Some clarity is emerging over statements by Biden administration officials that no one making less than $400,000 will see higher audit rates from the Internal Revenue Service, which is poised to step up its control of wealthy taxpayers.
The Inflation Reduction Act, the tax and climate package enacted last summer, allocated $80 billion to the IRS over the next decade and a half. The money is intended in part to facilitate more audits of corporations and wealthier individuals.
Before the bill passed, Treasury Secretary Janet Yellen promised there would be no audit fee increase for households and small businesses with annual incomes below $400,000 “relative to with historical levels”.
But Republican critics and other observers have questioned what “historic levels” might actually mean.
The audit rate on tax year 2018 returns is the benchmark to consider, IRS Commissioner Danny Werfel told senators on Wednesday. He stressed that “there is no increase for workers, retirees and others.”
The IRS audited less than 1% of 2018 returns with total positive income, the sum of all positive amounts shown for multiple sources of income reported on an individual income tax return, which it excludes losses, between $1 and $500,000, according to statistics the tax agency released last week.
The agency has three years to begin an audit from the time it receives the return.
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The figures show that 0.4% of the returns of taxpayers earning up to $25,000 were audited. That number was 0.3 percent for returns between $200,000 and $500,000 and more than 9 percent for returns above $10 million, IRS data show. Six years earlier, more than 13% of returns above $10 million were scrutinized, according to the IRS.
“Help us understand what the words ‘historic level’ mean,” Sen. James Lankford, R-Oklahoma, asked Werfel during a budget hearing Wednesday.
“We’ll take the most recent final audit rate, and it’s historically low … and let that be the benchmark for at least a few years, and then we review it,” Werfel said. The 2018 audit rates were the newest final rates, he added.
“So what’s the 2018 number going to be?” Lankford asked.
“Yes,” Werfel replied.
“Werfel’s explanation that 2018 audit levels will be the benchmark is the most detailed I’ve heard so far,” Erica York, senior economist at the Tax Foundation, told MarketWatch. “It seemed to leave open the possibility of revising the reference year for ‘historic’ in the future,” he added.
Another open question has been how the $400,000 income threshold will be determined. Months after the Inflation Reduction Act passed, IRS and Treasury officials still hadn’t finalized what amounted to $400,000 in revenue, according to a Treasury Department watchdog report from January.
“How are you getting to that number?” asked Sen. Marsha Blackburn, R-Tennessee. Blackburn State has many self-employed people who might appear wealthier on paper than they really are, he said. “Although they may have a higher gross, their net is very low,” he added.
“We’re going to look at total positive revenue as a metric,” Werfel said. He later added that “there would be no greater likelihood of an audit if they have less than $400,000 of total positive income.”
The IRS description of total positive income as “the sum of all positive amounts shown for the various sources of income reported on an individual income tax return and therefore excludes losses ” effectively represents a count of income before taxpayers deduct their losses.
Total positive revenue is a metric the IRS typically uses to categorize audits, noted the Tax Foundation’s York. But one challenge with strict thresholds for more audits, he said, “is that it creates incentives for underreporting of income” to stay below the line.
Compared to past years, there are now more details about how the IRS will implement additional audits of higher-income taxpayers, said Janet Holtzblatt, a senior fellow at the Tax Policy Center.
“But there are still questions,” he noted, about how the agency will handle situations where taxpayers don’t provide a complete picture of their income.
Continue reading: Make sure the tax breaks you take now don’t affect you in retirement
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