GAO Report Highlights Fairness Issues In IRS Audit Rates

Taxes

The Government Accountability Office (GAO) was asked to report on trends in IRS audit rates, audit results, and resources used for audits across individual taxpayer income levels. Their report, issued this week, analyzed audit rates and results and IRS resources used by taxpayer income for the most recent years data was available. According to the report, “In recent years, IRS has examined, or audited, a decreasing proportion of individual tax returns. This trend has raised concerns about the potential for declining taxpayer compliance, as well as whether IRS is equitably selecting taxpayers for audit, as audit rates for higher-income taxpayers have decreased more than audit rates for lower-income taxpayers.”

On May 18, 2022 IRS Chief Taxpayer Experience Officer, Ken Corbin, and the GAO Director of Strategic Issues, James McTigue, appeared before the House Ways and Means Oversight Subcommittee (Bill Pascrell, D-NJ, chair) to discuss the reports findings with respect to taxpayer fairness across the IRS. Of particular concern were reports that the IRS audits low income taxpayers at a disproportionately higher rate than higher income taxpayers. In his comments before the subcommittee Chairman Pascrell notes that in a hearing of the House Oversight and Reform Subcommittee on Government Operations (Gerry Connolly, D-VA, Chair) held on October 7, 2020 IRS Commissioner Charles Rettig stated that such claims were “absolutely false” (Mr. Pascrell puts this question to the Commissioner at ~1:47 in the video). The recent GAO report was, in part, requested to provide data to substantiate IRS audit rates.

The report shows an overall drop in the average audit rate for individual filers from .9 percent to .25 percent. The rate for individual filers for with incomes between $25,000 and $500,000 is .17 percent while the audit rate for individual filers with incomes between $1 and $25,000 is .4 percent and the audit rate for individual filers claiming the Earned Income Tax Credit (EITC) is .77 percent. From the report it is clear that low income taxpayers, especially those claiming the EITC are audited at a significantly higher rate than middle to upper middle income taxpayers. Indeed, it is not until income exceeds $1M that the audit rate for upper income earners exceeds that of those claiming the EITC.

An Audit By Any Other Name

A distinction often lost on average taxpayers but highlighted multiple times during the May 18th subcommittee hearing is the difference between correspondence audits and in-person audits. When the average taxpayer hears the word “audit” they think of the IRS coming to the home or office to review tax returns and substantiating information. Correspondence audits (sometimes referred to by tax practitioners as “prove it letters”), however, are simply letters that the IRS sends to the taxpayer that requires the taxpayer to substantiate their eligibility for a deduction or a credit. For example, Sch C taxpayers are often asked to provide written proof of business mileage and/or business travel and meal expenses. For taxpayers claiming the Earned Income Tax Credit (EITC) the letters often require the taxpayer to substantiate the eligibility of a “qualifying child.”

Not lost on the subcommittee or the witnesses was the fact that audits of higher income taxpayers usually fall into the in-person category and require many more resources than correspondence audits. Mr. McTigue noted that the volume of high income returns (individuals reporting more than $200,000 in income) has doubled. To keep the audit rate the same for high income individuals would require many more audits than were required in prior years. He also noted that in terms of “tax per audit hour” the results were best when lower income individuals were audited. In other words, it’s just cheaper and easier to audit lower income individuals.

It is well understood that the IRS has been and continues to be both underfunded and understaffed. During the testimony Mr. Corbin noted that the IRS has not yet hired half of the 5,000 additional employees they wanted to add for customer service and enforcement (the so-called “surge teams”). Throughout the hearing it was evident that the disparity in the audit rates was largely due to the amount of resources required for the two different types of audits (correspondence v. in person). Both the witnesses and Congress clearly understand that the optics resulting from the data is that “wealthy tax cheats” are getting away with gaming the system while low income taxpayers are being punished because they don’t have the resources available to game the system or challenge an audit.

Pay Now or Pay Later

Another distinction that sometimes gets lost is that in most reports the “tax gap” concerns under reporting of income, not ineligibility for credits. Under reporting is a problem that is typically higher for higher income individuals. Indeed, Mr. McTigue testified that the IRS estimates approximately $110B (or roughly 25%) of the $245B tax gap is the result of under reporting income on Schedule C (the form used by unincorporated sole proprietors). This under reporting is not addressed unless the IRS initiates a correspondence or in-person audit of the taxpayer. In other words, if a Schedule C filer is under reporting their income, they get away with underpaying the associated taxes until the IRS initiates some type of audit.

The system works differently for EITC filers subject to a correspondence audit. In those cases the EITC claim (the taxpayer’s refund) is held until the matter is resolved to the IRS’ satisfaction even though the individual’s income is likely to have been reported by various third parties on Form(s) W2. Still, there is a “sweet spot” for low-income, self-employed filers where the EITC is maxed out. Reporting that much income, but no more, gets these filers the maximum amount of EITC. Beyond that amount and the amount of the credit starts to decline. Unscrupulous taxpayers and paid preparers are well aware of this sweet spot and it is certainly a part of the approximately 25% ($19B) improper payment rate for EITC claims. Reports of this type of abuse of the system have Reagan era “welfare queen” optics about them so media and Congressional focus is often placed on this type of willfull abuse. The reality, according to Mr. Corbin and those in the tax industry who assist EITC filers and those under correspondence audit, is that the rules for claiming the credit are complex. Indeed Mr. Corbin asserted in his testimony that the complexity of the law and confusion surrounding how to qualify for the credit and determine the proper credit amount causes confusion and that it is confusion more often than willful disregard of the law or fraud that is often the cause of improper payments. In any case, it is clear that low-income taxpayers eligible for the EITC who become the subject of a correspondence audit do not have the same advantages as higher income taxpayers with respect to payment of tax due. EITC claims for refund are held until the matter is resolved, while under-reporters have the use of their money until the IRS returns a negative audit result.

Solutions?

To prevent improper payments, reduce the number of correspondence audits, and assist EITC filers with notice resolution Mr. Corbin said the IRS is working on increasing education and outreach around credit eligibility, making correspondence audit notices more understandable, and on providing increased opportunities and access for resolution. Various members of the subcommittee noted that lower income taxpayers often do not respond to IRS correspondence and, consequently, give up money to which they may be eligible. Mr. Corbin testified the IRS is aware that many taxpayers who claim the EITC prefer to work with non-profit organizations rather than directly with the IRS when trying to resolve tax controversy matters and that the IRS was looking at how to expand access to resolution services through the third-party organizations with which low income individuals feel most comfortable.

Mr. McTigue noted that about half of all EITC claims are prepared by a paid preparer. Tom Rice (R-SC) stated that seeing “Get your EITC Money Here Today” signs in front of houses is part of the problem (~58:00 in the video). Mr. Rice indicated that both making the credit easier to administer and requiring preparer regulation with respect to continuing education and competency would go a long way to reducing improper payments. Mr. Rice noted that he is a co-sponsor of the “Taxpayer Protection and Paid Preparer Proficiency Act” which is one such measure.

Unfortunately, increasing the audit rate for higher income filers requires two things in short supply at the IRS—money and staff (especially trained staff). Staff attrition, the tight labor market, and ongoing funding shortages (both in general and specifically for enforcement) continue to contribute to the declining audit rate for in-person audits of higher income taxpayers. Until Congress passes enforcement-specific funding or decides to provide an avenue for consistent long-term funding of the Service, increasing enforcement activities likely remains beyond its reach.

Articles You May Like

Top Wall Street analysts are upbeat on these stocks for the long haul
Social Security beneficiaries to soon receive notices revealing the size of their 2025 benefit checks
How the world’s 431 women billionaires make, spend and give away their fortunes
Acurx Pharmaceuticals to add up to $1 million in bitcoin for treasury reserve, following MicroStrategy’s playbook
Your Life Can’t Wait! Learn To Decumulate.

Leave a Reply

Your email address will not be published. Required fields are marked *