Tax Analysts Blog

City of Tacoma Considers Contingent-Fee Auditors

Posted on Mar 19, 2014

The city of Tacoma, Wash., has put out a request for proposals for third-party contractors to perform tax audits. Payment for the work would be based on a percentage “paid as a contingency of the additional revenue received by the City as a result of the services provided by” the contractors. In other words, the city would tie the contractor’s fee to the amount of tax revenue that is recovered.

The use of contingent fee consultants is not unheard of in the state tax context. States have for years used contingent fee consultants to conduct unclaimed property audits. Those consultants are authorized by state statutes and are generally compensated based on a percentage of unclaimed property that is recovered for the state. That type of arrangement has been met with scorn by many in the tax community. Although states may find it difficult to hire, train, and retain qualified unclaimed property auditors, contingent fee arrangements encourage abuse.

An article published by the Council On State Taxation said:

Contingent-fee arrangements encourage auditors to be overly aggressive, to interpret State laws to their
own advantage rather than in society's best interest, to "cherry pick" audit targets, and to ignore holder
errors that would result in lower assessments.

Third-party consultants can be a beneficial resource for state tax departments. They may provide states with the ability to engage in more sophisticated analysis of complex transactions than state auditors would otherwise be able to do. For example, some states have explored the use of outside transfer pricing consultants who have experience with transfer pricing and are better equipped to examine corporate taxpayers’ tax positions and identify potentially abusive transfer pricing schemes.

But there is a significant difference between third-party consultants who are working on a fixed rate and those who are working on a contingent basis. Unfortunately, despite taxpayer and practitioner disapproval of contingent fee contracts, if it appears that the use of contingent fee consultants will generate additional revenue, states and localities (like Tacoma) will take notice and employ them.

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