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IRS Audits and Corporate Governance

The phrase "IRS audit" carries connotations that differ from taxpayer to taxpayer. If you've done all you can to file flawless tax returns, notice of an audit might seem like an outrage. Yet a different feeling - one of anxiety - could come if you fear you might have been too aggressive in your tax strategy.

You might also be feeling anxious just because you know it will be a lot of work to round up the paperwork to show the agency you're in the right.

Interestingly, according to a new research study, the prospects of an audit by the Internal Revenue Service have the greatest impact on companies with loose governance structures. The study appears in the current issue of Accounting Review. It found that the possibility of an IRS audit does not only encourage companies to pay more taxes; it also tends to result in more transparency in public financial documents.

"The idea that shareholders benefit from having their companies audited by the IRS may seem strange to some investors," said the study's co-author, Jeffrey Hoopes of the University of Michigan. "Our research, however, suggests that strict tax enforcement promotes good financial reporting and tends to check managers' proclivities to divert corporate resources for their personal use under the guise of saving taxes."

In other words, the reality check of a possible IRS audit may discourage not only tax fraud, but other forms of fraud as well.

This certainly does not mean, though, that the IRS is always right when it demands an audit. Whether the taxpayer is an individual or a corporation, the fact remains that sometimes audits will occur even when there is nothing amiss.

Source: "IRS Audits Keep Companies Honest, Says Researcher," Accounting Today, Michael Cohn, 9-12-12

Our firm handles situations similar to those discussed in this post. To learn more about our practice, please visit our tax audits and appeals page.

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