The latest available data from the Internal Revenue Service show that the pace of corporate audits is running substantially below the record-low levels registered in FY 2003.
The finding -- based on data released on Friday to the Transactional Records Access Clearinghouse (TRAC) -- conflicts with a series of statements made by IRS Commissioner Mark W. Everson asserting that the IRS had halted the long decline in the government's efforts to police corporate tax non-compliance.
In a March 15 speech at the National Press Club, for example, Everson said that because of strong evidence that corporate governance "was coming off the tracks", tougher enforcement was required: "We are correcting our course and re-centering the agency." The first priority, he continued, is "to discourage and deter non-compliance, with emphasis on corrosive activity by corporations, high-income individuals and other contributors to the tax gap."
About a month later, in a series of newspaper and television interviews on April 12, the IRS commissioner continued to assert that the agency was reversing its direction. "Our basic message is we've arrested the decline in enforcement that started in the 1990"s," Everson told the Washington Post. "We will start to bring the numbers up rather dramatically." Talking with the Wall Street Journal on the same day, he acknowledged there had been a lag in corporate tax enforcement but "we're turning the corner now and the decrease has stabilized....This is the hinge year."
The Agency's Record Overall
According to the IRS data covering the first six months of FY 2004, however, the annual pace of audits for all corporations has in fact continued to decline, so far running 26% below what it was in FY 2003.
A second kind of measure -- this one examining the actual hours expended on examining corporate tax returns -- produced a similar finding. They were running 30% below last year's pace.
And so far, IRS's success in uncovering additional taxes thought to be owed by corporations is also down. In fact, the latest available data for the first six months of FY 2004 show that taxes recommended by auditors are running 36% below the pace reported during the previous year.
See table for latest comparisons. See prior report for longer trends tracking corporate audit declines.
Trade Off Between Audit Coverage and Audit Thoroughness
These overall trends, however, conceal important differences in the patterns found for different sized corporations.
The audit pace for smaller corporations, those with up to $10 million in assets, was significantly down -- by a margin of almost fifty percent.
For the larger corporations, however, the audit pace came close to matching, and sometime exceeded, what the IRS had accomplished in the previous year.
Here is one example. For the largest corporations -- defined by IRS as entities with $250 million or more in assets -- the pace of audits in the first half of 2004 was down only 1.4% from levels in the previous year.
But the IRS managed to hold the line on the number of large corporate audits it completed only by sharply cutting the time the agents spent doing this challenging work. The result is an apparent reduction in the thoroughness of large corporate audits. The decline in audit length was related to the size of the corporations involved. For the moderately sized corporations, audit time decreased by only 10%. For the largest corporation, the average decreased by 33%. See table.
Because most of the additional taxes recommended in the corporate area are derived from the audits of the largest corporations (see table), the decline in the apparent thoroughness of the audits of these entities may well be a factor in the substantial reduction of the additional taxes the IRS concluded were due from corporations.
The figures also suggest that the two divisions in the IRS which handle corporate audits may have adopted different enforcement strategies. Smaller corporations (assets less than $10 million) are handled by the Small Business and Self-Employed Division. Here, while the audit numbers fell the average length of audits rose. And the pace of additional taxes recommended after audit in the first half of FY 2004 actually was higher by 22% over the results in FY 2003.
The Large and Medium Size Business Division, on the other hand, has tried to hold the line on audit coverage by allowing the time allocated for each audit to slip. But, as noted above, potential additional tax revenue uncovered from these large corporate audits thus far has slipped -- down 38%. The Division also kept its coverage numbers up by concentrating more on the smallest corporations that fell under its jurisdiction -- those with assets sizes between $10 and $50 million -- which take less time to complete.
One caution: while the conclusions summarized here about the decline of corporate audits are valid, they are based on six months of data. The figures, particularly for dollar amounts, can be sensitive to a few individual cases with unusually large tax adjustments. For the definitive verdict, audit trends for a full fiscal year will need to be examined. It should be noted that the six-month audit data provided TRAC on Friday afternoon, October 29, was requested back in April. The belated delivery of the information followed repeated promises by the agency that it would soon be forthcoming. Despite numerous requests, the IRS has so far balked at releasing 9 month or later figures. The agency has also withheld any details on how their underlying numbers were derived.
The long term decline in corporate audits has been a serious concern of a variety of government and non-government experts. Just three months ago, for example, the IRS Oversight Board -- an independent body established by Congress to maintain watch over the policies and practices of the agency -- said flatly in its fourth annual report that the decline in enforcement programs aimed at business was a "serious and ongoing problem that threatens the very integrity of our tax administration."
The board added that fighting back against those who fail to pay their fair share is not easy. "Since 1996, the number of enforcement personnel required to effectively combat tax evasion has shrunk by 36 while the workload has increased. The effect of this disparity in trends is painfully obvious."
Both the board and the General Accounting Office questioned the Bush Administration's promise that a slight increase in IRS funding it was proposing would be sufficient to deal the problem.