IRS examinations of individual income tax returns declined between 2010 and 2019 across the board, but the trend was most pronounced for taxpayers with incomes of $200,000 or more, the U.S. Government Accountability Office (GAO) reported Tuesday.
The report, Trends of IRS Audit Rates and Results for Individual Taxpayers by Income (Rep't No. GAO-22-104960), also included the GAO's look into how the IRS deployed its audit personnel and other resources across taxpayer income levels. It was produced at the request of Rep. Bill Pascrell Jr., D-N.J., who chairs the Subcommittee on Oversight of the House Ways and Means Committee. The subcommittee is scheduled to conduct a hearing Wednesday on "Taxpayer Fairness Across the IRS."
Also on Tuesday, the GAO released a second report on the IRS's enforcement of taxpayers' proper claiming of business tax measures providing COVID-19 relief — principally, the employee retention credit and the paid sick and family leave credits (IRS Implemented Tax Relief for Employers Quickly, but Could Strengthen Its Compliance Efforts (Rep't No. GAO-22-104280)).
For all individual taxpayers, the average audit rate fell from 0.9% in 2010 to 0.25% in 2019, or by 72%, the GAO found. When segmented by taxpayer income, all ranges declined, but not by the same amount.
For taxpayers with annual income from $1 to under $25,000, the rate declined by 61%. The greatest decrease was for taxpayers with incomes of between $200,000 and $500,000, which decreased by 92%. The wealthiest taxpayers, those with incomes of $5 million or more, were the most likely to be audited throughout the decade but also saw their audit rates drop precipitously, by 86%.
The GAO also looked at taxpayers claiming the earned income tax credit (EITC), whose audit rate was higher than the average rate for all taxpayers. It was generally above those of other taxpayers with incomes under $200,000 throughout the decade and above those with incomes below $500,000 for each year except 2010. EITC claimants' audit rate also fell during the decade, but by less, 58%.
Incomes in all cases were reported as "total positive income," defined as the sum of all positive amounts shown on an individual tax return, with losses treated as zero.
Higher-income taxpayers' audit rates decreased the most, IRS officials told the GAO, mostly because their audits tend to be more complicated and require more auditors. IRS staffing decreases during the decade have curtailed the number of these audits performed, even as the number of higher-income taxpayers has increased.
In 2019, the audit rate was lowest for taxpayers with incomes between $25,000 and $500,000, at 0.17%, while for those with incomes below $25,000 it was 0.4%. EITC claimants' rate was 0.77%. The rate was highest for taxpayers with $5 million or more in income, 2.35%. The rate was 0.53% for incomes between $500,000 and $1 million and 1.02% for incomes between $1 million and $5 million.
EITC audit rates were likely higher than for many other taxpayers because EITC audits are limited in scope and less time-consuming, IRS officials told the GAO. Also, most EITC audits are performed during processing returns, before issuing a refund.
The GAO also studied the results of audits by income level, in terms of how much additional tax the IRS assessed as a result. Naturally, the higher the income cohort, the more tax was assessed. As audit rates decreased during the decade, so did the amount of additional tax, from more than $8 billion in 2010 to about $4.9 billion in 2019. The amount fell still further in 2020 to $3.7 billion before rebounding in 2021 to $5.4 billion.
The average number of hours spent per audit increased about 30% between fiscal years 2010 and 2021, the GAO reported. Average audit hours changed little for taxpayers in the lowest income cohort but more than doubled for those with $200,000 or more in income. Average audit hours per EITC return were low but increased by 59%.
In fiscal 2021, additional tax per audit hour was more than $2,000 for taxpayers with income under $25,000 and less for taxpayers going up the income ranges until the $5 million–$10 million cohort, at nearly $4,000. Audits of taxpayers with incomes over $10 million produced $5,320 per audit hour, making them the most efficient by that measure.
Pandemic-related business credits
In the second report issued Tuesday, the GAO noted that, since the employee retention credit and sick and family leave credits were only recently enacted, examinations of returns claiming them are ongoing, and many have yet to be started.
From preliminary data, however, the GAO identified 337 filings claiming credits totaling $100 million by entities that had been established in or after April 2020 but have since stopped filing employment tax returns. Filters had enabled the IRS to flag for further scrutiny more than 65% of these questionable returns. But other spurious claims could still slip through, the GAO said, because the IRS's controls do not also take into account refund amounts, employer establishment dates, and other factors.
Also, while the IRS has established processes to measure and address compliance risks associated with the credits, the Service could do a better job of making sure its stated objectives are measurable, with criteria for success, and take into account statutory changes in the credits.
— To comment on this article or to suggest an idea for another article, contact Paul Bonner at Paul.Bonner@aicpa-cima.com.