IRS Overlooks Fraud Indicators during Field Audits

The Internal Revenue Service could increase its revenue by an estimated $20 million a year if it took steps to ensure that fraud indicators are recognized and properly investigated during field audits of individual tax returns, according to a new report.

The report, by the Treasury Inspector General for Tax Administration, found 26 audits out of a statistical sample of 116 field audits in which fraud indicators were not recognized and investigated to comply with several key IRS procedures and guidelines. Each of the field audits involved unreported income and/or overstated expenses that resulted in the taxpayers agreeing they owed additional taxes of at least $10,000.

"Our review found that a combination of factors caused indicators of fraud to not always be recognized and properly investigated," said TIGTA Inspector General J. Russell George in a statement. "Because of this, the IRS may be missing opportunities to further promote voluntary compliance and enhance revenue for the Department of the Treasury.”

TIGTA recommended that the director of exam policy at the IRS’s Small Business/Self-Employed Division enhance job aids such as a fraud development lead sheet, which examiners are required to maintain in their audit files for documenting and investigating any fraud indicators. TIGTA also suggested that the IRS provide specific examples in the Internal Revenue Manual for examiners and first-line managers to use when considering whether to consult IRS technical advisors if field audits of returns suggest possible fraud.

IRS officials did not agree with the first recommendation.  They indicated that the fraud development lead sheet was significantly enhanced in March 2011.

“The cases reviewed as part of this audit were closed between July 2009 and June 2010 and used an older version of the lead sheet,” wrote Faris R. Fink, commissioner of the IRS’s Small Business/Self-Employed Division. “Thus, the enhancements have been incorporated into the lead sheet currently being used.”

In addition, IRS officials did not agree with the second recommendation, but stated that they do plan to take alternative corrective action. IRS officials will issue a memorandum to all of their Examination employees emphasizing the importance of involving the technical advisors in audits.
As part of the review, TIGTA evaluated the enhanced Fraud Development Lead Sheet and continues to believe further enhancements to it would be beneficial.

TIGTA considered the alternative corrective action IRS officials plan to take and concluded that it is responsive to the recommendation. However, TIGTA encourages IRS officials to go beyond merely reiterating existing procedures in their memorandum by providing additional instructions and guidance to clarify when the assistance of a technical advisor should be sought.

IRS officials agreed that TIGTA's recommendations have the potential to increase revenue by some $19.7 million over a year (or $98.5 million over five years) from approximately 1,872 field audits.