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IRS Underreporting Its Compliance Activities

Few things are as unwelcome as a notice from the IRS saying that it intends to audit your tax return. However, since IRS-provided statistics show a consistent decline in the taxpayer audit rate over the last several years, taxpayers may assume that the likelihood of the IRS questioning their return is slim.

That confidence may be misplaced. The National Taxpayer Advocate's 2017 Annual Report to Congress* says that the IRS has underreported the extent of its compliance contacts with taxpayers for years. The report notes that the IRS only measured what it calls "real" audits. The IRS, the report states, takes the position that many taxpayer compliance contacts through programs and procedures such as math error corrections, Automated Underreporter (AUR), identity and wage verification, and Automated Substitute for Return (ASFR) are not classified as "real" audits. However, these contacts, or "unreal" audits -- where taxpayers must provide documentation or information to the IRS -- comprise the majority of compliance contacts and eclipse "real" audit figures.

For example, the report notes that in 2016 the IRS conducted 1,033,356 "real" audits and its audit rate dipped to 0.7%. However, the IRS conducted approximately 8.5 million "unreal" audits through its math error, AUR, identity and wage verification, and ASFR programs in that same year, and the combined coverage rate was 6.2%. By reporting only its "real" audit activity, the IRS is masking the true extent of its compliance activities. Moreover, its actions have a real-world impact on statutory taxpayer protections.

Defining Traditional, or "Real," Audits

Typically, an audit of a taxpayer's income tax return will be one of three primary types:

Correspondence audit. This takes place when the IRS contacts a taxpayer by mail and informs the taxpayer that it detected a mistake or error in the tax return. It could be as simple as a reminder that a required schedule was not included with the tax return. Typically, no further action occurs if the paperwork submitted in response to the request is satisfactory to the IRS.

Office audit. With this type of audit, taxpayers are asked to bring their tax records to a local IRS office for examination. For example, the IRS could ask to see records that support a large deduction claimed for charitable contributions.

Field audit. As its name implies, this type of audit takes place at the taxpayer's home or place of business. The IRS auditor will review paperwork or other material that can support the veracity of the taxpayer's return. Field audits generally deal with tax issues that are more complex than those involved in a correspondence or office audit.

"Unreal" Audits (Other Compliance Contacts)

The various other compliance contacts that are categorized by the Taxpayer Advocate as "unreal" audits often solely rely on matching third-party documentation against the taxpayer's return. These contacts include:

Math or clerical error. The tax code authorizes the IRS to make a summary assessment of tax due where that addition is the result of a mathematical or clerical error on a return.

AUR. This program uses third-party documents, such as documents from employers, banks, and brokers, and matches amounts reported on tax returns with the information returns.

Programs to stop identity theft and refund fraud. These programs use filters, rules, data mining models, and manual reviews to identify potentially false returns and to stop fraudulent refunds before the IRS issues them.

ASFR. This program enforces filing compliance by taxpayers who have not filed individual tax returns but have incurred a significant tax liability.

Why It Matters

While "unreal" audits may look and feel similar to IRS correspondence exams, they do not allow taxpayers to request Appeals review of their cases and have their documentation considered by an impartial third-party prior to receiving a statutory notice of deficiency. The National Taxpayer Advocate says that because of the prevalence of "unreal" audits, the IRS should revisit its classification approach and provide taxpayers with additional opportunities to seek Appeals review. The Taxpayer Advocate also recommends that there be increased protections against repeat review of cases. *National Taxpayer Advocate Annual Report to Congress 2017, January 10, 2018.