Title: Who Gets Audited by IRS the Most and How Have Audit Rates Changed? Description: IRS estimates that individual taxpayers underreport their income during tax season by hundreds of billions of dollars each year. The IRS determines whether taxpayers have reported their income accurately by auditing them. But in recent years audit rates have declined. Why has this happened and what impacts could it have? We find out from GAO's Jay McTigue. Related GAO Work: GAO-22-104960, Tax Compliance: Trends of IRS Audit Rates and Results for Individual Taxpayers by Income Released: May 2022 [Music] [Jay McTigue:] If audit rates continue to decline taxpayers may begin losing confidence in our tax system. [Holly Hobbs:] Hi and welcome to GAO's Watchdog Report, your source for news and information from the U.S. Government Accountability Office-- I'm your host, Holly Hobbs. The IRS estimates that individual taxpayers underreport their income during tax season by hundreds of billions of dollars each year. The IRS determines whether taxpayers have reported their income accurately by auditing them. But in recent years audit rates have declined. Why has this happened, and what impacts could it have? Today, we'll talk with GAO Director Jay McTigue, an expert on tax policy, about a new report on trends in IRS audit rates? Thanks for joining us! [Jay McTigue:] Glad to be here, Holly. Thank you. [Holly Hobbs:] So Jay, maybe we can start with a basic question--why would someone get audited by the IRS? What might trigger an audit? [Jay McTigue:] That's a great question. And honestly, anyone can be audited by the IRS at any time. [X] Typically, IRS uses computer algorithms and models that are based on historical characteristics of noncompliance and patterns that they have seen over the years. They have a tremendous amount of data on taxpayers, both through tax returns as well as through information returns that employers and banks send to the IRS and to taxpayers to help them comply with their tax liability. In addition to the automated processes. IRS also conducts research on emerging issues of noncompliance and uses data analytics to identify groups of like returns that have characteristics that suggest potential noncompliance. And lastly, IRS also selects taxpayers at random for research purposes. So there are a lot of different ways IRS selects taxpayers for audit. And, you know, I'd like to point out up front that audits are a very important part of our tax system. They're one of the key tools that IRS has to ensure compliance with our tax laws and to kind of assure that everyone is paying their fair share of taxes. Our tax system of voluntary compliance rests on the belief that taxpayers will more likely comply if they think IRS might check. [Holly Hobbs:] And what do we know about the folks who get audited? Do they have anything in common? [Jay McTigue:] Essentially anyone can be chosen for audit. IRS tries to maintain a level of audit presence across all different types of taxpayers and income levels to try to ensure that everyone is paying their fair share and build confidence in the tax system. What we did see however is that, since about 2010, audit rates of individual tax returns has decreased across all income levels. But we also noticed that audit rates for taxpayers with higher incomes decreased the most. [Holly Hobbs:] So, are people who make less money more likely to be audited? [Jay McTigue:] Well, as I said, higher-income taxpayers are indeed being audited at a higher rate than lower-income taxpayers. In fact, the highest-income taxpayers, those making $5 million or more a year, right now are being audited at about 2.3%. Whereas on average the audit rate is less than 1% So there is still a focus on the higher-earning individuals. [Holly Hobbs:] And do we know why the number of audits conducted has decreased in recent years? [Jay McTigue:] Good question. The audit rate overall has decreased in parallel with the decrease in the IRS's budget. IRS's budget for fiscal year 2021 was about 20% lower than it was in 2010 in real terms. So IRS's buying power to bring staff on board and train people has really been reduced, and that has translated directly into the audit rates. And, we talked about audit rates decreasing at a greater rate for higher-income individuals. Those audits are the most labor-intensive. Returns of higher-income individuals tend to be much more complex, deal with a lot of different tax issues. Whereas a lot of the lower-income audits are more automated. They cost a lot less for IRS to undertake as well. I think IRS has about 75,000 employees now, and that's at a level of where it was about 50 years ago. And obviously, technology has changed. I've mentioned automated processes and computer algorithms, which IRS has leveraged quite a bit. But again, there are certain audits that require people still to really understand the issues and work those cases. [Holly Hobbs:] Did COVID have an impact on the number of audits that were conducted? [Jay McTigue:] Oh, absolutely. During the height of the pandemic, like many agencies, IRS shut down its operations temporarily. And, within a month or so, they were moving a lot of work to be done remotely. But that took a little bit of time to get staff transitioned. IRS also deals with a lot of highly sensitive taxpayer information. So security and safeguards had to, be in place to protect that information. And, you know, for the safety of IRS employees as well as taxpayers, a lot of what we call field audits where examiners go out and meet with taxpayers in their offices, their homes, or bring tax papers into an IRS office-- those stopped completely for, you know, public health concerns. A t the same time IRS experienced these declines in staffing, it was also being tasked with ever-increasing responsibilities, such as making Economic Impact Payments during the pandemic and paying individuals the advance payment of the Child Tax Credit. And all of this is also on top of implementing major changes to our tax system that Congress passed under the Tax Cuts and Jobs Act of 2017 and other changes that occur every year in the tax code. So IRS has had increasing responsibilities that it needs to accomplish with fewer and fewer staff resources. [Music] [Holly Hobbs:] So it sounds like IRS faces a number of challenges--including budget decreases and staffing shortages--that have contributed to lower audit rates for all taxpayers, but in particular taxpayers with higher incomes whose taxes are more labor intensive to audit. So Jay, why did we look at this? Why do audit rates matter, and what's the impact? [Jay McTigue:] Great question. Audits are a very important tool that IRS has at its disposal to ensure voluntary compliance. Taxpayers, when they see audits being conducted, they're more inclined to pay their taxes, file their taxes, because they know IRS is out there. As audit rates decline, there is the concern that taxpayers will notice that. And according to the latest estimates from IRS, individual taxpayers underreported their income tax on average by about $245 billion annually. And that's a lot of money, when we're faced with large budget deficits. Some people have also raised concerns about whether IRS is selecting taxpayers for audit in an equitable manner. As we talked about, audit rates for lower-income taxpayers have seen a smaller decline than audit rates for higher-income taxpayers. But as we've discussed, overall, the trend is toward fewer audits across the board, regardless of income. [Holly Hobbs:] And last question: What's the bottom line of this report? [Jay McTigue:] Historically, the rate of voluntary compliance has been pretty flat. But if audit rates continue to decline, taxpayers may begin losing confidence in our tax system. As the Congress begins reinvesting in IRS, we will continue to look at how IRS leverages its budget resources to address these trends and help taxpayers meet their tax responsibilities to ensure that everyone is paying their fair share. [Holly Hobbs:] That was Jay McTigue, talking about GAO's recent review of trends in the IRS's audit rates. Thanks for your time, Jay. [Jay McTigue:] Thanks, Holly. [Holly Hobbs:] And thank you for listening to the Watchdog Report. To hear more podcasts, subscribe to us on Apple Podcasts. And make sure you leave a rating and review to let others know about the work we're doing. For more from the congressional watchdog, the U.S. Government Accountability Office, visit us at GAO.gov.