TIGTA questions LB&I audit inefficiencies

Editor: Howard Wagner, CPA

As practitioners might expect, the IRS’s Large Business & International (LB&I) division devotes most of its time and resources to auditing large businesses, but a recent Treasury Inspector General for Tax Administration (TIGTA) audit found that the division actually conducts the greatest number of its audits on individual taxpayers. In fact, 67% of the audits closed by the LB&I division in fiscal years 2017 through 2021 were of individuals (TIGTA Rep’t No. 2023-30-019 (May 25, 2023)). TIGTA questioned whether this was an efficient use of LB&I resources, given the small dollar amounts that result from these audits. TIGTA also questioned LB&I’s use of high-level examiners on audits of lower-income individuals.

TIGTA did note that although two-thirds of LB&I’s audits were of individual taxpayers, those audits only comprised between 12% and 19% of LB&I’s time during that period.

Within LB&I, most examinations of individuals are conducted by the With-holding Exchange and International Individual Compliance (WEIIC) practice area. WEIIC examines returns of individuals with an international component, namely, U.S. citizens living or working abroad, U.S. citizens or resident aliens who hold income-producing assets in a foreign country or who claim a foreign earned income exclusion or foreign tax credit, and foreign individuals who have a U.S. filing requirement.

During the years that TIGTA focused on, 90% of the audits closed by WEIIC involved individuals with less than $200,000 in total positive income (TPI). TIGTA noted that TPI for nonresident aliens may not reflect their worldwide income, since they are generally required to report only U.S. income on their U.S. tax return. Also, taxpayers who did not file a U.S. tax return will be regarded as having a TPI of $0, regardless of what their U.S. taxable income is determined to be on examination.

Only 1% of LB&I’s examinations of individuals involve the Global High Wealth program, even though those examinations usually result in “high tax productivity,” in the words of TIGTA.

Meanwhile, only 20% of LB&I’s examinations during the period involved large businesses — that is, the C corporations, S corporations, and partnerships with assets greater than $10 million that one might expect to be the focus of LB&I’s attention. However, those 20% of audits took up 82% of LB&I’s examination staff time.

Dollars per hour

TIGTA found that the extra staff time devoted to examining individual taxpayers — and especially individuals with TPI under $200,000 — is not an efficient use of examiners’ time. On a dollar-per-hour basis, examinations of individuals with TPI under $200,000 brought in as little as $380 per hour (in fiscal year 2021) and no more than $967 per hour (in fiscal year 2018). Meanwhile, audits by the Global High Wealth program brought in between $2,354 and $11,523 per hour. (TIGTA’s dollar-per-hour metric does not include penalties, which are a significant focus of WEIIC’s compliance efforts.)

IRS management disputed TIGTA’s findings regarding LB&I examinations of individuals with TPI under $200,000, which are assigned Activity Code 272, because substitute-for-return cases are also assigned Activity Code 272 by default.

TIGTA believes that only 16% of Activity Code 272 examination closures involve substitute-for-return cases. The IRS also maintains that some revenue agents are not properly recording TPI in examinations involving substitutes for returns.

IRS management has asked WEIIC examination managers to review Activity Code 272 examinations to determine if the activity code is correct and is requiring team managers to email the IRS Planning and Special Program to detail whether the activity code should be updated before any substitute-for-return case is assigned.

Experienced examiners on lower-income examinations

TIGTA also found that many more-experienced examiners in WEIIC are conducting examinations of lower-income taxpayers rather than focusing on high-income taxpayers. Seventy-three percent of WEIIC examinations of taxpayers with less than $200,000 of TPI are conducted by revenue agents at the GS-13 level, which is the second-highest level of examiner in WEIIC.

TIGTA says that having these audits “completed by GS-13 revenue agents appears to be a misallocation of resources because GS-13 revenue agents [can] conduct examinations characterized by complex financial, accounting, and auditing issues, while these tax returns are by taxpayers with TPI of less than $200,000” (TIGTA Rep’t No. 2023-30-019, p. 12).

TIGTA recommendations

TIGTA made two recommendations to the IRS. The first was that the IRS should evaluate the composition of international individual compliance (IIC) cases “to ensure the highest compliance risk work is selected and assigned to IIC examiners in alignment with their skills” (id., p. 13).

The second recommendation was that the IRS should monitor the activity codes for IIC substitute-for-return case closures “to ensure that the activity code accurately represents the taxpayer’s TPI” (id.).

The IRS agreed with both recommendations.

Editor Notes

Howard Wagner, CPA, is a partner with Crowe LLP in Louisville, Ky. For additional information about these items, contact Wagner at howard.wagner@crowe.com.