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IRS shifts audit focus to small biz operations

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in Small Business Tax

Small business owners, beware.

The number of IRS field audits of the nation’s largest corporations—companies with more than $250 million in assets—declined from 4,693 in 2005 to 3,308 in 2007, while the IRS has told Congress that the number of audits of all corporations has increased, according to the latest report from the Transactional Records Access Clearinghouse (TRAC).

Alert: This shift in emphasis suggests a change in IRS enforcement strategy with the agency ordering its agents to concentrate on smaller corporations, which take a lot less time to audit.

The IRS also cut back on the number of Coordinated Industry Case audits it conducts, the in-depth examinations of the largest corporations, from 454 in 2005 to 353 in 2007. The total of additional taxes large corporations were found to owe the government declined by 20%.

The change in audit rates from the largest to midsize and small corporations has not resulted in a sizable revenue gain for the IRS. The audit rate for the smallest corporations has increased by 41% in two years, the report says. But audits of smaller corporations with assets of less than $5 million produce less revenue per agent hour, only $682 per hour in 2007 compared with $7,498 for the largest corporations with assets of more than $250 million. Audits of midsize corporations with assets in the $10 million to $50 million range produced only $474 per agent hour.

In the past, the IRS has measured audit success by tracking hours devoted to either “productive”or “nonproductive” audits. A productive audit is one in which the IRS found that the company owed additional taxes. Based on TRAC analysis of IRS data, more than one-third of small and midsize business audits were nonproductive in 2006 and 2007.
Nonproductive time jumped 24% between 2006 and 2007.

In a recent press release, the IRS suggested that its “continued efforts to review more returns of pass-through entities—partnerships and S corporations”—represented a partial substitute for the declining number of large corporation audits. But while concern about the level of compliance among these entities is viewed as valid by tax experts, the TRAC report says, the huge drop in corporate audits cannot be fully explained by the increase in audits of pass-through entities.

In addition, the decline in the number of corporate audits cannot be explained by a decline in the number of agents or staff years. The IRS defines one audit staff year to equal 2,000 audit hours. IRS data show that the total number of revenue agents increased by 664 from 2005 to 2007, and the agency added 113 staff years during that period.

— Adapted from AccountingWEB Inc.,

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