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IRS Audit Rates at Historic Lows

Worrying about a personal tax audit? It’s less likely than ever before…

If you are worried about being audited by the IRS, you may be able to sleep easier. The IRS audit rate for individuals is down to a historic low of 0.70 percent, according to the latest IRS Data Book. The IRS audited just over 1 million tax returns of individuals in FY 2016, down almost 16 percent from the prior year’s total of 1.2 million.

Although the IRS collected more than $3.3 trillion, processed more than 244 million tax returns and other forms, and issued more than $426 billion in tax refunds, there were much fewer enforcement actions taken during FY 2016. Collections fell in FY 2016 along with the audit rates. IRS levies also were down 40 percent compared to the prior year, and the agency filed almost 9 percent fewer liens than in the prior year.

High-Income Taxpayers More at Risk

Looking at only the overall audit percentage rate does not give you the whole picture, however. It is important to realize that taxpayers at higher income levels are more likely to be audited. In addition, taxpayers who file certain Schedules with their returns, and who have unusually high amounts of deductions, are more closely scrutinized. It is known that deductions on Schedule C, the form used to report income and expenses of self-employed taxpayers, are one of the ten most litigated issues with the IRS. Litigation starts with an audit.

The IRS uses a well-guarded computer program to identify returns for audit that are likely to yield a significant upward adjustment in tax, its so-called “DIF” system. No one knows exactly how it works, but tax professionals have a good sense of the types of income and deduction items that can trigger an audit. For example, if at $100,000 of adjusted gross income (AGI) a taxpayer has an unusually large charitable contribution deduction, such as $10,000, the return would likely be flagged for examination.

The chart below shows the FY 2016 audit rate per income level for individual taxpayers. The highest audit percentages are at adjusted gross income (AGI) levels above $1 million, ranging from 4.60% for taxpayers with between $1 million and $5 million in AGI, up to 18.79% for taxpayers with AGI of $10 million or more. Interestingly, however, you also see a slightly higher-than-average audit rate for taxpayers with between $1-$25,000 in AGI. This is because taxpayers in that income level frequently claim the Earned Income Tax Credit, which has become a major IRS audit target in recent years.

Table 9b: Examination Coverage: Individual Income Tax Returns Examined, by Size of Adjusted Gross Income, Fiscal Year 2016

Examination Coverage table

Has the Audit Rate Reached Bottom?

Forty-three percent of the IRS’s current appropriated budget of $11.2 billion is allocated to enforcement, according to the National Taxpayer Advocate. The IRS has over 3,000 revenue officers who conduct field collection activities and over 8,800 revenue agents who conduct field audit activities. While this may seem high, the IRS’s budget has been cut more than $1.2 billion since 2010, and President Trump has proposed another $239 million dollar reduction for the next fiscal year in his FY 2018 budget blueprint.

What is driving the IRS budget cuts? “Several incidents over the last few years have reduced the confidence of many Members of Congress in the leadership of the IRS. Largely as a result of that reduced confidence, Congress has cut the IRS budget to the point where the agency is now struggling to meet taxpayer needs.” This assessment was made by National Taxpayer Advocate Nina Olson in testimony before Congress in March 2017.

So, have we seen the audit rate hit bottom? It appears that with the new Trump Administration’s efforts to contract the size of the federal government and with a Republican majority in both Houses of Congress, the IRS’s enforcement efforts will continue to decline.

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