Tax Administration

For 1992, according to the most recent Internal Revenue Service (IRS) estimate, individual taxpayers failed to pay about $100 billion in income tax liabilities. An audit is one of the enforcement tools that IRS uses to try to reduce this amount. Recently, Congress has voiced concerns about the methods that IRS uses to select returns for audit and the techniques used to conduct audits. IRS has many sources for which to select tax returns for audit. IRS' intent is to choose returns with audit potential -- returns for which an audit is most likely to find errors and recommend changes to the reported tax. One source is the discriminant function (DIF), an automated system for scoring individual tax returns according to their audit potential. In examining how effectively IRS selected individual income tax returns for audit, GAO focused on audits in which auditors in IRS district office hold face-to-face meeting with individual taxpayers to review their books and records. For these books and records, GAO (1) determines the extent to which IRS district offices have used various sources to select these individual returns for audit and (2) compares the results of audits selected using these sources in terms of the rate at which audits recommended no-change to the tax reported, amount of additional taxes recommended per return audited, and rates at which IRS assessed and collected such recommended taxes after the audit.

GAO noted that: (1) of the 1.1 million closed books and records audits of returns received in 1992, 1993, and 1994, GAO's analysis showed that IRS selected 59 percent of the returns using its discrimnant function (DIF) source; (2) the other 41 percent were selected using non-DIF sources; (3) when GAO compared the results from DIF and non-DIF audits of returns received in 1992, 1993, and 1994, the non-DIF audits generally resulted in lower no-change rates and higher recommended additional taxes than DIF audits; (4) these results are consistent with IRS' policy to use non-DIF sources if the audit potential appears to be higher than it would be from a DIF audit; (5) in contrast, GAO estimated that IRS collected a greater proportion of the additional taxes recommended in DIF audits than for non-DIF audits, based on a sample of returns received in 1992; (6) an estimated 57 percent of the recommended additional taxes were collected for DIF audits versus 35 percent for non-DIF; (7) several IRS operations affect collections and GAO was unable to determine from IRS' data which of these caused the non-DIF collection rate to be lower; (8) caution is needed if one uses the three results analyzed to compare the effectiveness of DIF and non-DIF sources; (9) the no-change rate, the recommended additional tax amounts, and the collection rate on these recommended amounts do not present a complete picture of audit effectiveness; (10) for example, data are not readily available on how audits affect voluntary compliance and taxpayer burden; and (11) nor are data readily available on how other factors, such as the quality of the audits, affected the results across the selection sources.