The Treasury Inspector General for Tax Administration has released a report on the S corporation audits the IRS performed over the last four years. The study was to determine the effectiveness of the audits and what improvements could be made by the agency. S corporation returns are the fastest growing area for tax filing. They are 4.5 million a year but growing at a rate of 26% They are twice the number of C corporations.

Over the period of the study the IRS conducted 53,544 audits of S corporations. They recommended $5.7 billion in adjustments. This was a 54% increase over the prior four year period. However, 62% of the audits were closed with no adjustments at all. This suggest that the IRS is not allocating their resources very well.

The Discriminant Index Function (DIF) system is used by the IRS to identify where to allocate their audit resources. It uses algorithms to determine the best targets for audits based on return potential. It may be time to examine what factors are being used to calculate the scores. This has been recommended but not completed but the IRS because they say the lack the manpower to complete it. Another problem with this method is it does not identify what area led to the higher score but rely on the auditor to determine what transactions should be included in the scope of the audit. 


One area that the study identified for potential change is the expansion of audits into S corporations to include the personal tax returns of the owners. This came up in a sample of owners who identified a significant discrepancy between income and living expenses. Six returns were identified where the owners declared living expenses that were more than $10,000 above their incomes. The issue is the auditor is limited in the scope of the audit to the the return filed but the corporation.


What I like to believe is the tax accountants are doing a great job with the tax return preparation for the corporations. Better training and tools allow accountants to reduce errors and omissions on the return.