IRS continues to increase compliance audits

Individuals and business alike need to take care when assembling their tax information and need to be increasingly diligent in retaining all their receipts to document their income and deductions.

In early 2002, the IRS announced a compliance initiative. IRS described it as a comprehensive effort to measure payment, filing and reporting compliance for different types of taxes and various sets of taxpayers.

Initially, the program focused on individual income taxes. At that time, the IRS indicated that in the future, it will measure other taxes and other types of taxpayers.

IRS said the no-change rate was going up for individual audits and the new data would help reduce the burden of unnecessary IRS contacts on compliant taxpayers, which will benefit both IRS and taxpayers.

In March 2005, the IRS released preliminary results from this major research project assessing compliance with the tax laws. The study, which involved tax year 2001, reveals that the gross tax gap, i.e., the difference between what taxpayers should pay and what they actually pay on a timely basis, is more than $300 billion per year.

IRS has received an increase in funding for enforcement and says it is moving aggressively to reduce the tax gap. The next stage will be to finish the data analysis and refine the tax gap data in late 2005. IRS will use the data to update its statistical tools for selecting individual returns for audit.

In late July, the IRS has announced the launch of a new study to assess the reporting compliance of S corporations, which have grown significantly in number in recent years. The study will examine 5,000 randomly selected S corporation returns from tax years 2003 and 2004.

In the past twenty years, the number of S corporations has risen rapidly. As a result, S corporations are now the most common corporate entity. In 2002, the latest year for which data is available, S corporation returns accounted for 59% of all corporate returns filed for 2002 tax years.

The IRS is concerned about how this explosive growth in S corporations affects compliance. Thus, it has launched the new study, under which audits are to begin later this year. The new initiative will use a study approach designed to reach statistically valid conclusions regarding compliance behavior.

IRS says the results of the study will be used to more accurately gauge the extent to which the income, deductions and credits from S corporations are properly reported on returns filed by S corporations and their shareholders. IRS expects that the information gleaned from the study will assist it in selecting and auditing S corporation returns with greater compliance risk.

Any S Corporations selected in this new initiative should make every effort to locate all the documentation to support their tax returns. Given the nature of these examinations, auditors will be required to take note of weaknesses and make adjustments so to reflect the most accurate selection results. Due to the serious nature of these audits, businesses are suggested to involve their tax advisors in this process.

Article provided by Kristina Drzal Houghton, CPA, MST, Partner in Charge of Taxes for Meyers Brothers Kailicka, P.C. in Holyoke ,MA. MBK is the largest privately owned CPA firms in western MA and northern CT providing a full range of accounting, tax and advisory services.