IRS Can Improve Its Process for Deciding Which Corporate Returns To Audit

A vital part of the Internal Revenue Service's (IRS) program for auditing corporate tax returns is the process for deciding which ones to audit. Because IRS does not have unlimited audit staff, it must have a way of identifying returns most in need of audit while maximizing revenue, treating taxpayers equally, and promoting voluntary compliance.

The first step in selecting corporate returns for audit is the development of long- and short-range plans for determining how many to audit and where those audits should be done. Although the planning process is conceptually sound, the annual plan could be enhanced if more definitive data were available to assess (1) the relationship between audit coverage and voluntary compliance; (2) the validity of examination rates, which specify the average number of returns that can be audited in a direct examination staff-year and which form the cornerstone of the annual plan; and (3) the adequacy of audit attention to miscellaneous corporate returns, such as those filed by life insurance companies and homeowners associations. IRS has developed a system directed at identifying those returns most worthy of audit. A primary concern with any such system is whether it adequately protects against returns being audited or not audited for reasons other than audit potential. A major aspect of the corporate selection system, whereby classifiers evaluate returns for audit potential, has not been very effective. IRS has little assurance that the corporate returns most in need of audit are being addressed or that the most productive issues are being addressed during the audit process. The IRS process for determining which corporate income tax returns to audit could be more effective and equitable.

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