The Internal Revenue Service closes an unusually high percentage of audits of S corporation tax returns with no recommended adjustments, suggesting that many of the audits are unnecessary and unproductive, according to a new government report.

The report, by the Treasury Inspector General for Tax Administration, cited IRS statistics showing that 62 percent of the returns of S corporations selected for auditing by the IRS’s Discriminant Index Function were closed by the IRS with no recommended changes to the items reported on the return in fiscal year 2011.

“These results are troubling because, according to the IRS, a high no-change percentage means the agency is spending a significant amount of resources on unproductive audits and burdening compliant taxpayers with unnecessary audits,” said TIGTA Inspector General J. Russell George in a statement.

However, the report also acknowledged that the IRS makes a substantial amount of recommended adjustments when auditing the returns of S corporations.

TIGTA conducted its review to determine whether the IRS’s Small Business/Self-Employed Division examiners are conducting audits of S corporation returns in accordance with IRS procedures and guidelines. S corporations annually file Form 1120S, U.S. Income Tax Return for an S Corporation, although they generally do not pay any federal income taxes. Instead, an S corporation’s income, deductions, and other items are divided among and passed on to its shareholders, who are required to report the items on their individual income tax returns.

TIGTA did not identify any significant quality problems suggesting that the way in which items are selected and audited on S corporation returns substantially contributes to the no-change percentages. However, TIGTA believes that the IRS’s SB/SE Division researchers should explore the use of S corporation data files to determine if examiners are auditing the most productive returns.

TIGTA also found that more steps could be taken to strengthen controls over the return classification process to further minimize the risk of selecting tax returns for audit that have limited audit potential.

TIGTA recommended that, as resources become available, SB/SE officials should analyze S corporation data files to help identify additional productive returns for audit, and revise the classification guidelines to clarify that quality reviews need to be completed for each type of return classified.

In response to the report, IRS officials agreed with TIGTA’s recommendations and said they plan to take corrective actions.

“Reducing the number of no-change audits will minimize taxpayer burden and enhance overall compliance,” wrote Faris R. Fink, commissioner of the IRS’s Small Business/Self-Employed Division. “With this goal, we agree to initiate research of S corporation return data to help identify more productive returns for audit.”

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