A news service for the people of Michigan from the Mackinac Center for Public Policy

Measures recently introduced in the Michigan House would prohibit businesses being subjected to government audits paid for on a contingency fee basis.

Supporters of the legislation argue that paying for audits based on the amount of tax liabilities produced can turn auditors into bounty hunters. In other words, there's an inherent conflict of interest in rewarding auditors for finding ways of claiming taxpayers owe more to governments.

“I'm in favor of creating incentives for doing good things,” said Rep. Aric Nesbitt, R-Lawton. "But I'm not in favor of giving auditors incentives to rip businesses apart looking for more government revenue. These audits should only be paid on a flat-fee arrangement.”

Rep. Nesbitt is the sponsor of House Bill 5524, part of a three-bill legislative package to prohibit government from paying for certain types of audits on a contingent-fee basis. House Bill 5524, pertains to unclaimed property; House Bill 5525, sponsored by Rep. Peter MacGregor, R-Rockford, pertains to the general property tax; and House Bill 5526, sponsored by Rep. Brad Jacobsen, R-Oxford, pertains to the state Revenue Act. The three bills have recently been assigned to the House Tax Policy Committee.

The State of Michigan currently uses third-party auditors paid on a contingent-fee arrangement for audits conducted under the Unclaimed Property Act. In addition, numerous local units of government use third-party auditors for personal property tax purposes.

Michigan is not alone when it comes to using contingent-fee audits. As states struggle through tight budgetary times, many have expanded the types of property subject to so-called “escheat” laws and are aggressively pursuing unclaimed property audits.

The Michigan Department of Treasury would be the major government entity affected by banning contingent-fee audits. Treasury spokesman Caleb Buhs said the department has yet to adopt a position on the new legislation.

“We don't have an official position yet,” Buhs said. “These bills were only recently introduced and there hasn't been a committee hearing yet. If a hearing were scheduled for today, we'd be neutral. But I can say that initially we're a little bit guarded. We don't have much to go on yet in terms of analysis.”

Tricia Kinley, director of tax policy for the Michigan Chamber of Commerce, said the Chamber strongly favors ending the practice of governments using contingent-fee audits.

“When government uses a contingency fee for an audit, there's clearly a danger that it will influence the auditor's judgment,” Kinley said. “We understand that there is pressure to bring in extra revenues to the state. However, the practice of paying contingency fees for audits has cast a cloud over the entire process.”

Attempts by Capitol Confidential to find proponents of contingency fee audits willing to speak out publicly in favor of the practice were unsuccessful.

“If there were such a thing as an association of the auditors who do those kinds of audits, it would undoubtedly be opposed to this legislation,” Kinley said. "But they're probably too busy making money hand over fist to take the time to comment.”

Rep. Nesbitt said he's waiting to see what estimate the Department of Treasury will make regarding the revenue impact the State of Michigan would experience if contingency based audits were outlawed.

“This is something I've asked for, and I'm waiting for their (Treasury's) response,” Rep. Nesbitt said. “Keep in mind that the former administration (under Gov. Jennifer Granholm) used some of these juiced up tax revenues to balance its budget for 2010-2011.”

The “juiced up” revenues Rep. Nesbitt referred to were from Gov. Granholm's maneuver, which was approved by the legislature, to speed up the processing of unclaimed property. According to estimates, the state was expected to get a $166 million one-year revenue bump from the acceleration in fiscal year 2010-11. It seems likely that contingent-fee audits elevated that revenue bump by extracting an increased amount of money from taxpayers.

If Michigan were to prohibit tax audit contingent-fee arrangements, it would not be alone:

  • The American Institute of Certified Public Accountants Standards and Code of Professional Conduct prohibits performance of an audit that reviews financial statements to be paid on a contingent-fee basis.
  • In 2004, the U.S. Securities and Exchange Commission issued a letter clarifying the SEC's position that the receipt by an accounting firm of a contingent fee from an audit client impairs the auditor's independence with respect to that client. Accordingly, the SEC concluded that the use of contingent fees in tax matters for audit clients is prohibited.
  • In August 2011, a National Conference of State Legislatures task force passed a resolution opposing certain contingent-fee based auditing practices. The resolution is awaiting full NCSL consideration in 2012.

There are signs that if the three-bill package passed out of the House, it could eventually be passed by the Senate as well.

It's believed that a somewhat related bill, House Bill 4563, soon will be passed by the Senate. This legislation, which is also sponsored by Rep. Nesbitt, would exclude business-to-business transactions from the unclaimed property process.

House Bill 4563 was passed by the House in June and has been in the Senate for 10 months. However, an agreement has recently been struck that appears to have cleared a path for the bill to be sent to Gov. Rick Snyder.

Another sign of possible passage is that the Senate Appropriations Subcommittee on General Government has recently taken language specifically allowing contingent-fee audits out of its proposed budget for the upcoming fiscal year.