Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. Today’s Adam Talks focuses on the recent IRS data reported on May 17th, 2022, by the Government Accountability Office report on trends of IRS audit rates and results from individual taxpayers by income.
Changes in IRS Audits
In recent years, the IRS has audited a decreasing proportion of individual tax returns. Now, this podcast is not an IRAs or 401(k)s or on individual tax returns that we all file. So according to the Treasury Inspector General for Tax Administration, it’s reported that the audit rate declined 44% between 2015 and 2019. And based on the report for these years, the audit rate drops 75% for incomes above a million dollars.
While the audit rate for lower-income taxpayers who claim the Earned Income Tax Credit, which is a hot audit area, decreased by 33%. So, the IRS is falling behind mostly because they don’t have people. They are losing people. People are retiring and they don’t have enough money to hire people. As a result, there’s been some recent legislation that they were going to increase IRA responsibilities or IRS responsibilities. The IRS budget in 2021 was 11.9 billion. That’s over 200 million less than eleven years ago. Okay, so their budget is 200 million less than eleven years ago. And according to various IRS officials, with inflation and anticipated mandatory pay raise, IRS 2021 budget is 2.7 billion less than what it was in 2010. 22% reduction. So, they need money. They need people. Now. The Build Back Better Act, which didn’t pass, had a provision in there that was going to add billions of dollars to their budget. That never passed, but I assume something will pass soon that will add some more money to the IRS budget. Essentially, they have IRS officials say they expect to support 74,000 full-time employees, which is basically what they had in when you look at their levels.
The IRS is drowning. They’re not even treading water. They are drowning. They’re swimming upstream. And you can see it in the results. They just don’t have enough manpower, not enough resources. So, they’re auditing the low-hanging fruit. And unfortunately, they’re auditing low-income taxpayers because it’s easy on it. With that information in mind, audit rates are going down.
From 2010 to 2019, the audit rates of individual tax returns decreased in all income levels. On average, individual tax returns were audited over three times more often for the tax year 2010, than in 2019. Okay, so things are going backward, and essentially it comes down to funding fewer people and more complicated taxpayers. So, let’s go-to auto rates for high-income earners. High-income earners also saw a decrease in audit rates, largely because their audits tend to be more complicated. Right. They have itemized deductions; they have more investment income. It’s not just a straight-up W-2 and generally requires others to spend more time on it. More sophisticated type auditors. And again, the IRS just doesn’t have enough of them. They just don’t have enough time, enough manpower to conduct enough of these audits.
IRS Audit Rates & High-Income Earners
So, the average audit rate for the highest income taxpayers, 5 million or above, it’s slightly increased from 17 to 18. But it’s still down. IRS generally audits high-income taxpayers at higher rates than lower-income taxpayers from 2010 to 2019 from a higher percentage. But they’re collecting less money, which we’ll see in a second. So, from 2010 to 2019, the number of audits of individual tax returns decreased from 1.2 million to 386,000, while the number of tax returns at the same time, the number of tax returns increase that were filed from 142,000,000 to 157,000,000. Okay, so more tax returns, more people following returns, fewer audits. The auto rates decreased 1.2 percentage points for taxpayers with income from five to 10 million. Now, interesting, the earned income tax credit, which I mentioned, is the hot audit area. They have higher audit rates than audit rates for high-income earners. They’re auditing low-income people’s earned income tax credits at a higher rate than rich people, wise because they’re easy audits that take less time. So, it kind of is working in reverse. People that make less money are getting audited more than people that make more money just because the IRS doesn’t have enough people, enough costs, is running high inflation, don’t have the volume of employees.
So, they’re going after the low-hanging fruit, which is basic income tax returns. And you earn income tax credits just the easiest ones to make sure you’re entitled to it. And sometimes they collect, sometimes they don’t. But they’re still putting through those taxpayers, putting those taxpayers through the audit cycle. Here’s some interesting IRS data that I collected from the geo report. I’m just going to throw it out there for you to digest. From 2010 to 2021, the total amount of additional taxes the IRS recommended from individual taxpayers has decreased while they’re auditing less, right? So, they’re collecting less money. From 2010 to 2021, the average number of hours spent per audit increased 30% from five to six and a half hours. The average audit hours were generally stable for low-income returns, but for the higher income returns, they’re spending more time and they just don’t have the people. So that’s why they’re tilting their audits towards the earned income tax credits and lower-income folks. Taxpayers’ income of 50,000 above average spent fewer average on average on no change audits compared to audits. With tax changes, taxpayers at this income level are more likely to respond to IRS.
So that means if you’re a low-income person, you may not respond or it’s a very simple issue. If you’re a higher income earner, you may respond with more documentation, which creates more work for the IRS. That’s one of the reasons they aren’t auditing those folks at a higher rate because there’s just too much work involved, and they don’t have the manpower. This is from the IRS, the Geo report. We found that audits on the lowest income taxpayers, particularly those claiming the EITC, result in higher amounts of recommended additional tax per audit hour compared to the highest income group. Audits of individual taxpayers with income of 5 million and above had the highest average recommended additional tax per audit hour, followed by audits claiming the EITC. So, either they’re going after the super-rich people where they can find something and then hit them up for a bunch of tax, or they’re going after the low-income folks that maybe didn’t file their EITC properly, the earned income tax credit, or filed it improperly. And unfortunately, they are getting targeted. So the low income and the higher income seem like they’re a target in these audits because the high income, even though they’re audited less, they’re getting more revenue from those audits because there are big-ticket items, the money’s bigger, and then they’re just going after the low hanging fruits and the EITC audits and then the people in the middle, pretty much all of us are slipping through the cracks, which I’m not complaining with the IRS.
And that’s why they are demanding more money, a higher budget because they feel like they’re not collecting as much money. You look at the statistics, they’re collecting money like they did 30 years ago. So, what did the IRS explain? How do they explain that? They say, listen, we must invest fewer hours in these easy audits. The higher income audits need more sophisticated agents, more time, and more resources, and sometimes it just doesn’t pan out. Let’s talk about cost versus auto award. Between 2016 and 2020, I estimate that the revenue collected from audits was about two to four times greater than the budget cost. They’re still making some money. They’re not making enough. So, I’m going to throw you some more data here. And this is from 2019. From people that made a dollar to 25K, the number of returns was 46 million or so, they audit 196,000 people. Let’s go 100 to 200. They audited 22 million returns of the audit, 37,000. Let’s go million to 5,574,000, 5800 or so audited returns. Five to 10,040,000 returns, 549 audited.
Okay, how about this? So, 25 to 200K, you’re looking at about 162,000 audits out of 97 million returns. That’s the big bucket, right? If you make between 25 and 200K, there are 97 million returns. Almost 100 million returns. Only 162,000 are audited. Okay. So not a huge number. Now, if you look at trends, let’s just look at some basic numbers. The audit rate in 2010 was 0.8%. In 2019, it was 0.2%. Huge numbers. Now, look at 25 so let’s see what numbers stick out here. Five to 10 million. The audit rate in 2010 was 13%, 2019. 1.4%. See, it’s just going down. Ten plus million in 21%, which is a high audit rate, in 2019. 3.9%. So, if you look at all these numbers in the aggregate, if you make under two hundred K, you have a .2% chance of getting audited. If you make 200 to a million, you have around the same .2% to 5%. So maybe a .3% chance and a million-plus, you’re probably around 1% or so. Still, very low audit rates. The IRS is frugal. What does that mean for all of us? It means that chance of getting audited is a lot less today than it was ten years ago.
That could change. It just comes down to dollars and cents. Right. Iris has more money. They’ll hire more people, better training, and more sophisticated audit folks. And we’ll all get audited more frequently. So the numbers speak for themselves, just especially if you’re a high-net-worth person. Right. In 2010, if you made more than $5 million, 13% chance of getting audited now one 4%. You made over a million in 2010. 8.2% now, 1%. So even five hundred K to a million in 2010 is about 3.6% now .5% so it’s across the board. IRS is struggling. These numbers prove it. We’ll see what Congress does to get them some funding. I’m assuming that’s going to happen at some point. Whether you’re a Democrat or Republican, you understand the money the IRS brings in, and the principle of our system that there needs to be an oversight. If people aren’t checked, they may not file returns or may not file their taxes properly. The system for to work, there needs to be supervised and infrastructure. So, the IRS does have a place it’s needed. If not, no one’s going to ever pay their taxes and our system will break down.
We’ll have no money for our military, roads, airports, schools, all that good stuff, health care, Social Security. So, we need it the issue is no one wants to get audited in an Overbury manner where your tax returns get audited every year or you have IRS agents that are Hawking you for frequent flyer miles. You’re not dead reporting stupid stuff like that. But it’s funny that they’re focusing on the EITC the earnings tax credits for low-income folks trying to hit them up because it’s easy and they don’t have enough costs. It’s crazy. And again, folks that make $25 to $50 are pretty much getting audited at the same rate that people that make 200 to a million take it for what it is, but chances of autos are going down. And yes, it’s good for all of us, but there’s probably a lot of money out there that’s not being collected that all of us, part of society would probably benefit from juggling. We don’t want the IRS in our business overbearing but at the same time. You want your neighbors and everyone to pay their fair share.
You shouldn’t be the only one doing so. And that’s without getting into the constitutional debate of whether income taxes are legal. I’m not going there. Not Wesley Snipes. I’ve gotten some interesting debates with clients and colleagues and friends about that. I’m not going there. That’s the system the IRS is there. We need to pay our taxes. We got to follow the tax code which essentially benefits all of us if we all comply because the government will have more money to hopefully do good things with it. Not to say the government always does good things with the money, but you don’t want to be in a system like Greece or some of these other smaller countries where no one pays tax and it’s all corrupt and infrastructure is a mess and schools are dismal and social fabric just doesn’t support the population. So that’s not beneficial as well. Other than that, I hope you guys found the podcast interesting. If you want, you can check out the geo report. I hope this podcast kind of sums it all up. I read every page, every word, and just highlighted the key parts of it. There are a lot of interesting graphs that I kind of summarized that you may want to just check out, but obviously, the trend is downwards, and the IRS needs more money to catch up because if not, they’re going to drown.