IRS Market Segment Specialization Program, The

CPA Journal, The, Feb 2001 by Smith, Darlene Pulliam

After using the Taxpayer Compliance Measurement Program (TCMP) from 1964 to 1998 to assess taxpayer compliance and focus auditing efforts, the IRS has developed a new audit selection program: the Market Segment Specialization Program (MSSP).

During the years they were used, TCMP audits supposedly resulted in very reliable computations of each audited taxpayer's income, deductions, and tax liability. Upon being randomly selected for such an audit, a taxpayer had to document and support every item on the return, in some cases providing a marriage license to support the filing of a joint return. The IRS's next step was to use the information collected during the audit phase to develop a discriminant function analysis (DID, which it could then use to score every filed tax return. A high score indicated a high probability of noncompliance, allowing an IRS employee to examine the return and determine whether to audit it.

But in the mid-1990s, political and budget battles blocked the TCMP process, and the program was last updated with current audit information in 1988. Many had expressed doubts about TCMP long before it became outdated, and by the mid-1990s the IRS, perhaps seeing the writing on the wall, was already developing the Market Segment Specialization Program (MSSP) as an alternative or supplement to the TCMP. In 1994, the IRS commissioner described the redirection of responsibility away from the national office to the IRS districts. The new program being developed had already identified 28 categories of taxpayers, including 24 business and farm categories and four nonbusiness categories.

The MSSP has been a major undertaking. Its main objectives are to increase the rate of voluntary taxpayer compliance and make the audit process more efficient and effective. The refocused effort by examiners and by other employees will be a challenge. It remains to be seen whether the MSSP will be attacked as the TCMP was. But if the new program succeeds, it has the potential for assisting taxpayers and the IRS in the audit process and enhancing the level of voluntary compliance.

Inner Workings of the MSSP

Chapter I of the MSSP Handbook (in Part 4 of the Internal Revenue Manual) describes the program as a change in approach to the examination of income tax returns in the general program. The general goal is to organize district compliance activity around market segments, where practical. A market segment can be an industry, such as gasoline retailing; a profession, such as accounting; or an issue, such as the alternative minimum tax. Individual market segments are then assigned to examiners with auditing experience, training, and research responsibilities in that area.

The IRS national office has developed a list of "areas of focus" (Exhibit 1) from which it selects specific topics for audit guides. In some cases, the national office may conduct an analysis using historical voluntary compliance levels, closed case data, filing populations, current compliance initiatives, and other available information. In other cases, a regional or district office may provide a suggested area for development based on an analysis at the regional or district level.

The overriding goal of the program is to enhance voluntary compliance. The audit guides listed in Exhibit 2 are available to the public from the superintendent of documents or online at www.irs.gov. Each audit guide discusses the market segment and the relevant tax law and lists specific audit techniques. Taxpayers and practitioners can use these audit guides to understand the applicable tax law and prepare the documentation that an examiner might eventually require.

After an area has been identified and selected, the districts are responsible for implementing the MSSP and using MSSP techniques to identify returns and conduct examinations. The handbook states that the districts are to "use interim approaches to supplement the current DIF ordering system ... until a statistically valid method is developed." Eventually, the districts will use a Market Segment Plan rather than the current Exam Plan.

In addition, a specific district is responsible for developing the Audit Technique Guide (ATG), using the following list as a guide. The district office is also responsible for the following:

* Maintaining and updating the list of examiners assigned to market segments

* Coordinating ATG development

* Communicating with industry representatives, as appropriate

* Providing administrative assistance and guidance to market segment and issue coordinators

* Maintaining the district library of ATGs and other resource materials

* Securing necessary copyright permissions when writing an ATG

* Coordinating market segment return classification

* Accessing the MSSP bulletin board and sharing information with examiners

* Coordinating the ordering and distribution of trade publications and other reference materials

* Participating on district steering committees

* Coordinating with the district counsel during the drafting stage and securing counsel's agreement before submitting the proposed ATG to the national office for final approval