The number of no-change audits is a concern.

• Author: VanDeveer, Mark A.

On June 20, 2012, the Treasury Inspector General for Tax Administration (TIGTA) released two reports for its study of the Small Business/Self-Employed (SB/SE) Division audits of partnerships and S corporations (Rep't Nos. 2012-30-060 and 2012-30-062, respectively). The findings in both TIGTA audits are similar. Each states that although the SB/SE audits recommended substantial adjustments, roughly 33% of all the audits in fiscal years (FYs) 2009-2011 resulted in no change. While this is probably not a surprise to many practitioners, the TIGTA reports do offer some interesting 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 one is the discriminant index function (DIF) system. The IRS has for years relied on this system to decide how to best allocate its audit resources. The system uses mathematical formulas to score returns based on their audit potential. The higher the score, the more an audit is considered likely to result in changes to the return.

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, 19% of S corporations (Rep't No. 2012-30-62, p. 5) and 17% of partnerships (Rep't No. 2012-30-60, p. 6) 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% (Rep't No. 2012-30-062, Figure 2; Rep't No. 201230-60, Figure 3). Other sources include IRS studies and projects designed to focus on specific areas of suspected noncompliance other than abusive transactions.

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 (Rep't No. 2012-30-062, p. 3); for each partnership audited in FY 2011, recommended adjustments averaged $137,000 (Rep't No. 2012-30-060, p. 5). Interestingly, due to systems limitations, neither the IRS nor TIGTA knows for certain how much additional tax was assessed based on the examiners' recommended adjustments.

How to Improve Audit Productivity

TIGTA found that...