IRS Audit Detection Risk and Firm Tax Behavior: Can Tax Fraud Be Deterred by Increasing IRS Budgets?

ABSTRACT This paper examines whether tax fraud and aggressive tax positions at firms are affected by changes in the IRS budget. Changes in a firm’s risk profile affect many users of financial information including the IRS, forensic accountants, and investors among others. We find that concurrent IRS resources are related to firms’ tax aggression and tax fraud likelihood and that they explain incrementally more of these tax decisions at a firm than historical information often used in prior literature. Taken together, our results suggest that firms increase their tax risk profile thus more tax aggression and higher likelihood of tax fraud when they believe IRS scrutiny will be lower.