IRS has made ‘limited progress’ on setting audit rates for those earning under $400,000, watchdog says

Two years after the Internal Revenue Service received billions of dollars to strengthen enforcement of wealthy taxpayers while keeping audit rates flat for most Americans, a new watchdog report says the agency has yet to establish a way to count how many audits it does below. the crucial income threshold of $400,000 per year.

The report, released Thursday by the Treasury Inspector General for Tax Administration, says the IRS has “made limited progress” in developing its methodology and needs to move faster.

Most Read on MarketWatch

In response, the IRS said it still had time to finalize its approach, but agreed to move faster.

The tax collector said that while he is still determining a technical point about audit rates, he has used the additional funding in many other ways to focus enforcement on wealthy households without weighing on most taxpayers.

“While the IRS continues to work to formalize its audit rate reporting methodology, our focus on high-level enforcement will continue,” the agency said in a statement to MarketWatch, noting that it conducts audits of higher incomes, but no. on people earning less than $400,000.

The agency outlined a number of ongoing efforts, including a crackdown on millionaires who are late on their tax debts; wealthy households that did not file tax returns; questionable cancellations regarding the use of the corporate jet; and a new batch of audits for complex, large partnerships.

The TIGTA report focused on the IRS’s efforts to ensure that its extra funds aren’t used to increase audit rates for taxpayers making less than $400,000 — but there’s a longer story.

Two years ago, a Democrat-controlled Congress passed the Inflation Relief Act, which appropriated $80 billion for the IRS over a decade. More than half of that amount was intended to fund stronger tax oversight of corporations and wealthy households.

Republicans criticized the influx of funding, warning it could prompt the taxman to probe everyone. Treasury Secretary Janet Yellen issued a directive saying the extra money would not be used to increase audits of households and small businesses making less than $400,000 “compared to historic levels.”

The story continues

About $20 billion of the $80 billion in funding was canceled after 2023 negotiations to raise the debt ceiling.

The IRS has chosen tax year 2018 as the “base year” for income tax returns. It now determines the “audit coverage rate” for 2018 returns of up to $400,000 so it can avoid exceeding that rate in the future.

To be sure, the IRS already segments audits into income segments. The percentage of audited tax returns in 2018 with positive total income between $1 and $500,000 ranged from 0.2 percent to 0.4 percent, IRS figures show.

The challenge is drawing the new $400,000 line — and it matters a lot, the report says. More than nine out of 10 audits from 2019 to 2023 focused on taxpayers with positive total income below $400,000. Positive total income, the income measure the IRS says it will use for the $400,000 threshold, is all income reported on a profit, excluding losses.

Part of the challenge for IRS officials is finding a counting method broad enough to encompass the types of returns from taxpayers who make at least $400,000 but report income below that amount.

Tax officials considered excluding certain audits from the count, but TIGTA officials said that would give the IRS too much discretion. The IRS has abandoned the idea of ​​waiving certain audits, the report said.

Another roadblock is defining what counts as a “small business” for tax and audit purposes when creating the audit coverage rate, the report added.

The effort to avoid increasing audit rates for those making less than $400,000 compared to historical levels begins with tax returns in 2023. Those returns were filed earlier this year and will not be reviewed until the government’s fiscal year 2025 federal.

Fiscal year 2025 begins in October, the oversight report said. “We believe the IRS needs to accelerate the completion of its plan to comply with the Treasury Secretary’s Directive,” the report said.

As the IRS works to determine the audit rate for those earning less than $400,000, that income threshold may play an even larger role in tax policy.

Vice President Kamala Harris, the Democratic presidential nominee, followed up on President Joe Biden’s pledge that if elected in November, she would not raise taxes on households making less than $400,000.

Meanwhile, former President Donald Trump has pledged to extend his 2017 tax cuts if elected and possibly cut taxes.

Most Read on MarketWatch