GAO says IRS needs more financial status audit guidance.

What type of car do you drive? How much money is in your bank account? Let me know a little more about your credit card debt. These are the kinds of questions asked during an IRS financial status audit--an audit the IRS uses to identify unreported income.

Congress had asked the General Accounting Office to determine how frequently financial status audit techniques were used, how they were applied, whether they were intrusive and burdensome for the taxpayer and, also, how the IRS measured its quality control. In a report to Congressman Bill Archer (R-Texas), chairman of the House Committee on Ways and Means, the GAO said financial status audits were useful in collecting unreported income but the IRS needed to provide its staff with guidance on when and to what extent to use such audits to ensure they are not overly intrusive.

Probing too soon

In 1992, the IRS estimated that the tax gap--the amount of tax taxpayers owe but have not paid--was $95.3 billion. Because of this, the IRS urged its auditors to consider a taxpayer's financial status and to probe for unreported income, initiating a financial status audit program in 1994.

According to the GAO report, Tax Administration: More Criteria Needed on IRS' Use of Financial Status Audit Techniques, by early 1995, the IRS was criticized for certain techniques used in its financial status audits. The AICPA, members of Congress and various other taxpayer groups argued that IRS auditors were asking financial status questions before and during the initial interview with the taxpayer without any evidence of underreported income, thus blurring the difference between probing for unreported income and a fraud investigation. (See "Financial Status Audits: A Widespread Problem," JofA, May96, page 44.)

However, the GAO report found that the number of audits in which auditors were asking financial status audit questions before or during the initial interview had not increased drastically after the 1994 initiative. In fact, intrusive initial interview question were asked in fewer than 5% of the audits in 1995 and 1996. The GAO did find that as many as 83% of that period's financial status audits resulted in no adjustment of income. The report said the "no-change" rate was too high and the IRS needed to better monitor when and when not to use financial status questions.

More guidance for IRS staff

The GAO recognized it is the IRS auditor's responsibility to determine how and when financial status audit techniques should be used, but it recommended that the IRS provide specific criteria to help an auditor judge when employing such techniques is appropriate. It also suggested that the IRS provide further guidance to its auditors based on its monitoring of the use of these audit techniques.

Copies of the report (GAO/GGD-98-38) are available from the GAO by phone at 202-512-6000 or through its Web page at www.gao.gov.