GAO to IRS: Shift Taxpayer Exam Priorities

Correspondence exams of taxpayers earning more than $200,000 are less costly than field exams, GAO says

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The Internal Revenue Service (IRS) could "significantly increase" its revenues by performing more correspondence exams than field exams of taxpayers earning more than $200,000, according to a recent recommendation by the Government Accountability Office (GAO).

Due to the heightened attention to federal deficits, increased pressure has been placed on the IRS to reduce the tax gap—the difference between taxes owed and taxes paid on time—and better enforce taxpayer compliance, according to the GAO.

The Accountability Office recommended in its December paper that the IRS review disparities “in the ratios of direct revenue yield to costs across different enforcement programs and across different groups of cases and consider this evidence as a potential basis for adjusting its allocation of enforcement resources each year.” IRS agreed with the recommendations, according to GAO.

While the IRS spends most of its enforcement resources on examinations, correspondence exams of individual tax returns, which target fewer and simpler compliance issues, are significantly less costly and more productive on average than the broader and more complex field exams, GAO found.

GAO estimated that the average cost (including overhead) of correspondence exams opened in 2007 and 2008 was $274, compared with an average of $2,278 for field exams. "IRS spent almost 20% of the $1.6 billion per year that it devoted to exams on returns from taxpayers with positive income of at least $200,000," GAO states, "even though such returns accounted for only 3% of the 136 million individual returns filed per year." It added that positive income is an IRS measure that disregards losses that may offset the income.

For the two years of cases reviewed—using data from 2007 and 2008 tax returns—GAO estimates that correspondence exams were “significantly more productive in terms of direct revenue produced per dollar of cost than field exams. Both types of exams of taxpayers with positive incomes of at least $200,000 were significantly more productive than exams of lower-income taxpayers.”

GAO demonstrates in its paper how these estimates could be used to inform resource allocation decisions. For example, GAO says, “a hypothetical shift of a small share of resources (about $124 million) from exams of tax returns in less productive groups ... to exams in the more productive groups could have increased direct revenue by $1 billion over the $5.5 billion per year IRS actually collected (as long as the average ratio of direct revenue to cost for each category of returns did not change).” These gains, the GAO continues, “would recur annually, relative to the revenue that IRS would collect if it did not change its resource allocation. This particular resource shift would not reduce exam coverage rates significantly and, therefore, should have little, if any, negative effect on voluntary compliance.”

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