The Challenge of “Unreal” Tax Audits To American Taxpayers

The National Taxpayer Advocate, Nina E. Olson, has just released the 2017 Annual Report to Congress, an annual report that sets forth problems in the IRS and challenges for the IRS to improve its service to the American taxpayer. This year it contains what is called “The Purple Book,” which presents 50 proposed legislative changes intended to strengthen taxpayer rights and improve tax administration.  

One of the areas discussed is so-called “unreal” tax audits versus “real” tax audits. In “real” tax audits, taxpayers have significant procedural rights to challenge the IRS’ proposed audit increases in taxes, penalties and other changes to a return. But, the IRS is increasingly using other methods of advising taxpayers that they owe taxes other than through traditional audits.  To a taxpayer, these feel like audits as they usually require the taxpayer to accept the changes or provide documentation or other information to contest it. 

However, the protections that apply in “real” audits do not apply in these cases.  These “unreal audits” include proposed changes based on math error authority, the Automated Underreporter document-matching program, and the Automated Substitute for Return program. In the 2016 fiscal year, the number of returns audited under “real” audits was only 0.7 percent.  However, when “unreal” audits are included, the audit rate jumps to 6.2 percent. This is a significant difference. Important rights not available in these “unreal” audits include the opportunity to pursue relief from the auditor’s conclusions in an administrative appeal to the IRS Office of Appeals. 

A taxpayer who fails to timely respond to a math error notice loses the opportunity to pursue the matter in the United States Tax Court, which is important since it is the only chance to obtain judicial review without first paying the proposed increases in tax and penalties. Because the IRS is increasingly using these “unreal” audits, the taxpayer protections provided by Congress are being circumvented.  Further, the Taxpayer Advocate contends that IRS compliance activity statistics based on “real” audits are misleading because the overwhelming majority of tax adjustments are being made through “unreal” audits.  The Advocate also claims that the IRS intends to increase “unreal” audits pursuant to its “Future State” plan. Accordingly, the Advocate is recommending that the IRS revise its definition of an audit and expand the application of taxpayer protections provided under the Taxpayer Bill of Rights to these “unreal” audits.