Thoughts on the Corporate Audit Lottery

The audit lottery is a gambit in which taxpayers claim tax benefits to which they are not entitled in the hope that the IRS will never audit the returns or, if audited, the improper benefits will not be discovered.  The audit lottery is simply an attempt to exploit the IRS's limited resources.  The IRS has limited audit coverage.  Most taxpayers are not audited and, when audited, tax benefits may not be reviewed.  The taxpayer wins the audit lottery if the IRS does not discover the improperly claimed benefits.

Taxpayers' positions exploiting the audit lottery often are criminal in nature.  By criminal I mean that the taxpayer voluntarily violated a known legal duty.  This is often referred to as the Cheek definition of willfulness which is the standard for most tax crimes...

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... [S]ome argue... that the U.S. tax penalty structure permits the inference that it is OK for U.S. taxpayers to claim risky positions and play the audit lottery so long as they (i) do not cross the criminal line and (ii) pay any civil penalties for their conduct.  Seen in this light, the 20% [accuracy-related] penalty [imposed under IRC § 6662 would be just a cost of playing the audit lottery and, so long as there the benefits to be derived from winning that lottery exceed the cost and risk, the potential cost is not only acceptable, but playing the lottery is sanctioned by the penalty provisions.  I am not sure that is a proper way to view the tax penalty structure, but it certainly is not uncommon for businesses in many legal contexts to view the risk of civil penalties as just a cost of doing business (i.e., achieving the benefits they want, in this case the financial statement benefits).  I think the penalties for playing the audit lottery, particularly when the chance of avoiding detection is enhanced by complex structures involving a maze of provisions designed to obscure the nature of the transaction, should be higher than 20%...

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View Jack Townsend's thoughts in their entirety on the Federal Tax Crimes blog site.

For additional insight, explore Tax Crimes, authored by Jack Townsend and available at the LexisNexis® Store.

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