The IRS has abandoned a 2020 Treasury secretary directive to audit 8% of individuals making more than $10 million and instead has shifted to focusing on high-income taxpayers making more than $400,000, according to a report by a Treasury inspector general.
The report also claimed that the focus on the ultra-wealthy led to more revenues.
IRS executives shifted the focus early last year after concluding that trying to achieve an 8% audit rate on the $10 million-and-up pool of filers was "unproductive," meaning that "a high percentage of examinations that did not result in a change to the amount of tax due," states the report by the Treasury Inspector General for Tax Administration.
Noting that the agency continues to audit individuals who make more than $10 million, but to a lesser degree, the report said the IRS has since last year conducted audits based on a 2022 Treasury directive that the agency not use its $60 billion Inflation Reduction Act funding to increase audits on individuals and businesses that make less than $400,000.
"The executives explained that the IRS’s new focus will be on compliance with the 2022 Treasury Directive to expand examinations of individuals with incomes of $400,000 or more," the report said.
Despite the $60 billion in funding it received, the IRS said in May it will likely be forced to downsize its workforce as soon as 2026 without additional funding.
Also troubling to some taxpayer watchdogs is the inspector general's finding that 63% of audits last year were aimed at those earning less than $200,000.
“It shows how limited and vague the IRS’s directives are and proves they are still looking at lower and middle income earners,” Demien Brady, vice president of research for the National Taxpayers Union Foundation, told Financial Advisor magazine.
“Our concerns are that they’re now targeting people who may just be facing confusion over tax preparedness issues. We think the IRS ran into a wall with high earners and businesses who have hired professionals, so now the agency is pivoting to households and smaller businesses that don’t have access to the same top-tier talent,” Brady said.
Brady said he is particularly concerned as the IRS prepares to require 1099k statements on all forms of electronic payments including PayPal, Venmo, Cash App and eBay.
The new form is to ensure that gig workers and others report their business income, “but we’re concerned that this will turn every person who earns $5,000 into a small business for purposes of IRS audits,” Brady said.
The inspector general's report, released last week, found that the 2020 directive issued by then Treasury Secretary Steven Mnuchin calling for the IRS to annually audit at least 8% of individual tax returns from those with an adjusted gross income of more than $10 million. The report found that while the IRS's small business/self-employed division's audits of these individuals were "generally more productive than income ranges below $10 million, yielding four times more dollars assessed per return and two times more dollars assessed per hour when compared to examinations of returns with income of $400,000 to under $10 million." However,the report also said it found the agency's efforts to audit large and international businesses were less productive.
But the shift to households earning more than $400,000 produces less revenues, TIGTA reported.
The inspector general found that between tax years 2016 and 2021, when the Mnuchin directive was applicable, audits on individual returns with income of $10 million or more produced more than $574 million in revenue, or an average $124,389 per return and roughly $2,220 per hour of IRS employee work. During the same time period, tax returns audited on households with incomes of more than $400,000 but less than $10 million netted an average of only $31,000 per return or $1,100 per hour of IRS employee work.
“Our analysis of the average dollars assessed per return and per hour shows that examinations of returns with $10 million or more are more productive than returns with the lower income ranges reviewed by TIGTA,” the report said.
IRS management “stated that this is because returns with TPI of $10 million or more tend to have larger issue adjustments and therefore higher recommended [unpaid] tax amounts,” TIGTA said.
The inspector general recommended that the IRS include a separate category for taxpayers earning $10 million or more to track the productivity of their audits relative to examinations of taxpayers at other income levels.
The IRS partially agreed with TIGTA’s recommendation and said it already monitors such information, but disagrees that it should compare audit effectiveness specific income levels.