IRS has the power to decide who gets what, when, and how when it comes to federal taxes. Many of these decisions are made by IRS employees as part of examining tax returns. This is why we are all watching the IRS reorganize its audit function. The Treasury Inspector General for Tax Administration (“TIGTA”) recently released a scathing audit report that addressed how the IRS was going about implementing these changes. This report provides an opportunity to reflect on the changes the IRS is making to its audit function.
The IRS’s Regional Divisions
Many of us who have been doing audit work for awhile will remember that the IRS used to be divided into regions. Each region operated somewhat autonomously when it came to examining tax returns. There was a clear chain of command that taxpayers could follow if they had an administrative issue with how the IRS audit was being handled.
The IRS also had technical guidance personnel who provided assistance to IRS auditors on specialized tax issues. It was generally up to the IRS auditor to request the technical guidance input. The IRS auditor could also turn to his or her local IRS attorney in the IRS Office of Chief Counsel for technical help on audits.
This regional approach was viewed as inefficient and prone to producing inconsistent results across jurisdictions.
The IRS’s Industry Specialization Program
The IRS then reorganized along industry lines. The hope was that the industry specialists would be able to provide better service and results to particular groups of taxpayers in various industries by focusing on issues related to those taxpayers. The IRS Office of Chief Counsel and the IRS Office of Appeals followed suit and reorganized by industry.
This industry specialization structure did not work. It was plagued by logistical challenges. For example, the Natural Resources and Construction Industry team members in Houston, Texas were not able to effectively work cases located outside of the Houston metro area. So taxpayers in the oil and gas industry who were headquartered outside of Texas often ended up being audited by IRS employees who were assigned to another industry. If they were headquartered in Denver, Colorado, they would likely be audited by IRS employees in the Communications, Media and Technology Industry.
The IRS also implemented a tiered issue system for identifying issues of strategic importance to the IRS. The IRS focused its audit resources on these tiered issues. This included auditing specific issues, such as research tax credits. This had the result of nearly anyone who took a research tax credit being selected for audit by the IRS. The tiered issues were viewed both internally within the IRS and by taxpayers with suspicion. So the audits started to result in tax adjustments that were not logical or warranted. The adjustments did not survive review by the IRS appeals function or by the courts.
The tiered issue system was abandoned by the IRS. It was replaced by issue practice groups and international practice networks. These groups and networks are similar to the IRS’s prior technical guidance personnel; however, they have less visibility and provide less access to taxpayers. They are more focused on preparing administrative documents that IRS examiners can use when auditing specific issues.
The IRS’s Future State
The IRS has recently started implemented its future state reorganization. With this reorganization the IRS audit function will have four regions and five industry divisions. So it is best described as a mix of the two prior organization structures.
The IRS implemented this change recently by assigning most of its current employees to these groupings. This was a major shake up at the IRS. It resulted in IRS employees having to re-apply for jobs, transitioning to other roles, etc. It also resulted in many IRS audits closing with no explanation. Practitioners also know that it resulted in even fewer tax returns being selected for audit as the IRS was expecting to implement these changes. This brings us to the TIGTA audit report.
The TIGTA Audit Report
The TIGTA audit report described above considered the IRS’s efforts to implement its future state reorganization. The report gets at what we are all waiting to know, namely, how is the IRS going to identify the issues that it will allocate its limited audit resources to? Put another way, what is going to replace the IRS’s tiered system for selecting and allocating audit resources?
The IRS has publicly stated that it will use targeted campaigns for this purpose. So the campaigns sound similar to what the IRS previously used to describe as a “project.” With a “project” the IRS would pull local–and sometimes national–resources to address a specific issue. For example, a tax return preparer who prepared false returns for hundreds of local taxpayers could have resulted in a project as the IRS attempted to audit and correct all of the incorrect returns.
The IRS has not provided any real explanation as to what will constitute a campaign or what issues will be selected for the campaigns. The TIGTA audit report gets to this issue.
According to the TIGTA report, the IRS has not really put any thought into what issues will be subject to its campaigns. In fact, IRS management was not able to produce a viable list of issues that it would be pursuing. Worse yet, the list it did produce did not even get close to listing the majority of tax issues that we all know that the IRS should be considering on audit.
The TIGTA audit report suggested that the IRS start considering its audit results in deciding what issues to allocate its audit resources to under its future state initiative. The report goes on to note that this is not really possible currently, given that the IRS does not track its audit adjustments effectively.
For those of us who worked at the IRS, we know the issue well. IRS auditors are required to track issues in the IMS computer program. Issues are input by SIC and UIL codes–as is the time IRS employees work on the various tax issues. These are supposed to be updated as the IRS does its initial audit risk assessment, its mid-cycle assessment, and then when the audit closes.
As a practical matter, it is impossible for IRS auditors to use the SIC and UIL codes. They are cryptic and have no real meaning when you try to apply them to the case at hand. As noted by the TIGTA audit report, this results in IRS auditors just plugging in an issue and an arbitrary amount of time using generic SIC and UIL codes.
This does not even get to the cases where the IRS does not input anything other than the basic audit details into IMS and it does not do a formal risk assessment at the start of the audit or the mid-cycle risk assessment. The IRS will often not even bother doing this when taxpayers specifically ask the IRS auditors to do them. It is not unheard of for the IRS’s upper management in some regions to tell taxpayers that the IRS does not even do mid-cycle risk assessments.
Yet, the TIGTA audit report explains that IRS management intends to rely on this information to identify what issues it will base its campaigns on.
This is a very serious issue. The stakes are high. We will all be living with the new structure for quite some time.
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