Few words do more to chill the hearts of American taxpayers than the phrase “IRS audit.” However, the fact is that the IRS is in a bad way, with audit rates at historic lows.
This piece of information might sound like good news if you hate paying taxes. But in the long run, it results in higher government deficits and higher taxes for everyone.
IRS audit rates
You can claim anything you want in your tax return. But your return is subject to review by the IRS—otherwise known as the dreaded IRS audit.
If the IRS determines you underpaid your taxes, you must pay what you owe plus interest. Penalties are also often assessed.
However, the IRS does not audit all tax returns because it lacks the resources to do so.
Indeed, the odds that your tax return will get audited by the IRS are shockingly low.
Here’s a breakdown by income of how many taxpayers had their 2016 tax returns audited by the IRS by the end of 2019. The IRS ordinarily has three years to audit a return after it’s filed, so these numbers represent almost all the audits the IRS will ever perform for 2016 returns.
|2016 Income||Audit Rate|
Overall, the chance of a 2016 return getting audited was 0.49%. That’s less than one in 200 returns.
Ironically, individuals with zero income got audited more often that most–2.98%. That’s because these people file returns to receive the earned income tax credit. The IRS audits them at a high rate in an attempt to prevent fraudulent claims to the credit.
Returns filed in 2020 will likely get audited even less, partly due to the disruptions caused by the coronavirus (COVID-19) pandemic.
And most IRS audits—75%—are correspondence audits. This type of audit is where the IRS sends you a letter asking about one or two tax issues. Only 25% of all reviews are the more thorough field audits where you go into the IRS office to get questioned by a field agent.
Why are audit rates so low?
IRS audits have been declining for years. Since 2010, audits of individual returns have fallen by 46%. Corporate audits declined by 37%.
There are two reasons for this: big cuts in the IRS budget combined with an increase in the number of returns filed.
In 2010, the IRS received 230.4 million returns. In 2019 it received 253.0 million returns.
Congress has cut the IRS budget by 20% since 2010. As a result, the agency eliminated 22% of its staff, including 30% of its employees working in enforcement. The IRS lost about 14,000 of its enforcement employees since 2010—a drop from about 45,000 to 31,000.
Low audit rates contribute to the tax gap
The “tax gap” is how much all American taxpayers underpay their taxes each year. It results from people cheating on their taxes and unintentional non-compliance. However, most of the gap comes from higher-income taxpayers underreporting their income.
From 2011 to 2013, the tax gap was $441 billion per year. That amounts to about one/seventh of all taxes owed. The IRS was able to collect $60 billion of this amount through enforcement.
The tax gap is likely higher today (we don’t have more current statistics).
Obviously, the lack of IRS enforcement encourages taxpayers to underpay their taxes.
The Congressional Budget Office estimates that increasing the IRS’s funding for examinations and collections by $20 billion over ten years would increase revenues by $61 billion. Taking further, increasing such funding by $40 billion over ten years would increase revenues by a whopping $103 billion.
Does this mean you’re free to cheat on your taxes?
Do the low audit rates mean you can cheat on your taxes and, more than likely, get away with it?
The short answer is “no.”
Although IRS audits are at historic lows and may sink farther, lots of taxpayers still get audited. For example, the IRS audited 743,127 of all the individual tax returns filed for 2016.
The IRS uses sophisticated software to decide which returns to audit. Your audit chances go way up if your return shows signs that you could be cheating. For example:
- Your deductions are unusually large for your income
- Your deductions look peculiar—for example, a plumber deducts the cost of a European vacation as a business expense
- You claim to lose money from a business—especially for several years
- You have many deductions prone to abuse such as substantial charitable deductions; or outrageous deductions for auto and travel expenses
- A lot of cash transactions associated with your business
- You engage in cryptocurrency transactions, or
- You have foreign bank accounts
Moreover, the IRS audit rates do not include other types of compliance tools the IRS employs. Chief among these is the Automated Underreporter Program. IRS computers match the data on taxpayers’ returns with the information received by the IRS on W-2 and 1099 forms filed by employers and other third parties.
Take note; the IRS received more than 3.5 billion of these forms in 2019.
If there is a mismatch between the income shown on a taxpayer’s return and payments shown on a W-2 or 1099, the IRS sends a notice demanding extra payment or an explanation. The IRS closed more than 1.9 million cases under the Automated Underreporter Program in 2019, resulting in almost $6.7 billion in additional assessments.
The IRS also has an Automated Substitute for Return program to identify individuals who don’t file tax returns. In 2019, the IRS closed more than 364,000 cases under this Program, resulting in nearly $6.6 billion in additional assessments.
The only sure way to avoid getting in trouble with the IRS is to pay what you owe.