IRS is behind on Biden policy to not increase audits for households under $400K

President Joe Biden promised that tens of billions of dollars for the IRS in the 2022 Inflation Reduction Act would not be used to increase audits of individuals making $400,000 or less annually. But an IRS watchdog is questioning whether the tax agency will actually be able to fulfill that promise. 

The Treasury Inspector General for Tax Administration reported on Aug. 26 that IRS has not developed a plan to comply with a 2022 directive from Treasury Secretary Janet Yellen that implements Biden’s long standing promise regarding IRA funding and the audit rate. 

While the agency has selected tax year 2018 as the base year for comparing future audits conducted with IRA funding, it hasn’t finalized a methodology to calculate the audit rate for that year with respect to tax returns under $400,000. That is mainly because IRS is considering alternative methods to follow the 2022 directive. 

For example, the agency at one point proposed an authority to waive audits from the calculation if a taxpayer seems to have purposefully understated income to avoid the $400,000 threshold. TIGTA warned that such a waiver could be abused. 

“We were concerned that the proposed waiver authority would allow the IRS too much discretion to waive examinations that are under the $400,000 threshold, essentially permitting the IRS to say, ‘we’ll know what constitutes a waiver when we see it,’” investigators wrote. 

According to the report, IRS dropped the idea and emphasized that any proposal shouldn’t be considered definitive until the methodology is finalized.  

TIGTA said that IRS also should examine adjustments for cases when two spouses each earn less than $400,000 but together make more than that amount and craft a definition for small businesses, which the 2022 directive also exempts from the increased audit rate. 

IRS officials told investigators that they are not treating the development of the methodology as an urgent matter because the directive applies to audits beginning with tax year 2023. However TIGTA said those returns will begin to be examined in fiscal 2025, which starts in October. 

“The IRS was unable to provide TIGTA with a timetable or milestone dates to ensure that it is progressing toward completion,” investigators wrote. “The absence of timetables and milestones increases the risk that the methodology may not be developed in time to ensure compliance with the 2022 Treasury directive.”

Additionally, the inspector general predicted that conducting increased audits of those making more than $400,000 would challenge IRS because historically it has focused on taxpayers reporting less than that amount. Between fiscal 2019 and 2023, examinations of individuals under that threshold consistently accounted for more than 90 percent of total audits. 

IRS agreed with a recommendation to accelerate discussions with the Treasury Department to finalize a methodology to ensure IRA funds are used in compliance with the 2022 directive. It set an implementation date of Dec. 31. The agency also agreed with a TIGTA recommendation to formally document discussions and meetings regarding the methodology’s development. 

However the agency disagreed with a recommendation to use “return transaction file” data to determine the number of filers above and below the $400,000 threshold. Instead, it will use “statistics of income” data, which TIGTA criticized for being derived from a probability sample. IRS countered that TIGTA’s preferred option is a raw data source that is subject to inconsistent reporting and other data anomalies. 

TIGTA also recommended that IRS ensure a field in its audit information management system includes a taxpayer’s reported income plus any unreported income identified during the audit in order to measure post-audit income. While IRS only partially agreed with the suggestion, the inspector general said that actions the agency plans to take in response to it are in the spirit of the recommendation.  

Previously, a TIGTA analysis found that targeting a smaller portion of wealthy individuals, as opposed to all those making more than $400,000, could be more effective.