IRS compliance and enforcement trends

The IRS and state and local taxing authorities are developing compliance goals and strategies that are affecting CPAs and will continue to do so in new ways in the coming decade. Jim Buttonow and Brian Howell described them in a presentation at the AICPA Practitioners Symposium and TECH+ Conference in Las Vegas in June, and what follow are selected highlights from their talk. Buttonow, a former IRS large case audit team coordinator, is vice president of product development at New River Innovation Inc. in Greensboro, N.C., for the company’s tax compliance software, and Howell is the company’s product manager.

Buttonow said an average CPA firm spends 66 days a year responding to IRS notices to clients and other post-filing work. The annual volume of IRS notices and letters to taxpayers increased nearly sevenfold from 2001 to 2009, from 30 million to 201 million.

The IRS is likely to employ the following enforcement strategies and priorities during the next decade, according to Buttonow:

Do more with less. For fiscal year 2012, the IRS’s budget was cut by $305 million. Even though the IRS is expected to receive a budget increase in 2013, it will have more programs to administer, including implementing provisions of the new health care law. 

Technology provides the IRS with its best return on investment (ROI). The cost for GS-4 agents to handle mail audits is as low as $13.41 per hour, yet these audits can average returns of $4,578 per hour, Buttonow said. Field auditors are paid about $28 per hour, and these audits yield an average of $330 per hour in new assessments. Therefore, practitioners can expect to see more computer-matching and mail-driven compliance programs.

Increase compliance rate to 90% by 2017. The voluntary compliance rate is the amount taxpayers actually pay versus what they should report and pay. The most recent IRS study of compliance rates, completed in January 2012, reported 83.1% voluntary compliance on 2006 returns, which falls within the 83% to 84% range that has prevailed for the past 27 years.

The IRS’s goal for 2009, which will be measured in three years, is 86% voluntary compliance. The IRS hopes to raise the rate to 90% by 2017, which would reduce the current $450 billion tax gap by about 40% to $266 billion. Every one percentage point increase in compliance generates at least $27 billion, and the most recent compliance rate is 83.1%, so the 2017 target, if met, would increase revenue by $186 billion.

Focus on high-yield assessments. The IRS will continue to focus on areas yielding large assessments where it has found significant risk of underreporting, including:

• High-income individuals;
• Worker classification;
• S corporation losses claimed in excess of basis;
• Rental property losses (passive vs. active);
• General small business underreporting of taxable income;
• Form 1099 filing compliance; and
• Review of international taxpayers/FBAR, etc.

Increase tax document matching and mail audits. Computer matching of documents, such as Forms 1099 and W-2, results in a 99% compliance rate in reporting those amounts. However, for certain small businesses (e.g., S corporations, partnerships, and Schedule C filers), the compliance rate is only 44% because their income generally is not subject to such matching. In 2011, 70% of compliance audits were conducted via mail, and 30% were field audits. In 1995, the ratio was 54% mail audits to 46% field audits. Based on ROI, the trend toward more automated compliance activity will very likely continue.

Regulate and deputize tax professionals. The IRS is regulating tax preparers to remove “bad players” and, where necessary, imposing and expanding significant penalties on preparers and their clients. Tax preparers now must register, meet certain requirements, and be listed in a database, which has thinned their ranks from 1.2 million to 850,000.

Mandate disclosures. Over the past few decades, the IRS has increased the level of detail tax preparers must include in their clients’ returns or in other filings. Failure to make those disclosures can result in civil and sometimes even criminal penalties. CPAs need to inform their clients that the IRS and other tax authorities are aggressively auditing taxpayers, and that clients can expect an increase in notices and audits. 

Editor’s note: A version of this article first appeared in the AICPA’s Corporate Taxation Insider newsletter on June 28, 2012. To subscribe to the free monthly electronic newsletter, click here.

By Blake E. Christian, CPA, (blakec@hcvt.com) a tax partner in the Long Beach, Calif., office of Holthouse Carlin & Van Trigt LLP.

To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at pbonner@aicpa.org or 919-402-4434.