NCSL Opposes Contingent-fee Audits, Passes Resolution

  by Stewart Weintraub and Jennifer Weidler

As a means of increasing corporate tax collections, some states have turned to contingent-fee audit contractors – sometimes referred to as “bounty hunters.”  These bounty hunter firms are compensated based upon a percentage of the amount of tax assessed, creating an incentive for the firms to not only aggressively audit taxpayers, but to stretch interpretations of the law to and beyond the limits.  Having an economic interest in the assessments resulting from the bounty hunter audits, creates an inherent conflict of interest.

Not surprisingly, corporate taxpayers oppose the use of contingent-fee audits because the bounty hunters have a financial stake in the outcome of the audit, thereby creating an unfair and antagonistic aura.  Questions about a lack of transparency, confidentiality of taxpayer information and inflated assessments – with almost inevitable consequential legal fees – are some of the concerns surrounding contingent-fee audits.  For instance, a class action suit involving Alabama taxpayers, brought against the largest contingency-fee auditing firm in the state, is currently pending in state court.  The complaint alleges violations of the Alabama Taxpayers’ Bill of Rights and Uniform Revenue Procedures Act for, among other issues, entering into contingency-fee audit agreements with local governments and compensating its employees and independent contractors through incentive bonuses based on tax collections or assessments.[1]  For further detailed coverage on the status of this case, click here.

However, due to their need to raise revenue, cash-strapped states support the use of contingent-fee audits, backed by the private audit firms profiting from the agreements.  Other states have even gone a step further, drafting legislation mandating that the state’s taxing authority investigate the use of outside audit firms to perform certain audit functions.  Moreover, some states have entered into contracts with bounty hunter firms that ignore a taxpayer’s books and records, and instead focus on estimating a taxpayer’s potential liability by examining financial statements and other publicly available data.

Responding to these issues, the National Conference of State Legislatures (“NCSL”) recently approved a resolution opposing contingent-fee taxpayer audits.  Additionally, the resolution opposes the use of third-party auditors that do not use a taxpayer’s books and records when conducting the audit.  The resolution is a step in the right direction for corporations fighting the implementation of contingent-fee audits, but it has yet to be seen what the states’ reactions will be, if any, to the NCSL resolution.

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[1] Alabama Code § 40-2A-6 prohibits the use of contingent fee auditors and hearing officers, but it does not apply to unclaimed property audits.

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