Who audits the IRS the most?

Vaseline4 weeks ago

0 6 minutes read

The IRS should focus on audits of corporations and high-income, wealthy taxpayers. But who is really under the agency’s microscope?

Some answers may be found in a new report that sheds light on the IRS’s struggle to implement a key directive: not to raise audit rates for taxpayers making less than $400,000 a year.

That challenge stems from President Biden’s promise not to raise taxes on low- and middle-income earners. (Democratic Vice President Kamala Harris has accepted that promise.) In particular, the pledge, which sounds simple and appears to be rooted in tax fairness, is wreaking a bit of havoc at the IRS.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, more informed investor.

Save up to 74%

Sign up for Kiplinger’s free e-newsletters

Profit and prosper with the best expert advice on investments, taxes, retirement, personal finance and more – straight to your email address.

Profit and prosper with the best expert advice – straight to your email address.

The General Treasury Inspector for Fiscal Administration (TIGTA) say The IRS must address several complex issues to comply with the $400,000 directive as it applies to taxpayers selected for audit.

Meanwhile, data shows the IRS audited nearly half a million taxpayers making less than $200,000 a year as recently as six years ago.

So on one hand, there are political promises, and on the other hand, there is the reality of who is actually facing high IRS audit rates.

Here’s more on what you need to know.

Tax liability of $400,000

The $400,000 income tax threshold came up during President Biden’s presidential campaign four years ago. Biden promised that people and households making less than that amount a year would see no tax increases.

Two years later, the Biden administration enacted the Inflation Reduction Act (IRA). That massive law, packed with tax credits (like the electric vehicle tax credit) and other clean energy incentives, allocated $80 billion in funding to the IRS.

These funds were to improve processes, technology, staff and compliance.
Congress has since clawed back some of the funding, but about $24 billion is earmarked for IRS enforcement.

However, the IRA prompted Treasury Secretary Janet Yellen to go all-in at the $400,000 mark. Yellen director tax agency to ensure that new funds will not be used to increase historic audit rates for small businesses and households making less than $400,000 a year. Instead, the agency would focus on high-income noncompliance.

Note: The tax audit directive should address concerns that new IRS funding would increase scrutiny of middle-class taxpayers. As Kiplinger reported, the idea sparked fear and concern on social media when some lawmakers argued that 87,000 new IRS agents are essentially coming for the tax dollars of middle-income earners.

Related: Are 87,000 IRS agents coming for your tax dollars?

Despite the Treasury directive, the TIGTA report shows that turning a political promise into effective policy and changing the IRS audit landscape will be challenging.

How will these challenges affect taxpayers?

IRS Implementation Struggles

Conformable PANThe IRS has made only “limited progress” in figuring out how to comply with the $400,000 tax audit directive. Here are some of the issues.

Definition of “income”. It appears that the IRS is trying to determine how to calculate the $400,000 threshold. The tax agency currently focuses on “total positive income,” which is the total of all positive income sources (eg wages, salaries, investment income, social security benefits, rental income, etc.) before deductions and losses.
Establishing a historical baseline. To effectively measure future compliance, the tax agency must determine “historical” audit rates. The IRS will likely use fiscal year 2018 as the base year, but the TIGTA report says the calculation method has not been selected.
Definition of “small business”. Treasury and the IRS disagreed on what constitutes a small business for purposes of the $400,000 threshold. (Note: The US tax code does not define “small business”).
The potential penalty of marriage. The current IRS approach does not distinguish between individual and joint filers. So the $400,000 limit applies to single people, while married couples share the threshold. The TIGTA report indicates that this could put married couples at greater audit risk.

Is $400,000 an accurate income indicator?

There’s another problem with the $400,000 threshold: Making $400,000 a year for some does not equate to having an income of $400,000 a year. So it raises questions about whether the income threshold is somewhat arbitrary or unfair.

Sen. Mike Crapo (R-Idaho) wrote in a column about the tax audit directive that for most Americans, what they “make” means what they take home after paying expenses and incurring losses. Crapo added that using total positive income for the audit threshold could “catch many unsuspecting taxpayers in the IRS audit net.”

Crapo also expressed concern that the IRS may audit too many people who earn less than $200,000 — far less annual income than the Treasury directive calls for.

For example, six years ago (base tax year 2018 used by the IRS), nearly half a million federal returns with income of less than $200,000 were audited.

Who gets audited the most by the IRS?

Despite the $400,000 threshold and the IRS’s intention to focus tax compliance efforts on high earners and large corporations, recent data paint a different picture.

EITC Recipients: In recent years, taxpayers claiming the Earned Income Tax Credit (EITC), a tax break designed primarily for low- to moderate-income workers, have been audited at a rate of about 1.27 percent. This is more than five times the overall average audit rate (in 2021) of 0.25%.

Taxpayers with low incomes: Data from Syracuse University’s Transactional Records Clearing House shows that two years ago, taxpayers earning less than $25,000 had an audit rate of about 1.27 percent. That’s higher than any other income group that year except those earning more than $1 million.

Beneficiaries with average and upper average incomes: In 2022, taxpayers with annual income between $200,000 and $1 million had an audit rate of just 0.6%.

Despite intentions to focus on high-income taxpayers, the audit rate for millionaires has fallen. In 2022, only about 1.1% of millionaires’ tax returns were audited, down from 8.4% fourteen years ago.

The data also show that the IRS audited lower-income taxpayers at higher rates than many middle- and upper-middle-income taxpayers.

In response, some will point out that Secretary Yellen has said that audit rates have not increased from historic levels and that overall audit rates for all tax returns have declined in recent years.

However, others believe that as a practical matter and with tax fairness in mind, lower income taxpayers are audited more than they probably should be based on earnings level.

Higher IRS Audit Rates?

Why would people with lower incomes be subject to potentially higher audit rates? Various agencies, including the Government Accountability Office (GAO), have quote several factors. Here are some.

Automation: Many audits of lower-income taxpayers are automated, making them easier and less expensive for the IRS.

Resources: Before the IRA, the IRS’s limited resources led the agency to focus on simpler audits that could be conducted quickly, often affecting lower-income taxpayers. (The argument is that wealthier taxpayers and large corporations tend to have more complex returns that require more time and highly skilled agents..)

Dates: The IRS can match reported income to third-party self-employment information returns, making it easier to spot discrepancies.

Correspondence: The IRS has increasingly relied on mail audits (conducted entirely by mail), which require fewer resources and often target lower-income taxpayers. According to the Congressional Research Service (CRS), these audits accounted for approximately 85% of all individual audits in recent years.

On the other hand, some reasons for lower audit rates of higher incomes include (but are not limited to) reduced IRS staffing and the complexity of higher income audits, which require more staff time and expertise.

That’s why the agency said it will use some of its IRA funds to hire and train experienced agents and auditors, among other staff.

IRS Audit: What You Can Do

Many eyes will remain on the IRS as the agency tries to finalize its audit, compliance and enforcement approach under the $400,000 directive.

Recent figures show some progress. For example, the tax agency has recognized that effectively targeting high-income tax evasion, with a focus on wealthy individuals and large corporations, is crucial to revenue collection. (As Kiplinger reported, the IRS recently collected $1.3 billion in back taxes from wealthy non-filers.)

But the disparity in audit rates remains a concern. This is particularly problematic because, not long ago, a study based on US Treasury data found that the IRS audited black taxpayers at much higher rates.

Related: Does the IRS audit some taxpayers more than others?

While we wait to see how the IRS approaches audit rates, stay aware of aspects of your tax return that may be considered IRS audit red flags.
Work with a qualified and trusted tax preparer if you’re worried about making a mistake on your return.

And remember, it’s your right to properly claim the tax deductions and credits you’re entitled to, so keep good tax records and documents to support your claimed tax credits. Proper documentation can go a long way in getting the IRS to take a second look.

Vaseline4 weeks ago

0 6 minutes read

Vaseline

Related Articles

VC firms are slowing crypto investment for a “nuanced reason” – venture capitalist

PrimeEnergy Resources Co. (NASDAQ:PNRG) Rothschild majority shareholder Robert De sells 904 shares

FX option expires for September 18 NY cut

Bitcoin network is a ticking time bomb: Crypto analyst