The Future of State Tax Audit Programs Joseph Milack MSATA 2017

What is the Objective of Audit? Espoused Educate taxpayers Assure that businesses, organizations and individuals file correctly Improve voluntary compliance by changing taxpayer filing and reporting practices Optimizing the revenue impact of audit resources In Practice - Maximize auditor ROI Audit performance is almost exclusively measured by audit dollars, not impact on the tax gap/voluntary compliance

US Tax Gap If the Net Gap was held at 2001 rate of 13.7%, there would have been $64 billion more annually going into the US Treasury in in 2010 - 23% more than all of the compliance and enforcement revenue. Sources: IRS Releases 2006 Tax Gap Estimates, FS-2012-6, January 2012 Tax Gap Estimates for Tax Years 2008–2010, Revenue Service April 2016 GAO-07-423R National Research Program Data, March 15, 2007

Impact of Information Reporting Percent of Income Unreported – Individual Income Tax Sources: IRS Releases 2006 Tax Gap Estimates, FS-2012-6, January 2012 Tax Gap Estimates for Tax Years 2008–2010, Revenue Service April 2016 TAX GAP Multiple Strategies, Better Compliance Data, and Long- Term Goals Are Needed to Improve Taxpayer Compliance GAO-06-208T October 25, 2005

More Challenges to Come Government budgets IRS has lost more than 30,000 full-time employees since 1992 and 27% of revenue agents since 2010 Few state revenue agencies have as many auditors as they had prior to 2008 Age of workforce 50% IRS workforce is over 50 Many states revenue agencies are facing this as well Online retail and business-to-business sales Significant changes in business models Growth of innovative tax evasion and avoidance

Rethinking Audit Approaches

Audit Effectiveness and Outcomes Audit Selection Use of Auditor Time Management, Policy, and Methods Centrally vs local/auditor Target known compliance issuance and past audit issues Data analytics and predictive modeling Critical to maximize ROI Management Reporting Audit Issues Political considerations Quality of audits Direct audit time Minimal non-audit tasks Audit tools and automation Desk/office vs field

Audit Effectiveness and Outcomes Audit Selection Use of Auditor Time Management, Policy, and Methods Education and Voluntary Compliance Centrally vs local/auditor Target known compliance issuance and past audit results Data analytics and predictive models Critical to maximize ROI Self-correction Risk of detection Campaigns ROI includes impact on voluntary compliance Quality of audits Direct audit time Minimal non-audit tasks Audit tools and automation Desk/office vs field Management Reporting Audit Issues Political considerations

IRS Large Business and International Division Changing the way it addresses compliance including how it identifies tax returns for audit and is moving toward implementing issue-based projects it calls “campaigns” compliance project focused on a specific compliance issue rather than characteristics of the whole tax return could consist of an audit, or a less burdensome treatment, such as “soft letters” (warnings) sent when specific issues are identified developed the campaign approach because its budget and resources are shrinking and tax laws are growing more complex. campaign approach is iterative in order to make adjustments as they gain experience with campaigns Announced the initial 13 issues for campaigns in January 2014 GAO-17-324 IRS RETURN SELECTION March 2017 Improved Planning, Internal Controls, and Data Would Enhance Large Business Division Efforts to Implement New Compliance Approach

IRS Campaign Outreach and Education Major effort to announce and describe campaigns Worked with internal and external stakeholders IRS website identifies and explains the 13 campaigns and corresponding issues 7 webinars announcing and describing campaigns (hosted by KPMG) Multiple discussions/articles about campaigns on news, practitioner, accounting, and legal websites

Identify & Categorize Universe Process Overview Identify & Categorize Universe General Education Instructions, Industry/Practitioner Events, Press Releases Payment Web content – Audit issues and Programs Opportunity to File Amended Returns Without Penalty Payment Opportunities and Channels, Payment Plans Options Customized Letter Conduct Audits Business Rules Queries Data Matching Predictive Analytics Determine Issue Single Issue Limited Scope Supportable by taxpayer specific documentation Describe Issue Filing/reporting requirements Self-review Amended Return Penalty and Interest Policy Targeted Will be audited Likely to be audited Return Alerts Self correction Field Office Correspondence Impose penalty

Expand Web Content Describe audit programs and reasons for being selected for audit Include and cross-reference other web content that provides in depth information about the applicable tax law, regulations, and instructions Explain the options File amended return Provide supporting explanation Risk being audited Describe records and documentation required for each audit program Enable taxpayer to correct/amend return and/or provide information to support return as filed on the agency website

Taxpayer Audit Alerts Identify audit selection criteria that can be determined at time of filing i.e. no use tax in 6 months Once return is processed and posted, send alerts to taxpayers meeting predetermined criteria Advise taxpayer that their return may contain an error/ommission or has been identified for potential audit Provide clear reasons why return was identified Explain actions taxpayer can take Review return and/or records File amended return Provide supporting explanation Make it convenient to self-correct

Customized Audit Correspondence “You have been selected for audit for the following reasons” This correspondence needs to be taxpayer specific Include mention of sources used to select return for audit such as 1099K The taxpayer needs to to know what the agency knows Explain options if taxpayer is selected for audit File amended return Provide explanation to support return as filed Risk being audited Enable taxpayer to correct/amend return and/or provide information to support return as filed on the agency website

Barriers At all levels, audit performance is measured in dollars per auditor Lack of reliable approaches to measuring the impact of compliance programs on voluntary compliance Counterintuitive to auditors and audit managers Resistance to announcing the issues for selecting audits Aversion to comprehensively focusing on a specific industry/business activity Limited data analytics and predictive modeling for audit Stakeholder expectations – audit dollars

Data Analytics and Predictive Modeling Slow going and lack of readiness Insufficient and/or poor data Lack of data and industry metrics related to model targets Inappropriate matching and modeling targets Lack of common factors amongst taxpayers Limited experience with and/or business knowledge of issues or entities Limited involvement of users Blind belief in the results Its not the tools!

Conclusions Audit programs will need to change to keep pace It will become necessary to integrate outreach and education with compliance programs Rethinking the balance between office and field audit As business activities are dispersed to networks of entities and individuals it will change the who and how audits are conducted New business models, activities, and networks may render current audit selection approaches less effective

Questions

Joseph Milack jmilack@gentax.com 480.209.3498