How do IRS Resources Affect the Corporate Audit Process?

ABSTRACT This study investigates how Internal Revenue Service resources affect the IRS audit process for publicly traded corporations. Using confidential IRS audit data, we examine the effect of IRS resources on the incidence and magnitude of proposed deficiencies and settlement outcomes. We find that IRS resources are positively associated with both the likelihood and magnitude of proposed deficiencies, but negatively associated with the proportion of proposed deficiencies collected. These results are consistent with the IRS focusing on fewer positions, but targeting positions supported by weaker taxpayer facts when resources are more limited. Based on our findings, we estimate the loss in tax collections from audits of LB&I corporate tax returns alone exceeds the savings from reductions in the IRS enforcement budget. This study contributes to the literature examining the strategic game between tax authorities and corporate taxpayers and has important implications for policymakers, particularly in light of recent IRS budget cuts.