From Reactive to Proactive: Stay Ahead of IRS Compliance Initiatives

Filing efficiency comes naturally to most CPA firms. With the current technology available and well-established industry best practices, it’s an obvious priority. But when it comes to post-filing work – issues, notices and other compliance activities that arise after tax filing – many CPAs face a manual process: Sift through files for documents from a previous IRS interaction, research the new issue, call the IRS, call the client, and repurpose the old documents to create a new response.

Now more than ever, CPA firms need to be just as efficient in their post-filing work as they are in filing taxes for their clients. A recent study showed that the average firm spends 66 days a year addressing client IRS issues. Even for the simplest post-filing notices, it takes firms a total of almost 35 days a year – an average of more than three hours per notice – to research, understand, respond and follow up.

On top of this, statistics show that the IRS and states are increasing compliance initiatives to close tax gaps and build up treasuries. This sounds ominous, but it doesn’t have to be. In fact, it represents a real opportunity for firms to establish better processes and provide superior service to their clients, through best practices that embrace technology.

The IRS is doing more with less

The IRS increase in post-filing initiatives did not arrive as a tidal wave. It increased steadily and slowly, like a rising tide. From 2001 to 2009, the number of IRS notices sent increased from 30 million to 201 million – that’s 570%. The reason is simple: Sending notices is a cost-effective approach for the IRS to increase compliance and cover more ground with fewer resources. For example, the return on IRS mail audits (correspondence audits) is more than $4,000 per audit hour.

That’s at least eight times more than a field audit, which returns less than $500 per audit hour and costs the IRS more to conduct. In 2010, mail audits constituted 82% of all audits, an increase from approximately 60% in 2001.

Another example is the IRS underreporter and nonfiling program. The IRS receives more than 2.7 billion information statements a year. When it matches these information statements to filed and unfiled tax returns, 20 million discrepancies result -- and these are only for individual taxpayers. Because of resource constraints, the IRS can send notices to only 6 million of these discrepant taxpayers, without pursuing the other 14 million.

With each underreporter notice returning an average of $1,670, with minimal personnel effort, the IRS can expand this program and get meaningful results.

As the IRS is facing a probable $500 million budget cut next year and mounting pressure to increase compliance to raise revenue, it’s being forced to do more with less. There is no question that it will send more notices, conduct more mail audits and step up compliance initiatives.

The practitioner’s challenge

While most firms have a clear, efficient process for filing tax returns, many do not have a process to best serve their clients after filing. Most of the time, practitioners simply slog through it, and eventually the work gets done. But the average firm can bill for an only 28% of that work, representing a significant drain on money, time and client goodwill. Several reasons for this come into play.

The majority of post-filing services are not related to complex engagements such as audits. Rather, they are related to understanding, analyzing and responding to an increasing wave of IRS notices that may involve client assessments, account corrections and errors, penalties or balances owed. CPA firms don’t often create engagement agreements or bill for the “learning time” associated with these services.

CPAs often cite client retention as the reason they don’t bill for learning time. There are more than 1,000 types of IRS notices, and the origin of any given notice is often unclear. CPAs spend time researching and understanding the notice, IRS process, potential client issues and facts, and analyzing a response.