Tax audits for some millionaires may be more effective than targeting a wider range, report finds

While the Biden administration is planning to audit more tax returns of those who make more than $400,000 annually to recoup revenue, a new analysis of a Trump administration policy suggests targeting a smaller portion of wealthy individuals might be more effective.

The Treasury Inspector General for Tax Administration report, released last week, examined the 2020 Treasury Directive issued by then Treasury Secretary Steven Mnuchin that called 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, dating as far back as tax year 2016. 

The tax agency now follows a 2022 directive from Secretary Janet Yellen as part of tens of billions of dollars in enforcement funding from the Inflation Reduction Act, which mandates that it focus on high-end tax compliance, including more audits of taxpayers making more than $400,000 per year. President Joe Biden has long said that his administration would not increase the audit rate for those making that amount or less. 

The TIGTA found that — between tax years 2016 and 2021, when the Mnuchin directive was applicable — examinations in the Small Business / Self-Employed Division for individual returns with a total positive income of $10 million or more assessed more than $574 million, or an average of $124,389 per return and roughly $2,220 per hour. 

During the same time period, tax returns audited on incomes more than $400,000 but less than $10 million netted an average of only $31,000 in assessments, or $1,100 per hour. 

“Our analysis of the average dollars assessed per return and per hour at the various [total positive income] ranges shows that the SB/SE Division examinations of returns with TPI of $10 million or more are more productive than returns with the lower TPI ranges reviewed by TIGTA,” the report said. “SB/SE management stated that this is because returns with TPI of $10 million or more tend to have larger issue adjustments and therefore higher recommended tax amounts.”

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. 

IRS partially agreed with the recommendation, arguing that it already monitors such information but disagreeing that it should compare specific income levels. 

However, the report found that at the Large Business and International Division auditing was more effective in the two tax years prior to the implementation of the 2020 directive and that a new model to select which returns to audit resulted in more examinations that did not change the amount of tax due. 

Specifically, the “no change” rate increased from 26% in tax years 2016 through 2017 to 54% in tax years 2018 through 2020 for examinations of returns with an income of $10 million or more. The report noted that the rate for tax years 2019 and 2020 could still decrease because audits are ongoing. 

IRS officials also told investigators that workforce attrition at the division contributed to the no change rate increase.

“There are multiple factors influencing the LB&I Division’s increasing no change rates and lower productivity measures,” according to the report. “Ultimately, all factors should be considered in reviewing the methods used by the LB&I Division to select returns for examination to promote the highest degree of voluntary compliance and efficient use of limited resources.”

The inspector general recommended that the division identify the potential causes for the increased no change rate and track productivity metrics for those making $10 million or more to ensure the returns most likely to generate more money are selected for examination. 

Similarly, the IRS partially agreed with the recommendation, saying it has already taken steps to identify such causes and will use “enhanced data and analytics” to select returns with the highest risk of noncompliance. 

Despite the surge in funding it received as part of the IRA, the IRS reported in May that it could be forced to downsize its workforce as soon as 2026 without additional funding.