How the IRS Ensures Compliance with the Tax Laws

When deciding which compliance tool to use, IRS aims to balance the burden on the taxpayer with the potential benefit of the compliance effort.

Get to know the IRS, its people and the issues that affect taxpayers

By Sunita Lough
CL-20-09, December 17, 2020

If I were to ask you how the IRS ensures that people are complying with tax laws, what immediately comes to mind? I’ll bet that most people think of audits. Audits (or examinations, as we call them) are certainly an important piece of the puzzle – but they are by no means the whole story. The reality is that the IRS has many additional tools to support compliance and fairness in the nation’s tax system.

When deciding which tool to use, we work to ensure fairness while also being conscious of taxpayer burden. IRS employees work to minimize the burden of our compliance actions, seeking the right touch – all with an eye toward enforcing the nation’s tax laws for the benefit of all taxpayers.

The compliance actions described below require different types of resources by the IRS (such as Tax Examiners, Tax Compliance Officers and Revenue Agents). In addition, the time spent in resolving the compliance actions can vary from a few days to a number of years. Therefore, our goal is to use the right resources and minimize taxpayer burden while encouraging voluntary compliance.

To help people understand our work, here’s a closer look at some of our compliance tools.

Types of compliance contacts

There are a number of compliance actions that do not require the IRS to review the books and records of the taxpayer in order to resolve the issue raised by the IRS. These compliance actions described in this section take less time and are less burdensome to the taxpayer.

No review of books and records

With our Automated Underreporter (AUR) Program, our computer systems match the income that a taxpayer reports on their tax return with information returns provided to us by third parties. For example, if an individual taxpayer declares less income on their Form 1040 than their employer says they earned on their Form W-2, the AUR Program will detect this. An IRS Tax Examiner will then send a letter to the taxpayer informing them of the difference and will work with them to resolve the issue.

We also mail math error notices to taxpayers who appear to make a calculation or clerical error on their tax return. For example, many tax forms require adding two lines together or subtracting one line-item from another. If these amounts are miscalculated, it could ultimately affect how much a taxpayer owes or the amount of refund they are to receive. Other examples include not using the correct row and column from the tax table for the filing status claimed and taxable income amount shown, not attaching all required forms and schedules to substantiate entries and missing or incorrect Taxpayer Identification Numbers. When that happens, we send the taxpayer a letter asking them to address the issue.

The Automated Substitute for Return program (ASFR) enforces tax compliance for individual taxpayers who have not filed tax returns, but whose available income information shared with the IRS indicates an income tax liability. As part of the ASFR program, the IRS sends notices to these taxpayers alerting them to their potential liability. In this situation, the IRS may file a substitute return for taxpayers who fail to file. This return might not include credit for deductions and exemptions the taxpayer may be entitled to receive. So, it is still in the taxpayer’s best interest to file their own tax return to take advantage of any exemptions, credits and deductions they are entitled to receive.

Another part of our compliance toolkit is the compliance check. This is a review to determine whether a taxpayer is meeting their information reporting and recordkeeping requirements. To do this, we typically send the taxpayer a letter asking them a few questions. For example, if a tax-exempt organization submits its annual information return and indicates that it has employees, but we did not receive a Form 940 reporting the organization’s payment into the federal unemployment system, we might send the exempt organization a compliance check letter asking it to provide the Form 940 or an explanation for why it did not believe it is required to submit the Form 940. Under some circumstances, the results of a compliance check might warrant us opening an examination of the taxpayer. Typically, compliance checks are carried out by tax examiners. 

Review of books and records

Unlike the compliance actions described above, examinations (or audits) require the IRS to review the books and records of the taxpayer. Therefore, they take more time than compliance actions like AUR or compliance checks. Depending upon the complexity of the tax return and the tax issue(s) under exam, the exam time can vary from a few months to a number of years. Examinations are conducted by tax examiners, tax compliance officers, or revenue agents.

Even within the wider category of audits, there are several different varieties. We use correspondence examinations to obtain additional information about limited issues on a taxpayer’s return. For example, we may open a correspondence exam on a taxpayer claiming the Lifetime Learning credit and ask for supporting documentation, such as tuition receipts, to verify they are entitled to the credit.

Such examinations are usually narrower in scope than a traditional examination and are conducted by mail or other written communication. They are usually carried out by Tax Examiners and/or Tax Compliance Officers.

In some cases, we may conduct an in-person examination on a taxpayer. This typically involves reviewing one or more years of a taxpayer’s tax returns in conjunction with their books and records. The taxpayer or representative visits an IRS office, or we visit the taxpayer’s office and interview them – or, depending on the situation, their employees or representatives (such as accountants and attorneys) -- to gather more information. These types of examinations are often performed by either Tax Compliance Officers (office examinations) or Revenue Agents (field examinations). This type of examination could involve income taxes or specialty taxes, which include excise, employment, estate and gift taxes.  When an examination reveals that a taxpayer owes additional taxes, we assess and collect the money owed as required by law. What many people don’t realize is that these exams can actually lead to more money going to the taxpayers. Believe it or not, we pay billions of dollars in refunds when appropriate after examinations – for individuals and businesses.

If tax is assessed at the end of the examination and the taxpayer does not agree with the IRS’ conclusions, the taxpayer generally has the right to request review by the Independent Office of Appeals.

Educational and “Soft” Letters

In addition, we send “soft” letters to taxpayers to provide them an opportunity to address an issue that could avoid the need for further IRS contact or examination. For example, if we have some indication that a foreign corporation has engaged in significant transactions in the United States but has not completed an income tax return, then we could send a letter reminding it of the possible obligation to file a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation. If the taxpayer does not respond, or the explanation is inadequate, the IRS could initiate an examination.

We often send educational letters to let taxpayers know about a change in the law or other circumstance that might affect their tax obligations. For example, we send notices to taxpayers who are potentially eligible for the Earned Income Tax Credit (EITC) or Additional Child Tax Credit.

Criminal Investigations

In the above section, I talked about various ways we encourage taxpayers to meet their tax obligations. After all, the United States believes, and counts on, voluntary compliance by individuals and businesses. Unfortunately, we sometimes need to use more severe tools to deter taxpayers who refuse to comply and intentionally avoid paying their tax. Our Criminal Investigation function investigates taxpayers who intentionally fail to pay their taxes and are suspected of engaging in fraud, money laundering or other illegal behavior. Such behavior, left unchecked, increases the tax burden on honest, law-abiding Americans who try their best to file on time and pay the right amount of tax. If our Criminal Investigation function determines that a tax crime has occurred, they refer the matter for possible prosecution to the Department of Justice.

Exams of returns with EITC and returns of higher-income taxpayers

On October 20, I wrote about audit rates of taxpayers with EITC on their return and higher-income taxpayers. So, what is the difference between the compliance actions we undertake for returns with EITC and returns filed by higher-income taxpayers?

The EITC is a meaningful subsidy for vulnerable, needy individuals and each year it lifts millions of people, including millions of children, out of poverty. Most returns filed by lower-income taxpayers, regardless of whether they owe any tax, are due to claims for the refundable EITC. So, to ensure the fairness and integrity of the EITC program, the IRS averages approximately 300,000 EITC audits per year out of the universe of more than 25 million EITC claims. The data we obtain from those audits tells us there is an annual error rate of approximately 25% in the entire population of EITC claims, resulting in improper payments to EITC claimants of more than $17 billion per year.

Due to this, the IRS continues to examine certain EITC claims as part of its efforts to ensure all taxpayers are properly complying with the tax laws. EITC exams are conducted by mail in the least intrusive manner as correspondence exams and more than 90% of these exams are completed within a few months of the filing of the return to expedite issuance of the refund. For context, the IRS audits higher-income taxpayers at much higher rates, as I explained in detail in an earlier Closer Look.

Field Exams of higher-income taxpayers are more complex than correspondence exams like returns with EITC.  These exams are conducted in-person by teams of revenue agents and can take years to resolve. They typically involve numerous complex issues and the examination of multiple tax years and returns of related entities (partnerships, trusts, closely held business interests, etc.) and individuals (business partners and others). These examination teams are comprised of our most highly trained and experienced revenue agents having substantial accounting and investigative skills, and can often include IRS attorneys and economists as well as subject matter experts for issues involving private foundations, international law and foreign tax, estate and gift tax, etc.  Despite the time and resources it takes to examine higher-income taxpayers, the IRS remains fully committed to examining a higher percentage of the returns filed each year. Auditing a meaningful percentage of the highest income taxpayers is critical to maintaining public confidence in the integrity of our tax system.

The IRS: We’re here for you

These are just some of the tools we use to ensure that we have a presence among all income and asset levels, and among all types of taxpayers. Regardless of which compliance method we use, we remain committed to treating all taxpayers fairly, equitably and with integrity and respect for taxpayer rights.

We take this so seriously that every IRS employee with taxpayer contact is rated annually by their supervisor on whether they meet these standards. They are required to take annual training on a range of issues to ensure they meet these high standards. Every IRS employee is also a taxpayer, so we know that sometimes tax rules can be complicated or intimidating.

Our job at the IRS is to help taxpayers. That means doing everything we can to help people understand the tax rules and help them with filing and paying their taxes. At the same time, we are also here to make sure we fairly uphold the nation’s tax laws and do everything we can to ensure everyone pays their fair share.

Sunita Lough
IRS Deputy Commissioner for Services and Enforcement