The Internal Revenue Service has improved its audits of high-income taxpayers but needs to re-evaluate whether the threshold of $200,000 for auditing wealthy taxpayers efficiently uses the agency’s examination resources, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, evaluated the IRS’s efforts to ensure the tax compliance of high-income taxpayers. The IRS identifies high-income taxpayers as those who reported total positive income of at least $200,000 on Form 1040. Because the IRS is devoting more audit resources to these taxpayers, TIGTA said it is important to know at what level of income or wealth taxpayers tend to begin establishing complex financial holdings that are at greater risk for noncompliance with the tax laws.

The IRS has taken a number of actions to help to ensure tax compliance of high-income taxpayers, the report acknowledged. The agency adopted a High-Income and High-Wealth strategy to audit more tax returns related to these individuals, and the resulting audit coverage of high-income taxpayers has indeed improved. However, the IRS’s High-Income and High-Wealth strategy devotes nearly 50 percent of the agency’s high-income audits to taxpayers earning $200,000 to $399,999, whose tax returns potentially present the least productivity of all high-income taxpayers.

“The IRS should re-evaluate the income level it uses to identify taxpayers for its High-Income and High-Wealth strategy so that it can better allocate audit resources to the most significant audit risks,” said TIGTA Inspector General J. Russell George in a statement.

The IRS Large Business and International Division established the Global High Wealth Industry, which takes a comprehensive approach to auditing high-income taxpayers by extending the audits beyond the individual income tax return and examines the entities that these taxpayers control. However, GHW is not yet a stand-alone industry capable of conducting all of its own examinations, the report noted. The IRS is using resources from three other LB&I industries to assist with auditing GHW cases, but has not evaluated the impact of that decision on those other industries. In addition, the IRS cannot quantify its GHW audit performance because of the limitations of IRS audit information systems. GHW has not implemented a quality review process for its audits.

TIGTA made six recommendations in the report, including that the IRS establish a permanent quality review system for GHW cases. The IRS agreed with four of the six recommendations, but did not agree that its decision to outsource GHW Industry enterprise cases requires a cost/benefit analysis and is not planning to explore system modifications needed to better quantify enterprise case examination results. TIGTA believes that both the cost/benefit analysis and better information on examination results would improve program decisions.

“Your report recommended that we re-evaluate the income thresholds that are used in our HIHW strategy, to ensure that we are selecting the most productive cases,” wrote Douglas W. O’Donnell, commissioner of the IRS’s Large Business and International Division, in response to the report. “We agree that a re-evaluation and a periodic indexing of this threshold would be advisable. However, as noted during the course of the audit, our decisions on resource allocation cannot be made solely on the basis of productivity measures (i.e., ‘yield’). As reflected in the IRS’ recent future state visioning, the keystone of our compliance activities is to promote voluntary compliance by identifying and working issues that have an impact on changing taxpayer behavior, and also providing a deterrent to other potentially noncompliant taxpayers.”

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