Executive Summary

Division of Tax and Revenue

Issue Area 1: The Audit Selection Process Can be Improved to Maximize Recovery of Revenue, Enhance Voluntary Compliance, and Reduce the Audit Burden on Honest Taxpayers Through Improved Identification of Non-compliant Taxpayers.

The goals for the Tax Department's Auditing Division are to encourage voluntary compliance, maximize revenue recovery, and identify non-compliant taxpayers. These goals are being accomplished to a limited extent primarily because the Auditing Division relies extensively on random selection of taxpayers for audits. Random selections contribute in a high percentage of audits with no assessments (no unpaid taxes were identified) because it does not rely on any indication of a taxpayer being out of compliance. In 1998, 79% of the audits had no assessments.



Number of audits
Audits with no assessment No assessment as percent of all audits
27 Tax Areas 8,345 6,598 79.1 %

The Audit Division's 79.1 % no assessment rate far exceeded the Internal Revenue Service (IRS) no assessment rate. The IRS conducted over 5.6 million audits between 1994 and 1996. The average percent of audits that had no assessments was 33%.

Another factor is the limited use of other selection processes. The Auditing Division has 8 sources to select audits. However, for the last three years (FY 1996 through 1998), the Division has used primarily only two sources to select taxpayers for audits: 1) random; and 2) referrals. These two selection processes account for about 97% of the selections. Nearly two-thirds of the audits were randomly selected in 1998.

Audit Selection Methods Used From FY 1996 - 1998

Selection Type 1996 1997 1998
Random 69.9% 54.3% 62.7%
Referral 28.8% 43.3% 34.5%
Cell 0.6% 0.6% 0.0%
Others 0.7% 1.8% 2.8%

Compared to other states, West Virginia relies to a much greater extent on random selection of sales tax accounts than other states. While other states use a wider variety of other selection processes than West Virginia (see Table below).

Selection Processes Used by Other States in Auditing Sales Tax Accounts

Random Selection Cell Selection Referral Selection Previous Audit Selection Other Selection Methods
West Virginia 67.5% 0.0% 30.1% 0.0% 2.4%
National Average* 7.9% 26.8% 21.5% 14.8% 27.1%
*The national average does not add to 100% because three states, Michigan, Missouri, and Tennessee, provided percentages for a limited number of selection methods.

Source: Results of a Survey of State Tax Departments that audit State Sales Taxes.

The high percentage of audits that result in no assessments results in a relatively low COLLECTION/COST ratio of 2.9:1, which indicates that for every dollar spent on auditing, $2.90 was collected. Revenue recovery could be increased using random selection less frequently.

Cost/Benefit Ratios
Assessments $23,335,871
Collections $7,120,914
Direct Costs $1,015,471
Total Costs (Direct & Indirect) $2,463,466

As a result, the goals of encouraging voluntary compliance, maximizing revenue recovery, and identifying non-compliant taxpayers are being accomplished to a limited extent. Furthermore, random selection imposes an audit burden on honest taxpayers. There may be public sentiment against being selected for an audit based on no indication of non-compliance. Attempts have been made at the federal level to prohibit the IRS from randomly selecting taxpayers for audits. Currently, the IRS is required by law to inform taxpayers of the method used in selecting them for an audit.