Companies near the IRS face a higher risk of audit

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Public companies located closer to IRS offices are more likely to face an audit, and those companies also engaged in greater tax avoidance, according to a recent study.

The study, by Profs. Thomas Kubick of the University of Kansas, G. Brandon Lockhart of Clemson University, Lillian Mills of the University of Texas at Austin, and John Robinson of Texas A&M University, examined “how the information environment, reflected by the proximity between corporate headquarters and IRS supervision, affects both tax avoidance and IRS enforcement.”

The study cited recent research finding that indirect networks influence corporate taxpayer behavior, and posits that proximity can provide information advantages to both corporate taxpayers and the IRS.
“The intuition is that when two parties operate in close proximity there is more information on both sides,” said Kubick. “I know more about you. We may not have met, but we have mutual friends. And people I know may have dealt with you.”

The findings could have implications for how the IRS allocates its resources and coordinates its audit efforts, because the study also found that audits of local taxpayers might not be the most efficient. Further, even though companies near an IRS regional office were more likely to be audited, on average, nearby taxpayers still paid less tax than more distant companies even after an audit.

The results might seem surprising, according to Kubick: “One might expect that distant taxpayers would be more likely to avoid taxes. However this ignores the ‘network effect’ documented in the literature that when two parties are located in close proximity to each other, there is more information available on both sides. The IRS is more familiar with nearby companies, and from the companies’ perspective, there is more information about the pool of likely IRS auditors. You may not have been audited by the team but you may share a professional relationship or connection with other companies that have dealt with the audit team.”

The positive association between geographic proximity and tax avoidance holds true unless the company is located close to an industry specialist, according to Kubick. “The companies nearer to the IRS avoid more taxes unless they’re also closer to an industry specialist,” he said. “Industry specialists are generally perceived by corporate taxpayers as being more knowledgeable about industry-specific tax issues.”

“One contribution we hope to make is to provide some useful results to the IRS on how to deploy their strategic resources,” he added. “Our study is the first to show a direct link between IRS outcomes and geographic proximity, and showing that nearby industry specialists constrain tax avoidance may be helpful as the IRS evaluates the geographic organization of enforcement.”

Of course, he noted, “The IRS has its own private information and compliance models that are not publicly available.”

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Corporate taxes Tax avoidance Tax returns IRS