IRS Criticized for Correspondence Audit Process; Expect to See More Prior/Subsequent Year Audits

The Treasury Department’s Inspector General for Tax Administration (TIGTA) has issued an audit report sharply criticizing the IRS correspondence audit process.  The report, entitled “The Correspondence Audit Selection Process Could Be Strengthened,” studied the effectiveness of the correspondence audit process utilized by the IRS.  In contrast to a traditional “field audit” when an IRS revenue agent meets the taxpayer face-to-face, correspondence audits are generally conducted through the mail and are less instrusive, more automated, and conducted by examiners who are trained to deal with less complex tax issues.  During a correspondence audit, agents do not perform “required filing checks” which are used during field audits in order to determine whether the same pattern of non-compliance identified on the audited tax return is present on prior and/or subsequent year tax returns. 

The IRS relies heavily on the correspondence audit process to identify possible underreporting on individual tax returns.  For example, during FY2012, the IRS audited a total of 1.5 million tax returns.  Of that number, 1.1 million, or 73%, were conducted through correspondence audits, and additional taxes of $9.2 billion were recommended from correspondence audits alone.  Correspondence audits are generally more economical to conduct than field audits, with the average cost per correspondence audit of $274 as compared to an average cost per field audit of $2,278.

During its review of the IRS correspondence audit process, TIGTA reviewed a statistical sample of single-year correspondence audits where the taxpayers involved agreed that they had understated thair tax liabilities by at least $4,000.  TIGTA found that similar tax issues existed for the prior and/or subsequent years tax returns for many of the sampled taxpayers, yet the IRS did not audit their prior and/or subsequent year returns, leading to significant lost revenue for the U.S. Treasury.  TIGTA projected that the IRS could generate approximately $69.4 million in additional revenue if the correspondence audit process were strengthened by focusing on prior and/or subsequent tax years.

As of result of these findings, TIGTA recommended that the IRS develop and implement procedures in the Interal Revenue Manual to instruct examiners how current year correspondence audit results are to be used in deciding whether the prior and/or subsequent year returns warrant an audit.  IRS management agreed with TIGTA’s recommendation and plans to develop an IRM section to provide examiners with direction on expanding correspondence audits, where appropriate, to prior and/or subsequent years. 

The correspondence audit process is a key enforcement tool used by the IRS to detect underreporting on individual tax returns.  The correspondence audit process is efficient, economical, and provides significant return to the IRS.  As a result of TIGTA’s findings and criticism of the correspondence audit process, we expect to see IRS revenue agents more frequently expanding current year audits to include prior and/or subsequent years.

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