving the Audit Selection Process

Academic journal article Journal of Accountancy

Improving the Audit Selection Process

Article excerpt

The Treasury Inspector General for Tax Administration (TIGTA) recently released two reports for its study of the IRS Small Business/Self-Employed (SB/SE) Division's audits of partnerships and S corporations. The findings in both reports are similar: Although the SB/SE audits recommended substantial adjustments, roughly 33% of all the audits in fiscal years 2009-2011 resulted in no change. While this may not surprise many practitioners, the TIGTA reports do offer insights into possible improvements in the audit selection process.

While the IRS has developed many resources to select returns for audit, perhaps the best-known is the discriminant index function (DIF) system, which the IRS has relied on for years. It uses mathematical formulas to score returns based on their audit potential. However, TIGTA found that DIF-selected returns had high no-change rates: 50% for partnerships and 62% for S corporations in FY 2011. This means that the IRS is spending significant time and resources on unproductive audits and unnecessarily burdening compliant taxpayers.

In contrast, in FYs 2009-2011, only 19% of S corporations selected for audit because of an abusive transaction were no-change audits. Returns selected for audit from sources other than DIF or abusive transactions also had lower no-change rates, ranging from 27% to 40%.

When examiners do recommend adjustments, the amounts are significant. For each S corporation audited in FYs 2007-2011 (including those for which there was no change), recommended adjustments averaged $105,534; for each partnership audited in FY 2011, recommended adjustments averaged $137,000. Interestingly, due to systems limitations, neither the IRS nor TIGTA knows for certain how much additional tax was assessed based on the examiners' recommendations.

HOW TO IMPROVE AUDIT PRODUCTIVITY

TIGTA found that improvements to the DIF system are not likely in the near future and suggests that the IRS pursue alternative selection methods by using existing databases containing S corporation and partnership information. …

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