WASHINGTON – While the Internal Revenue Service (IRS) makes a substantial amount of recommended adjustments when auditing the returns of S corporations, the number of audits the IRS closes with no recommended adjustments is very high, according to a new report released publicly today by the Treasury Inspector General for Tax Administration (TIGTA).

IRS statistics show that 62 percent of the Discriminant Index Function (DIF) selected returns of S Corporations were closed by the IRS with no recommended changes to the items reported on the return in FY 2011.

“These results are troubling because, according to the IRS, a high no-change percentage means the agency is spending a significant amount of resources on unproductive audits and burdening compliant taxpayers with unnecessary audits,” said J. Russell George, Treasury Inspector General for Tax Administration.

TIGTA conducted its review to determine whether the IRS’s Small Business/Self-Employed (SB/SE) Division examiners are conducting audits of S corporation returns in accordance with IRS procedures and guidelines.

S corporations annually file Form 1120S, U.S. Income Tax Return for an S Corporation, although they generally do not pay any Federal income taxes.  Instead, an S corporation’s income, deductions, and other items are divided among and passed on to its shareholders, who are required to report the items on their individual income tax returns.

TIGTA did not identify any significant quality problems that would suggest the manner in which items are selected and audited on S corporation returns substantially contributes to the no-change percentages.  However, TIGTA believes that SB/SE Division researchers should explore the use of S corporation data files to determine if examiners are auditing the most productive returns.

TIGTA also found that additional steps could be taken to strengthen controls over the return classification process to further minimize the risk of selecting returns for audit that have limited audit potential.

TIGTA recommended that, as resources become available, SB/SE officials 1) analyze S corporation data files to help identify additional productive returns for audit, and 2) revise classification guidelines to clarify that quality reviews need to be completed for each type of return classified. In their response to the report, IRS officials agreed with TIGTA’s recommendations and stated that they plan to take corrective actions.

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