Following public Senate hearings focused on IRS tactics, Congress enacted the IRS Restructuring and Reform Act of 1998, P.L. 105-206. With the adoption of the act and the public outrage created by the Senate hearings, a “gentler, kinder,” more service-oriented IRS was created. This resulted in a restructuring that saw more budget dollars ramping up service-related activities and a decrease in compliance efforts, especially taxpayer audits.
Commissioner Mark W. Everson took office at a time of growing budget deficits and a public perception of poor voluntary tax compliance among taxpayers. Too little emphasis was placed on compliance, and too many audits resulted in no changes. Understanding that a smarter and more effective approach toward auditing taxpayer compliance was needed, Everson instituted the National Research Program (NRP). The original approach was to run audits in repeating cycles of Form 1040, U.S. Individual Income Tax Return, Form 1120S, U.S. Income Tax Return for an S Corporation, Form 1065, U.S. Return of Partnership Income, and Form 1120, U.S. Corporation Income Tax Return.
The initial cycle saw fewer than 50,000 individual returns for tax year 2001 selected on a statistical basis for examination. The selected returns were stratified and organized at the Austin Service Center and assigned to the field or campus for examination. The results were startling: They quantified the tax gap at $348 billion, of which the greatest piece resulted from unreported and underreported income. The program provided the Service with details on the composition of the tax gap and led to a more focused approach to compliance examinations.
The second cycle focused on S corporation tax returns. Approximately 5,000 returns for 2003 and 2004 were statistically selected and assigned to the field for examination. This cycle will be completed in 2007.
Based on the results of the initial NRP, Acting Commissioner Kevin Brown has announced a new NRP reporting compliance study to begin in October 2007 that will use a multiyear rolling methodology (Internal Revenue News Release IR-2007-113). The old approach will be halted after the completion of the S corporation cycle. In the new study, the IRS will select approximately 13,000 individual income tax returns (Forms 1040) each year. The sample will include all ranges of income groups, as well as farms and sole proprietors. Returns will be selected based on criteria established from the initial NRP results, which will enable the IRS to reduce the number of audits of compliant taxpayers.
This program will continue on an annual basis, with approximately 13,000 new returns selected each year. The intention is to look at three-year cycle results on a rolling basis. As patterns of noncompliance change over time, the criteria for examination selection will change accordingly. This approach will allow the Service to maintain the most current selection criteria to attack the tax gap.
Programs will continue to focus on flowthrough entities. Since the results of these entities are reported on individual returns, the NRP results will enable the IRS to concentrate on those flowthrough entities causing the greatest noncompliance problems.
The fact remains that the federal budget will remain tight, and additional dollars for enforcement will be difficult to obtain. This new study will provide the Service with information that will help it use its compliance enforcement personnel most efficiently.
John L. Miller, CPA is a Faculty Instructor at the Metropolitan Community College of Omaha, NE.
Mr. Miller is a member of the AICPA Tax Division’s IRS Practice and Procedures Committee. Messrs. Carlton, Starkman, and Zwick are also members of that committee.
For further information about this column, contact Mr. Miller at email@example.com.