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Companies Undertake More Aggressive Tax Positions When IRS Budget is Cut

An academic study tried to identify the correlation between corporate tax positions and the projected IRS budget for the following year.

A new academic study found that companies increase their tax risk profile—thus more tax aggression and a higher likelihood of tax fraud—when they believe IRS scrutiny will be lower due to budget cuts.

For the study, which appears in the American Accounting Association’s Journal of Forensic Accounting Research, researchers looked at data from 10,992 companies between the years of 2011 and 2021. To assess changes in how aggressive each company was being with its tax positions, the researchers examined changes in each company’s effective tax rates and uncertain tax benefits. They also collected data on IRS budgets from the Treasury Department.

“We wanted to explore what external factors affect a company’s decisions regarding tax avoidance,” said Danielle Stanley, study co-author and an assistant professor of accounting at Coastal Carolina University. “Specifically, we wanted to see if companies were more comfortable with aggressive tax strategies when they think the IRS has fewer resources to engage in audits.”

This particular study differs from previous research that looked at corporate tax decisions in light of historical audit rates, asking whether recent audit rates influenced tax strategy, said Hannah Smith Antinozzi, study co-author and an assistant professor of accountancy at the University of Memphis.

“We took a different approach and looked at corporate decisions in the context of publicly available data on the IRS’s forecast budget,” she added.

The research team then used statistical tools to account for confounding variables, allowing them to better identify any correlation between corporate tax positions and the projected IRS budget for the following year.

“We looked at IRS budget projections for the next year because that is when the IRS could begin conducting audits on this year’s tax filings,” Stanley said. “Our biggest finding was that companies appear to take IRS budgets into consideration and take more aggressive tax positions when budgets go down. That’s over and above any correlation to historical audit data.”

“In other words, our findings suggest companies pay more attention to the IRS’s projected budget than they do to recent audit rates when making decisions about how aggressive to be with their tax strategy,” Antinozzi added. “One takeaway message here is that cuts to IRS budgets seem to have the unintended consequence of encouraging aggressive tax behavior.”

And because companies are more likely to make dicey tax decisions when IRS budgets are down, Stanley said it’s particularly important for auditors to allocate their available resources in ways that will identify tax fraud.

In an update to its strategic operating plan, the IRS said last month it’s planning to triple audit rates on corporations with assets over $250 million by 2026. And the agency said earlier this year it has recouped roughly $482 billion in back taxes from rich tax cheats since last October because of improvements that have been made to modernize the agency using Inflation Reduction Act funding.