Tax Administration:

Factors Affecting Results from Audits of Large Corporations

GGD-97-62: Published: Apr 17, 1997. Publicly Released: Apr 17, 1997.

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GAO reviewed the Internal Revenue Service's (IRS) program to audit the tax returns of about 45,000 large corporations that are not in the Coordinated Examination Program (CEP), focusing on factors that contributed to the assessment rate and audit results.

GAO noted that: (1) IRS invested 25 percent more hours in audits of large corporations during 1994 than it did in 1988, yet it recommended 23 percent less additional tax per hour and doubled the rate at which it closed audits with no tax changes; (2) during this 7-year period, IRS assessed 27 percent of the additional taxes revenue agents recommended; (3) GAO's analysis of questionnaire responses and interviews of officials from across IRS identified at least four factors that had a negative effect on both the audit results and the assessment rate; (4) the complexity and vagueness of the tax code caused legitimate differences in interpretation between IRS and corporations over the correct tax liability; (5) this complexity and vagueness made it difficult for IRS revenue agents to find the necessary evidence to clearly support any additional recommended taxes without investing a lot of audit hours; (6) such recommended taxes were less likely to survive the IRS Office of Appeals process and be assessed; (7) also, complex and vague tax laws increased the tax burden on large corporations by increasing their uncertainty about what actions they had to take to comply with the tax code; (8) the IRS Examination Division and Office of Appeals used different performance measures; (9) this difference in measures resulted in a lower assessment rate; (10) these revenue agents worked alone on complex audits without much assistance from district counsel or their group managers, who tended to be responsible for managing all types of audits; (11) further, audit staff had a limited basis on which to classify and select returns that had the most audit potential; (12) IRS' approach for these large corporate returns gave a great deal of discretion to audit staff, however the staff had little information on previously audited corporations or industry issues to serve as guideposts; (13) all these aspects can contribute to a reduction in the amount of taxes recommended per audit hour and, with the possible exception of the problems in selecting returns, can affect the assessment rate; (14) Appeals usually did not share with Examination information that could be used to educate revenue agents; (15) even if Appeals did share information, revenue agents did not always have time to review the new information due to time pressures to do other audits; (16) although Appeals usually shared the final settlement on disputed issues, Examination management often did not distribute those results to the revenue agents; and (17) such feedback can help agents decide whether and how to audit similar issues in the future with better support of any recommended taxes.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should require Examination to: (1) indicate whether it wishes to review the new information; and, if so: (2) review the information and notify Appeals of the results of the review as soon as possible.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS has made some changes to its manual that will provide new direction for returning taxpayer data to Examination revenue agents. The action taken will require comments from Examination on cases going from Appeals to Examination within a specified timeframe, to be established by the Appeals officer.

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should require Appeals to notify Examination of new information received from a large corporation that could cause the appealed issues to not be fully sustained.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS has made some changes to its manual that will provide new direction for returning taxpayer data to Examination revenue agents. The action taken will resolve the issue that revenue agents be made aware of all taxpayer data so that they can revise audit recommendations, if appropriate, and be made aware of the taxpayer data considered by Appeals in final settlement.

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should encourage District Examination management to work with District Counsel officials on finding cost-effective ways to provide revenue agents with the necessary legal assistance.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS issued an IRS-wide memo to Examination management to work with District Counsel on finding cost-effective ways to provide legal advice to revenue agents. The memo confirms that IRS will include these instructions in its manual 4260 when it is reissued.

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should develop criteria and procedures to guide the evaluation across the districts of the impacts of groups specializing in audits of large corporations.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Not Implemented

    Comments: IRS has not done and has no plans to do the recommended evaluation. Since GAO issued this report, IRS reorganized, switching from functionally based (examination) to taxpayer based (small business). A 1998 Act prompted this switch, among other things. As part of this, IRS has created the LMSB (large and mid size business) division. In doing so, IRS adopted the general rule of auditing all large corporations through groups of auditors--unless using just one auditor makes more sense. Prior to this, IRS only audited the largest corporations through groups. Even so, IRS plans to evaluate all LMSB operations against strategic, operational, and program measures/standards.

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should provide more specific objective criteria and procedures to guide the selection of large corporate tax returns and classification of tax issues with high audit potential across the districts.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS is developing the Discriminant Analysis System (DAS) to select and classify large corporation returns. IRS is testing DAS in four phases over 5 years, starting with the smallest of the large corporations. Testing is being done to validate the DAS formulas. The first three phases have started, but have been delayed by IRS' reorganization and creation of large and mid sized business (LMSB). The last phase--involving large corporations--is underway with a projected completion date of October 2002. IRS is to update the status of many GAO recommendations after October 1, 2002. This one will be included in the review. LMSB has implemented a process of scoring returns and full implementation of a plan to place these returns in the field has been completed. With the completion of the process of return filings at Ogden, and IRS' ability to score returns and identify them post-pipeline, the identification of high-risk returns is underway. Return orders using DAS scoring as a predictor is also underway. External review of our DAS formulae is virtually completed and IRS is in the process of considering suggestions for improving the system and expanding it to other return types. Implementation was accomplished in March 2002.

    Recommendation: To improve the audits of tax returns filed by large corporations, the Commissioner of Internal Revenue should require Examination management to provide feedback to its revenue agents on the final settlements that Appeals reaches with large corporations.

    Agency Affected: Department of the Treasury: Internal Revenue Service

    Status: Closed - Implemented

    Comments: IRS issued a memorandum to the field, and plans to change the manual to require feedback to be given to revenue agents on Appeals' final settlements. The memo confirms that IRS' manual 4260 will include the change when it is reissued.

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