Study: yes, IRS audits do increase business tax compliance

Most Illinois businesses probably do not look forward to being audited by the Internal Revenue Service. This is because in raising issues in an audit, the government naturally is hoping to increase its tax revenue. On the other hand, businesses obviously would like to pay as little tax as is legally possible.

Interestingly, according to the recently published results of a 17-year-long study involving corporate taxes paid by 5,000 companies, the effective tax rate of a business increases as the likelihood that the business will be audited increases. In addition to higher tax rates, the research found that stricter tax enforcement encourages quality financial reporting.

While this result might seem intuitive on its face, the researchers who led the study did not see this result as obvious before they began the study. In fact, the researchers wanted to find out whether corporate tax avoidance depended upon the sophistication of the taxpayer, and not necessarily IRS monitoring. The researchers also considered the opposite possibility, that tax avoidance would increase with stricter IRS monitoring, which is the case with wealthy individuals.

Are there ways other than tax audits that the government could use in order to increase compliance? What about requiring more tax disclosure or raising the penalty for committing tax evasion? Another idea that is currently available might be for corporate taxpayers to work with the IRS when a complex issue arises in order to avoid an audit after the fact?

In any event, it is important for Illinois businesses to k eep in mind that even if an IRS audit deters future tax avoidance, this does not mean that a business will avoid a tax audit in the future.

Source: AccountingToday, "IRS Audits Keep Companies Honest, Says Research," Michael Cohn, Sept. 12, 2012

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