Last month we mentioned a study that was done by the Transactional Records Access Clearinghouse (“TRAC”) of Syracuse University that was critical of the IRS’ trend of auditing fewer large corporations and focusing smaller business. A major concern for not only small business owners and managers but also taxpayers since they pay for the audits that are occurring.

We recently spoke to Dr. Susan Long, co-director of TRAC and AssociaSyracuse’s Whitman School of Management about the study.

Dr. Susan Long: The report really does two things: 1) Presents a tool [link to tool] that users can use to look up all sorts of statistics about IRS audits for any size corporation. From very small to very large, you can look at trends over a long time so that you can see how things have changed.

2) The focus of our report was to look at the continuing large drop in corporate audits even though this is a time of rising deficits. The IRS has been given more budget for agent staffing but they have not chosen to focus on the largest corporations even though that’s where, historically, the IRS gets the biggest bang for the buck.

GC: One section of the report discusses the politics of tax collection and deficits. Is the IRS and Treasury taking the wrong approach into obtaining more revenue for the Federal Government?

SL: Our role was not to judge them but to lay out what they do and look for some kind of rationale. We could not find any rationale apart from some kind of a perverse quota system. It certainly does not appear to be at all consistent with focusing where tax dollars are underreported based on their own statistics.

GC: Do you have suggestions or opinions about what the IRS can do better? Is there a way that the Service can improve the quota system or do they need to reassess their strategy altogether?

SL: The role of TRAC is not the typical policy research organization. Our role, as we see it, is to present a picture of what the government, in this case what the IRS, is doing with respect to tax audits and to leave it up to the reader to decide what makes sense.

What we did find is that IRS sets performance goals, as all agencies do, and it sets group targets, not individual targets for agents. But nonetheless they are based on how many total audits of corporations take place for the large and mid-sized industry group (“LMSB”) and then separately for the small and self-employed business unit (“SBSE”). We noticed that there was a peculiar reversal in audit rates when you got to the margin of those companies at say, with the bigger companies for SBSE audits versus what would then be larger companies but represent the small guy for the LMSB auditors. It just showed quite clearly that there was a tendency for each branch to shy away from its biggest audits and put increased efforts on its smaller guys within its unit in a very perverse fashion.

GC: Since you used the IRS’ own data to compile your study does it appear that the statistics could be the result of the flawed goals or quota system?

SL: Right. We’re all human and we respond to what we’re measured on. If those measurements are not in accord with what the priorities are [i.e. where the largest underreporting occurs], you’ll work to the measure rather than to the overall priority. This is not the first report where we’ve noticed this. In this case, what was interesting was that for a long period of time, Congress had been cutting the IRS’ budget and it’s really tough when you have more and more returns and fewer and fewer agents to cover them. You’ve really got hard choices there.

So we were very interested to see, now that we’ve entered a new era, Congress has been giving the IRS more budget for hiring more revenue agents. Therefore they have more discretion about where they will put these additional resources and they are certainly not putting them in the large corporate area.

GC: What about the IRS’ contentions that they audit 100% of companies of $20 billion in assets or more?

SL: According to their figures, the IRS audits more than 100% of all the corporations of that size. These particular figures we took from the IRS databook that is put out annually. There has only been three years where there has been a breakout with these categories.

The first time it came out the IRS said, “yes it’s over 100% but that’s because you can audit more than one year’s return in the same year” and that’s true. But then in the second year it’s over 100% and they make the same excuse. Now this is third year and it’s still over 100% [see footnote at the bottom of the study].

They’re not doing a very good job of accurately measuring that [the number of companies audited] so we presented figures that give the IRS the benefit of the doubt. They’re not measuring the size of the returns vs. the size of the audits in a consistent way, so we just grouped it with the next largest category and saw exactly the same trends in terms of the hours spent auditing the biggest companies.

Simply, there’s a tendency to spend less time on less complicated returns. As companies get bigger their businesses get more complex. When you see that sort of thing in an organization, you look at what are the goals being measured against. If they’re being measured just on quantity and there isn’t any distinguishing between that workload that takes longer to do, it’s easier to up your numbers by choosing workload that you can churn out faster. It’s human nature.