1. The Future of State Tax Audit Programs
Joseph Milack
MSATA 2017

2. What is the Objective of Audit?
Espoused
Educate taxpayers
Assure that businesses, organizations and individuals file correctly
Improve voluntary compliance by changing taxpayer filing and reporting practices
Optimizing the revenue impact of audit resources
In Practice - Maximize auditor ROI
Audit performance is almost exclusively measured by audit dollars, not impact on the tax gap/voluntary compliance

3. US Tax Gap
If the Net Gap was held at 2001 rate of 13.7%, there would have been $64 billion more annually going into the US Treasury in in % more than all of the compliance and enforcement revenue.
Sources:
IRS Releases 2006 Tax Gap Estimates, FS , January 2012
Tax Gap Estimates for Tax Years 2008–2010, Revenue Service April 2016
GAO R National Research Program Data, March 15, 2007

4. Impact of Information Reporting
Percent of Income Unreported – Individual Income Tax
Sources:
IRS Releases 2006 Tax Gap Estimates, FS , January 2012
Tax Gap Estimates for Tax Years 2008–2010, Revenue Service April 2016
TAX GAP Multiple Strategies, Better Compliance Data, and Long- Term Goals Are Needed to Improve Taxpayer Compliance GAO T October 25, 2005

5. More Challenges to Come
Government budgets
IRS has lost more than 30,000 full-time employees since 1992 and 27% of revenue agents since 2010
Few state revenue agencies have as many auditors as they had prior to 2008
Age of workforce
50% IRS workforce is over 50
Many states revenue agencies are facing this as well
Online retail and business-to-business sales
Significant changes in business models
Growth of innovative tax evasion and avoidance

6. Rethinking Audit Approaches

7. Audit Effectiveness and Outcomes
Audit Selection
Use of Auditor Time
Management, Policy, and Methods
Centrally vs local/auditor
Target known compliance issuance and past audit issues
Data analytics and predictive modeling
Critical to maximize ROI
Management Reporting
Audit Issues
Political considerations
Quality of audits
Direct audit time
Minimal non-audit tasks
Audit tools and automation
Desk/office vs field

8. Audit Effectiveness and Outcomes
Audit Selection
Use of Auditor Time
Management, Policy, and Methods
Education and Voluntary Compliance
Centrally vs local/auditor
Target known compliance issuance and past audit results
Data analytics and predictive models
Critical to maximize ROI
Self-correction
Risk of detection
Campaigns
ROI includes impact on voluntary compliance
Quality of audits
Direct audit time
Minimal non-audit tasks
Audit tools and automation
Desk/office vs field
Management Reporting
Audit Issues
Political considerations

9. IRS Large Business and International Division
Changing the way it addresses compliance including how it identifies tax returns for audit and is moving toward implementing issue-based projects it calls “campaigns”
compliance project focused on a specific compliance issue rather than characteristics of the whole tax return
could consist of an audit, or a less burdensome treatment, such as “soft letters” (warnings) sent when specific issues are identified
developed the campaign approach because its budget and resources are shrinking and tax laws are growing more complex.
campaign approach is iterative in order to make adjustments as they gain experience with campaigns
Announced the initial 13 issues for campaigns in January 2014
GAO IRS RETURN SELECTION March 2017
Improved Planning, Internal Controls, and Data Would Enhance Large Business Division Efforts to Implement New Compliance Approach

10. IRS Campaign Outreach and Education
Major effort to announce and describe campaigns
Worked with internal and external stakeholders
IRS website identifies and explains the 13 campaigns and corresponding issues
7 webinars announcing and describing campaigns (hosted by KPMG)
Multiple discussions/articles about campaigns on news, practitioner, accounting, and legal websites

11. Identify & Categorize Universe
Process Overview
Identify & Categorize Universe
General Education
Instructions, Industry/Practitioner Events, Press Releases Payment
Web content – Audit issues and Programs
Opportunity to File Amended Returns Without Penalty
Payment Opportunities and Channels, Payment Plans Options
Customized
Letter
Conduct Audits
Business Rules
Queries
Data Matching
Predictive Analytics
Determine Issue
Single Issue
Limited Scope
Supportable by taxpayer specific documentation
Describe Issue
Filing/reporting requirements
Self-review
Amended Return
Penalty and Interest Policy
Targeted
Will be audited
Likely to be audited
Return Alerts
Self correction
Field
Office
Correspondence
Impose penalty

12. Expand Web Content
Describe audit programs and reasons for being selected for audit
Include and cross-reference other web content that provides in depth information about the applicable tax law, regulations, and instructions
Explain the options
File amended return
Provide supporting explanation
Risk being audited
Describe records and documentation required for each audit program
Enable taxpayer to correct/amend return and/or provide information to support return as filed on the agency website

13. Taxpayer Audit Alerts
Identify audit selection criteria that can be determined at time of filing
i.e. no use tax in 6 months
Once return is processed and posted, send alerts to taxpayers meeting predetermined criteria
Advise taxpayer that their return may contain an error/ommission or has been identified for potential audit
Provide clear reasons why return was identified
Explain actions taxpayer can take
Review return and/or records
File amended return
Provide supporting explanation
Make it convenient to self-correct

14. Customized Audit Correspondence
“You have been selected for audit for the following reasons”
This correspondence needs to be taxpayer specific
Include mention of sources used to select return for audit such as 1099K
The taxpayer needs to to know what the agency knows
Explain options if taxpayer is selected for audit
File amended return
Provide explanation to support return as filed
Risk being audited
Enable taxpayer to correct/amend return and/or provide information to support return as filed on the agency website

15. Barriers
At all levels, audit performance is measured in dollars per auditor
Lack of reliable approaches to measuring the impact of compliance programs on voluntary compliance
Counterintuitive to auditors and audit managers
Resistance to announcing the issues for selecting audits
Aversion to comprehensively focusing on a specific industry/business activity
Limited data analytics and predictive modeling for audit
Stakeholder expectations – audit dollars

16. Data Analytics and Predictive Modeling
Slow going and lack of readiness
Insufficient and/or poor data
Lack of data and industry metrics related to model targets
Inappropriate matching and modeling targets
Lack of common factors amongst taxpayers
Limited experience with and/or business knowledge of issues or entities
Limited involvement of users
Blind belief in the results
Its not the tools!

17. Conclusions Audit programs will need to change to keep pace
It will become necessary to integrate outreach and education with compliance programs
Rethinking the balance between office and field audit
As business activities are dispersed to networks of entities and individuals it will change the who and how audits are conducted
New business models, activities, and networks may render current audit selection approaches less effective

18. Questions

19. Joseph Milack