Real Effects of Tax Audits: Evidence from Firms Randomly Selected for IRS Examination

Tax audits are a necessary component of the tax system but have potentially adverse real effects on firms selected for audit. This paper examines the real effects on small firms of being subjected to a tax audit, using administrative data from both random and nonrandom tax audits. We find that audited firms are less likely to continue as going concerns following the audit. However, we find that the effect is almost entirely isolated to firms that underreported their tax liability. We find little evidence that the administrative costs of an audit are associated with ceasing to operate. Among audited firms that continue as going concerns, we find evidence of adverse real effects on future revenues but no evidence of effects on wages, employment, or investment. Finally, we consider whether tax audits could also have side-benefits and find that in certain cases tax audits help firms learn and make important changes.