TIGTA Releases Annual Report on IRS Compliance Trends

The Treasury Inspector General for Tax Administration (TIGTA) released its annual report on IRS compliance trends yesterday.  The key takeaway from the report is TIGTA’s finding that the total amount of revenue received and collected by the IRS increased for the third year running, despite the fact that the IRS had fewer employees and decreased funding levels.  However, the IRS conducted fewer examinations, and its Collection function continued to receive more delinquent accounts than it closed, the report concluded.

“Budget reductions contributed to a decrease in the number of examinations and an increase in the number of delinquent taxes being assigned to an inactive status at the Internal Revenue Service last year,” said J. Russell George, Treasury Inspector General for Tax Administration.  “However, overall enforcement revenue increased in 2013, due, in part, to several large appeal case settlements.”

Here are the key findings of TIGTA’s report:

  • The Internal Revenue Service’s appropriated budget decreased 7.4 percent between FY2010 and FY2013, from $12.1 billion to $11.2 billion after sequestration.  The budget cuts resulted in reductions in the number of employees available to provide services to taxpayers and enforce the tax laws.  Specifically, the number of full-time equivalents dropped by nearly 9 percent, from 94,618 at the end of FY2010 to 86,310 at the end of FY2013, including a 4 percent reduction between FY2012 and FY2013.  The number of enforcement personnel decreased by more than 1,000 employees during FY2013.
  • Despite these challenges, total dollars received and collected (gross collections) increased for the third straight year to $2.9 trillion (a 13 percent increase) in FY2013.  Enforcement revenue collected also increased from $50.2 billion in FY2012 to $53.3 billion in FY2013, due, in part, to several large Appeals case settlements.  Tax return filings continued to increase as did gross accounts receivable, which increased to $400 billion.
  • TIGTA found that the FY2013 Collection function activities showed mixed results. The amount collected on delinquent accounts by both the Automated Collection System and Field Collection decreased.  The Collection function continued to receive more delinquent accounts than it closed, although the number of delinquent accounts in the Collection queue decreased, due in part to the shelving of millions of accounts that were not resolved.  Fewer Notices of Federal Tax Lien were filed, fewer levies were issued, and fewer seizures were made.  Meanwhile, taxpayers’ use of payment options such as offers in compromise increased.

TIGTA’s report found that IRS Examination function conducted 6 percent fewer examinations in FY2013 than in FY2012.  The decline in examinations occurred across all tax return types, including individual, corporation, S corporation, and partnership. In particular:

  • Individual Income Tax Return Examinations – The number of individual income tax return examinations decreased for the third straight year.  The IRS examined 1,404,931 (one of every 104) tax returns in FY2013.  This is approximately 11 percent fewer examinations than the 1,581,394 reported in FY2010 (one of every 90). During FY2013, 81 percent of the examinations of individuals were performed by correspondence.  One of every 541 individual income tax returns filed received a face-to-face examination, which is a 4 percent decrease compared with FY 2012, when one of every 522 individual returns received a face-to-face examination.
  • Corporate Income Tax Return Examinations – Fewer corporate tax returns were examined during FY2013 than any of the past five years.  The number of examinations decreased in FY2013 to a five-year low of 27,480 (one of every 70 returns filed). Also in FY2013, there were fewer corporate tax filings than in any of the last five years (1,912,105).  Over the past five years, the number of corporate tax returns examined with assets of less than $10 million decreased 4 percent, from 18,298 in FY2009 to 17,604 in FY2013.  These examinations decreased by 17 percent in the past year alone, from the five-year high in FY2012 of 21,164. As examinations of these returns have reached lows, filings have also dropped over the past five years.  Corporate tax return filings with assets of less than $10 million have decreased nearly 14 percent since FY2009, with a 2 percent decrease since FY2012.
  • S Corporation Tax Return Examinations – The number of S corporation examinations decreased 14 percent from the 21,658 examinations conducted in FY2012.  However, the number of S corporation examinations in FY2013 (18,670) was nearly 7 percent more than the number examined in FY2009 (17,455).  In FY2012, one of every 206 S corporation returns filed were examined, compared with one of every 240 filed in FY 2013. S corporation return filings increased for the fifth straight year, reaching 4.5 million in FY2013.
  • Partnership Return Examinations – The number of partnership returns examined decreased 11 percent to 14,870 in FY2013 after increasing to 16,691 in FY2012.  One of every 211 returns filed in FY2012 were examined.  This decreased to one of every 239 in FY2013. Partnership return filings increased to 3.6 million in FY2013.
  • Other Tax Type Examinations (fiduciary, employment, excise, estate, and gift taxes) – The overall number of examinations in these five classes was 87,836 for FY2013.  This is a 13 percent decrease in examinations from FY2012, when the number of examinations was more than 101,000.  Each of the five other tax type returns experienced decreases in the number of examinations between FY2012 and FY2013.  Excise return examinations decreased by 25 percent and estate return examinations decreased by 14 percent.  During FY2012, only one of the five other tax types (estate) experienced decreases in the number of examinations.  The return filings increased for all five of these other tax type returns in FY2013.  Estate return filings and excise return filings increased 123 percent and 52 percent, respectively.

Another important measure of audit productivity is the percentage of audited tax returns that result in recommended adjustments to the tax return.  The IRS associates a high percentage of audited tax returns that result in recommended adjustments with greater audit productivity, while audits that result in no change are considered unproductive.  The no-change rates for:

  • Revenue agent examinations of individual tax returns reached a five-year low in FY2011 (8 percent).  Since then, the no-change rate gradually increased to 10 percent in FY2013.
  • Tax compliance officer examinations of individual tax returns continued to remain at either 9 or 10 percent between FY2009 and FY2013.
  • Revenue agent examinations of corporate tax returns increased to 29 percent during FY2013.
  • Revenue agent examinations of partnership returns increased during FY 2013 to 47 percent.  The no-change rate increased in FY2010 (44 percent) and FY2011 (48 percent) and decreased in FY2012 to 44 percent.
  • Revenue agent examinations of S corporations continue to decrease from 39 percent in FY2011 to 33 percent in FY2012 and 31 percent in FY2013.

The conclusion to TIGTA’s report is as follows:

The IRS faced many challenges during FY 2013, including implementing provisions related to new tax legislation and operating with fewer resources and employees.  Several indicators showed the negative effect of these challenges, including a continued increase in accounts receivable, an increase in the number of cases that might never be worked, and a decrease in the overall number of examinations of tax returns.  While some indicators are positive, including increases in gross collections, enforcement revenue, and dollar yield per hour on examinations of corporations, the negative trends continue to be cause for concern, especially given that diminished enforcement could also affect voluntary compliance over time.

High Court Opens Door To IRS Personnel Examination

Today’s blog was first published in the June 19, 2014 edition of Law360. To learn more, please click here or visit www.law360.com. Reprinted with permission from Law360.

The U.S. Supreme Court issued a unanimous opinion Thursday in United States v. Clarke (No. 13-301) addressing the standard that must be satisfied before a taxpayer can question Internal Revenue Service personnel about its reasons for issuing a summons. The standard announced by the court, in an opinion authored by Justice Elena Kagan, requires a taxpayer to show “specific facts or circumstances plausibly raising an inference of bad faith” before a taxpayer may examine IRS officials.

“Naked allegations of improper purpose are not enough,” the court held. Instead, “[t]he taxpayer must offer some credible evidence supporting his charge.”

The case arose out of an IRS examination of Dynamo Holdings Limited Partnership focusing on interest expenses reported on the 2005 through 2007 income tax returns. When the three-year statute of limitations was about to expire, Dynamo agreed to a one-year-long extension, and later to a second one-year extension with the IRS. Dynamo refused, however, to grant the IRS a third extension.

Shortly after being refused the third extension, the IRS issued summonses to five individuals seeking information about Dynamo’s tax liabilities. Four of the five individuals refused to comply with the summonses. Two months later, the IRS issued a Final Partnership Administrative Adjustment that increased Dynamo’s tax liability, and Dynamo filed suit in Tax Court contesting the adjustment. Three months later, the IRS initiated summons enforcement proceedings in the district court.

The enforcement proceedings focused on whether the IRS acted in good faith in issuing the summonses. An IRS agent submitted an affidavit that attested to the required factors to obtain enforcement of an IRS summons pursuant to United States v. Powell, 379 U.S. 48 (1964): (1) there was a legitimate purpose for the investigation; (2) the summons inquiry is relevant to the purpose; (3) the IRS does not already have the information sought; and (4) administrative steps required by the Internal Revenue Code have been followed.

Seeking to demonstrate that the IRS acted in bad faith, the summoned individuals claimed that the IRS issued the summonses for two improper purposes: (1) as retribution for Dynamo’s refusal to agree to a third statute of limitations extension; and (2) as an inappropriate end-around the limited discovery rules in Tax Court in order to obtain additional evidence to use against Dynamo in that proceeding. The individuals argued that they were entitled to question IRS personnel to explore these issues.

The district court denied the taxpayers’ requests and ordered them to comply with the summonses. On appeal, the Eleventh Circuit reversed, holding that the district court abused its discretion in refusing to allow the IRS agents in question to be examined.

Following established circuit precedent, the court of appeals reasoned that “requiring the taxpayer to provide factual support for an allegation of an improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible ‘Catch 22.’” The individuals therefore could “question IRS officials concerning the Service’s reasons for issuing the summons[es].”

Notably, the appellate court’s ruling was an anomaly, as every other circuit addressing the issue (including the First, Third, and Seventh Circuits) had held that bare allegations of improper motive were insufficient to justify examination of an IRS agent. The Supreme Court granted certiorari to resolve the conflict, and firmly guided the Eleventh Circuit back into the fold by holding that “some credible evidence” of alleged improper motive must be adduced before IRS agents may be examined.

Specifically, the taxpayer must come forward with “specific facts or circumstances plausibly raising an inference of bad faith.” Because direct evidence will rarely be available, circumstantial evidence is sufficient, but “[n]aked allegations” are not. This standard, the court reasoned, should sufficiently protect a summons dispute from turning into a fishing expedition. Because the Eleventh Circuit never assessed the facts and circumstances submitted by the summoned individuals in support of their bad-faith claims, the court vacated the decision and remanded for further proceedings.

The Supreme Court’s decision is not surprising in that it aligned the Eleventh Circuit with other federal circuits, but it is surprising in that it adopted a formulation of the summons enforcement standard that is different from the standards already in use by other circuits. Crafting its own standard, the court now requires a showing that “plausibly rais[es] an inference of bad faith” or improper motive.

Justice Kagan’s opinion also provided guidance regarding the appropriate standard of review for appellate courts in summons enforcement proceedings. First, a court of appeals must review for abuse of discretion a trial court’s decision as to whether an examination of IRS agents is warranted. But, the court cautioned, a district court’s decision in this regard is entitled to deference only if based upon the correct legal standard. Second, the district court is not entitled to deference as to legal issues as to what qualifies as an improper purpose for issuance of an IRS summons.

The court’s limited opinion focused almost entirely on the legal standard and refrained from deciding any other aspect of the case. For example, the court did not opine as to whether issuing a summons to gain an unfair advantage in Tax Court litigation or to retaliate against a taxpayer for refusing to further extend the statute of limitations are improper motives for issuing a summons. Instead, the court left those issues to be decided by the court of appeals on remand, noting that both are legal issues for which no deference is due the district court.

The court also chose not to opine as to whether the evidentiary proof of bad faith submitted by the individuals (primarily, two sworn declarations) would satisfy the new standard.

One declaration set forth the timeline of Dynamo’s refusal to extend the statute of limitations and the issuance of the summonses, thereby implying the retributive nature of the summonses. The other described how IRS attorneys who were handling the Tax Court litigation were present when the one individual complied with the summons, and the initial investigating agents were not, tending to show the summons’ purpose was to support the Tax Court litigation.

Whether these are in fact improper motives, and whether declarations of this type are a sufficient basis to meet the new standard, will have to be addressed on remand as well as by lower courts now that the legal standard for challenging a summons enforcement has been clarified by the Supreme Court.

IRS Releases Annual Data Book of Agency Activities

Today the Internal Revenue Service released its annual data book, which it describes as a “snapshot of agency activities for the fiscal year.”  The time period covered in the FY2013 Data Book is October 1, 2012, through September 30, 2013.  We will be analyzing the data book and reporting on its substance over the coming days.  In the meantime, here is the press release announcing release of the FY2013 Data Book:

WASHINGTON — The Internal Revenue Service today released the 2013 IRS Data Book, a snapshot of agency activities for the fiscal year.

The report describes activities conducted by the IRS from Oct. 1, 2012, to Sept. 30, 2013, and includes information about returns filed, taxes collected, enforcement, taxpayer assistance and the IRS budget and workforce, among others.

During fiscal year 2013, the IRS collected almost $2.9 trillion in federal revenue and processed 240 million returns, of which 151 million were filed electronically. Out of the 146 million individual income tax returns filed, almost 83 percent were e-filed. More than 118 million individual income tax return filers received a tax refund, which totaled almost $312.8 billion. On average, the IRS spent 41 cents to collect $100 in tax revenue during the fiscal year, matching low-cost results for 2008 and 2001.

The IRS examined just under one percent of all tax returns filed and about one percent of all individual income tax returns during fiscal year 2013.  Of the 1.4 million individual tax returns examined, over 39,000 resulted in additional refunds. The IRS provided taxpayer assistance through 456 million visits to IRS.gov and assisted almost 91 million taxpayers through its toll-free telephone helpline or at walk-in sites.

Our analysis of the FY2012 Data Book is available here.

IRS Extends Effective Date of LB&I IDR Enforcement Procedures to March 3

We previously posted about the new Information Document Request (IDR) enforcement procedures announced last fall by the IRS Large Business and International Division (see prior post here).  The effective date of those procedures was supposed to have been January 2, 2014.  On February 7, however, the IRS announced that the effective date of the new IDR procedures was being extended to March 3, 2014.  In its announcement, the IRS stated that the extension was needed in order to “provide the clarification that is necessary to ensure that the procedures governing IDR issuance and enforcement are easily and clearly understood.”

Latest IRS Statistics Show Decline in Audit Rates, Uptick in Criminal Investigations

The Internal Revenue Service has released its FY 2013 “Enforcement and Service Results” (available here), which provide statistics as to the agency’s audit, collection, and enforcement activities.  FY 2103 began on Oct. 1, 2012, and ended on Sept. 30, 2013.  A number of interesting conclusions can be drawn from the data.

Audit Activity

The audit rate for individual tax returns in FY2013 was .96 percent, the lowest such rate since FY2006.  The total number of audits during FY2013 was 1.4 million, with over 1 million of that number consisting of correspondence audits.

The audit rate based upon amount of income also decreased in 2013 in all categories reported by the IRS.  For taxpayers with income of under $200,000, the FY2013 audit rate was .88 percent (as comparied to 1.04 percent in FY2010, 1.02 percent in FY2011, and .94 percent in FY2012).  For taxpayers with income between $200,000 and $1 million, the audit rate dropped to 3.26 percent (as compared to 3.93 percent in FY2011 and 3.70 percent in FY2012).  For taxpayers with income in excess of $1 million, the audit rate in FY2013 again decreased, to 10.85 percent (as compared to 12.48 percent in FY2011 and 12.14 percent in FY2012). 

For businesses, the audit rate also declined.  For all entity returns, the FY2013 audit rate was .61 percent (as compared to .63 percent in FY2011 and .71 percent in FY2012).  Audit rates also dropped in each category of business returns, as shown below:

  • Small corp returns (assets under $10 million):  .95 percent (FY2012 1.12 percent)
  • Large corp returns (assets over $10 million):  15.84 percent (FY2012 17.78 percent)
  • S corp returns:  .42 percent (FY2012 .48 percent)
  • Partnership returns:  .42 percent (FY2012 .47 percent)

Enforcement Results

The IRS collected over $53 billion in “enforcement revenue” in FY 2013, which includes taxes, interest, and penalties.  This was an increase over FY2012 ($50 billion) but a decrease as compared to FY2011 ($55 billion) and FY2010 ($57 billion).  A likely explanation for this decline in enforcement revenue is steadily decreasing levels of IRS enforcement personnel (revenue officers, revenue agents, and special agents).  In FY2013, the IRS had a total of 19,531 enforcement personnel, the lowest number in a decade.  Enforcement positions at the IRS have been diminishing as a result of budget cuts, retirements, attrition, and the like, as the following figures demonstrate:

  • FY2010 enforcement personnel:  22,710
  • FY2011 enforcement personnel:  22,184
  • FY2012 enforcement personnel:  20,868

In FY2013, the IRS undertook fewer collection activities as well, again likely due to staffing reductions, as the following figures demonstrate:

  • Levies:  1.8 million (compared to 2.9 million in FY2012)
  • Liens:  602,005 (compared to 707,768 in FY2012)
  • Seizures:  547 (compared to 733 in FY2012)

On the criminal investigation side, the statistics generally show an uptick in activity by the IRS.  In FY2103, there was a spike in the number of criminal prosecutions recommended, to 4,364, as compared to 3,701 in FY2012.  The overall conviction rate for tax and tax-related cases remained generally flat, at 93.1 percent.  The average jail sentence for tax and tax-related case also remained flat, at 31 months.  Finally, the total number of criminal investigations initiated in FY2013 increased to 5,314 (as compared to 5,125 in FY2012) and the total number of taxpayers who were criminally charged in FY2013 also increased, to 3,865 (as compared to 3,390 in FY2012).

TIGTA Urges IRS to Scrutinize Tax Returns Claiming Foreign Earned Income Exclusion

The Treasury Inspector General for Tax Administration (TIGTA) issued an audit report on December 12, 2013, recommending that the Internal Revenue Service increase its scrutiny of tax returns claiming the Foreign Earned Income Exclusion.  The report, which is entitled “The Referral Process for Examinations of Tax Returns Claiming the Foreign Earned Income Exclusion Needs to Be Improved,” is available here

By way of background, to alleviate double taxation of taxpayers earning foreign income while residing overseas, IRC Section 911(a) provides for the Foreign Earned Income Exclusion (FEIE) and the Foreign Housing Exclusion/Deduction.  For Tax Year 2012, the FEIE allowed taxpayers to exclude foreign earned income of up to $95,100.   Qualifying taxpayers living and working in a foreign country may also claim a limited exclusion or deduction for the amount of their housing expenses.  These benefits can significantly reduce or eliminate taxpayers’ U.S. income tax liabilities regardless of whether they paid any foreign income taxes.

TIGTA found that of approximately 140 million individual income tax returns filed for tax year 2009, 372,119 (or 0.27 percent) tax returns included a Form 2555/2555-EZ, Foreign Earned Income/Foreign Earned Income Exclusion.  The exclusions, credits, and deductions claimed were as follows:

  • $23.3 billion in the FEIE.
  • $5 billion in foreign tax credits.
  • $2.7 billion in Foreign Housing Exclusions.
  • $102.6 million in Foreign Housing Deductions.

From a statistical sample of 2009 tax returns, TIGTA estimated that U.S. taxpayers living and working in foreign countries who claimed the FEIE reduced their federal income taxes by $562 million.  Taxpayers claiming the Foreign Housing Exclusion/Deduction reduced their federal income taxes by an additional $174 million for 2009.

In addition, during FY2009 through FY2011, 2,851 (or 99 percent) of the 2,876 individual income tax returns examined where a Form 2555/2555-EZ was present were not referred to an international examiner as required by IRS procedures.  TIGTA estimated that improving the audit referral process could result in approximately $2.7 million in additional tax assessments, or $13.5 million over five years.  Moreover, 1,583 examinations that were not required by the IRS to be referred might warrant referral to international examiners.  Referral of these tax returns could potentially result in approximately $1.5 million in additional tax assessments, or $7.5 million over five years.

As a result of its audit findings, TIGTA recommended that the IRS ensure that (1) domestic examiners and their managers are aware of the international referral criteria and (2) the international referral criteria process is evaluated to determine if it should be expanded to include the Wage and Investment Division.  In their response to the report, IRS officials agreed with the recommendations and plan to take corrective actions.

TIGTA Audit Report: Budget Cuts Devastate IRS Enforcement Activities

The Treasury Department’s Inspector General for Tax Administration (TIGTA) has issued a report entitled “Trends in Compliance Activities Through Fiscal Year 2012” which confirms that cuts to the Internal Revenue Service budget have taken a severe toll on the agency’s ability to carry out its enforcement mission.  The report studies the IRS’s collection and examination functions during FY2011 and FY2012.

The report opens by noting that while the “Tax Gap” — the difference between what is owed in taxes each year and what is paid voluntarily — is steadily growing, both the IRS’s budget and enforcement revenue are decreasing.  (In a separate audit report, TIGTA has criticized the IRS calculation of the Tax Gap as well.  That report is available here.)  For tax year 2001, the IRS estimated the Tax Gap at $345 billion.  For tax year 2006 (the most recent estimate available), the IRS estimates the Tax Gap to be $450 billion, an increase of 30 percent.  Meanwhile, the IRS budget has decreased from FY2010 to FY2012, with a further reduction of $600 million in FY2013 due to the sequester.  These budget cuts have caused a reduction of approximately 8,000 full-time IRS positions since FY2010, including 5,000 from what TIGTA describes as “front-line enforcement personnel.”  In addition, the report notes that over 30 percent of executives, and 20 percent of non-executive managers, are currently eligible for retirement. 

The audit report notes that enforcement revenue has declined for two straight years, and is currently 13 percent less than the FY2010 level.  TIGTA concluded that this decline correlates directly with the 14 percent reduction in the number of IRS enforcement personnel.  At the same time, the number of tax returns being filed has steadily increased.

On the collection front, the TIGTA report notes that revenue collection decreased by 7 percent from FY2011 to FY2012.  In addition, the overall use of key collection mechanisms — liens, levies,and seizures — has decreased.  Between FY2011 and FY2012, the use of tax liens dropped a whopping 32 percent, but that decline is likely attributable to the new Fresh Start Initiative which limited the IRS’s ability to impose liens in certain circumstances in order to help individuals and small businesses meet their tax obligations without adding unnecessary burdens. 

On the audit front, the IRS has experienced a 13 percent reduction in the number of personnel who conduct examinations of tax returns.  In FY2012, the IRS conducted 4 percent fewer audits, and 70 percent of those examinations were conducted by correspondence.  In FY2012, the number of individual tax returns that were examined decreased for the second straight year, while the number of corporate tax returns that were selected for audit increased to a five-year high.  Gift tax examinations have increased every years since FY2009, and have nearly tripled since FY2008. 

The TIGTA report concludes as follows:

The IRS faced many challenges during Fiscal Years 2011 and 2012, including implementing provisions related to new tax legislation and operating with fewer resources and employees.  Several indicators showed the effect of these challenges, including a decrease in enforcement revenue, a continued increase in accounts receivable, an increase in the number of cases that might never be worked, and a decrease in the overall number of examinations.  Nevertheless, many indicators increased, including gross collections and the examinations of certain tax returns.  Some of these trends are cause for concern, especially given that diminished enforcement could also affect voluntary compliance over time.