IRS Should Rethink How It Audits the Rich, Watchdog says

Though the wealthy provide the lion’s share of tax revenues, they also have greater opportunity to underpay by using complex schemes.

While the Internal Revenue Service in recent years has improved its efforts to audit high-income earners, an inspector general says the agency needs to improve the quality of those audits, better quantify the results and consider redefining the target income brackets.

The tax agency’s efforts to look beyond a single year’s return and examine high-wealth taxpayers’ complete financial picture often run up against complex corporate entities and trusts. That’s according to a report dated Sept. 18 but just released by the Treasury Inspector General for Tax Administration.

What is required are “systematic improvements,” particularly at the IRS’s Large Business and International Division, to quantify the tax impact of industry practices, called “enterprise cases.” While having numerous codes to control, monitor and manage cases, the IRS does not have an effective way of coding related entities of an enterprise case so that performance results can be easily summarized,” TIGTA said.

“It is important for the IRS to demonstrate that it enforces tax laws equally by ensuring that its compliance strategies are applied fairly to all segments of the taxpayer population,” it said of the agency’s efforts to strategically steer the extra attention from auditors to cases most likely to expose underpayments. And while the agency’s initiative on auditing the wealthy launched in 2010 has shown progress, “the IRS should reevaluate whether the threshold for its high-income and high-wealth strategy, set at $200,000, results in an efficient allocation of examination resources.”

Most audits were conducted not on the wealthiest taxpayers, but on those in the $200,000-$399,000 income range, potentially causing auditors to miss larger dollar amounts owed the government.

Managers in the division focused on the global wealth industry have also been pulling resources from other staffs without evaluating the impact on other priorities,” TIGTA found.

In the agency’s defense, “it is important to note that decisions on resource allocation should not be based solely on productivity,” the report said. “IRS management informed us that they must also consider other risks and audit coverage when determining which action would be most advantageous to the IRS, such as considering current prevalent issues affecting return types, income levels, and type of industry.”

TIGTA recommended, among other things, that IRS conduct a cost-benefit analysis of its global wealth industry outsourcing initiative, better quantify audit results and establish an ongoing quality review system.

IRS agreed with most recommendations, but disagreed that its “outsourced” project required a cost-benefit analysis to determine whether borrowing staff from other units is justified. The agency emphasized that at a time of declining budgets, its use of borrowed staff actually increased the coverage rate of audits for high-income taxpayers.

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