Tax Administration

Every year, the Internal Revenue Service (IRS) audits the tax returns of more than one million taxpayers, adjusting the tax liability of those who IRS believes did not comply with the provisions of the tax code. Taxpayers may challenge the proposed adjustments by filing a protest with IRS. This report discusses the issues that caused the most frequent disputes between IRS and taxpayers in connection with section 162 of the tax codes, which allows taxpayers to deduct from income "ordinary and necessary" expenses related to trade or business. GAO has previously reported that section 162 was the tax code section mode commonly cited in large tax cases at the IRS Office of Appeals.

GAO found that: (1) of the 185 Tax Court petitions reviewed, sole proprietors, small- and medium-sized corporations, and individuals claiming employee business expenses disagreed with IRS most often over the adequacy of documentation for a given expense deduction; (2) 47 percent of the petitions involved questions of proper documentation of all types of deductions, particularly for entertainment, travel, meals, and automobile expenses; (3) while sole proprietors most often disputed documentation issues, small- and medium-sized corporations frequently contested IRS decisions on the reasonableness of executive salaries; (4) although executive compensation disputes accounted for only 14 percent of the petitions, they accounted for about 50 percent of the total proposed tax adjustments; (5) documentation disputes accounted for 19 percent of the total proposed tax adjustments; (6) in the 117 Office of Appeals cases reviewed, large corporations' capital expenditure disputes accounted for 42 percent of the contested issues and almost 58 percent of the total proposed tax adjustments; and (7) corporate documentation and executive compensation disputes constituted 8 percent and 3 percent, respectively, of the Appeals cases.