Financial industry getting off easy on IRS audits

Introduction

With a week before tax day and the nation facing a massive deficit made worse by billion-dollar bailouts of financial companies, the Center took a look at just how often the IRS audits these firms. Suffice it to say that compared to other industries, the financial services sector has had far less reason to fear the IRS, according to agency data, even though those audits often turn up higher amounts of underreporting.

The financial services industry — covering a broad range of firms that deal with money management — played a central role in creating the current economic crisis through its backing of poorly regulated investment schemes whose vulnerabilities became clear after the housing market lost steam. This industry also represents a substantial portion of the U.S. economy and, thus, potential tax revenue.

The industry faced a nine percent audit rate in fiscal year 2008, a slight increase from FY2004 where the rate stood at eight percent. But compared to other industry groups, financial services got off easy. For all other industries, the audit rate was 19 percent in FY2008; in FY2004, it was 23 percent. (Other industry sectors include natural resources and construction; communications, technology, and media; retailers, food, pharmaceuticals and healthcare; and heavy manufacturing and transportation.)

In absolute numbers, the IRS did perform far more audits in the financial services arena than in other sectors, pointed out Frank Keith, an IRS spokesman, with audits there representing almost 29 percent of all large and mid-sized corporate audits in the last fiscal year. Sounds impressive… but on closer look, the financial services sector was responsible for around 45 percent of all large and mid-sized business returns.

Keith said that accounting rules make the financial services sector appear more significant than it is from a tax standpoint. Banks, for example, must claim deposits as assets. That means, he added, that many institutions in this category “have little audit potential.”

But the industry’s compliance with tax regs suggest otherwise, according to a just-released report by the Syracuse University-based Transactional Records Access Clearinghouse. Financial services sector “audits [the IRS] has completed have in recent years turned up ever higher amounts of tax underreporting than was uncovered by the units assigned to the four other industry groups,” the report found. The audit rate was determined by analyzing the number of audits against the number of tax returns filed by companies in those industry sectors. The tax return information was collected by TRAC.

TRAC has been in litigation with the IRS over the agency’s denial of a Freedom of Information Act request for the number of audits the agency has conducted.

“Interesting that a query from you and a handful of other reporters resulted in the IRS coughing up some stuff when the requirements of the FOIA did not,” said TRAC’s co-director David Burnham.