Affiliations: [a] Internal Revenue Service (IRS), Small Business Self-Employed Research (SBSE Research), St. Paul, MN, USA | [b] IRS, Research, Applied Analytics, and Statistics, St. Paul, MN, USA
Corresponding author: Anne Parker, Internal Revenue Service, Research, Applied Analytics, and Statistics, 30 East Seventh St. Wells Fargo Place, St. Paul, MN 55101, USA. Tel.: +55 612 845 2333; E-mail: [email protected]
Note:  The views expressed in this presentation are those of the authors and do not necessarily reflect the views of the U.S. Internal Revenue Service or the Department of the Treasury.
Abstract: We use Hidden Markov and Semi-Markov Models to study persistence of the compliance impact for tax examinations of Employee Business Expense (EBE). Using panels of yearly returns for taxpayers reporting EBE, we compare future filing behavior of those audited to those not audited, by fitting and comparing Hidden Markov and Semi-Markov Models for both groups. The Markov state space is EBE reporting compliance. The observation vectors are a function of reported line item amounts for a series of annual returns filed starting two years after the year of the tax audits, the baseline year. The functions used to create the observation vectors are proxies for compliance, and the unobserved Markov state space is true compliance. The observations have a probability distribution that is conditional upon unobserved compliance status. Our fitted models give some evidence that a no change audit may worsen compliance slightly.