The traditional IRS audit is becoming increasingly rare. However, this isn’t the whole story and taxpayers should not come to the conclusion that they now have a blank check to cheat on their taxes.
The latest IRS audit statistics paint a fairly grim picture. 2017 marked the sixth year in a row that audit rates declined. The statistics show that the 2017 IRS audit rate for individual tax returns was 0.6%. This means that only one out of every 167 individual returns were audited. That amounted to 934,000 unlucky taxpayers who were audited—the smallest number since 2003.
Moreover, 71% of these audits were correspondence audits in which the IRS sends the taxpayer a postal letter asking about one or two issues, not more thorough IRS field and office audits in which the taxpayer comes into the IRS office to have his or her whole return examined.
Audits rates have declined because Congress has been cutting the IRS budget for years. The IRS has lost about 20,000 full-time workers since 2010, including about one-third of its compliance staff who audit tax returns.
However, the low reported IRS rates are a bit deceiving. There are two reasons for this:
Certain types of taxpayers get audited far more than average. This is because the IRS knows they are more likely than average to underpay their taxes. The self-employed are among the biggest IRS audit targets. In 2017, the IRS audited 2.1% of Schedule C filers earning $100,000 to $200,000, and 1.3% of those earning $25,000 to $100,000. Even self-employed people who earned less than $25,000 were audited more than average—0.9%. These relatively high audit rates for the self-employed reflect the IRS’s belief—backed-up by much hard evidence—that such taxpayers habitually underreport their income, pad their deductions, or take deductions to which they are not entitled.
As you would expect, high income taxpayers also get audited more than average. Individuals with incomes between $200,000 and $1 million who didn’t file Schedule C had a 0.8% audit rate in 2017. Taxpayers with incomes of $1 million or more had a 4.4% audit rate, down from 5.83% in 2016.
In addition, traditional audits are not the entire IRS enforcement story. The IRS conducts many types of compliance activities that it does not count as traditional audits or include in its audit statistics. During 2016, it contacted almost 8.2 million taxpayers for the following reasons:
Math or clerical error checks.The IRS checks all returns for math and clerical errors. It assesses additional (or less) tax where an error resulted in the incorrect amount of tax being paid.
Automated Underreporter Program. The IRS’s Automated Underreporter Program matches the information on Forms W-2 and 1099 filed by third party payers such as employers, brokers, banks, and businesses that hire independent contractors with the amounts listed on taxpayers' tax returns. If a taxpayer fails to report income listed on one of these forms, the IRS will assess additional taxes or ask for an explanation.
IRS Programs Stop Identity Theft and Refund Fraud. The IRS has an elaborate and complex return integrity program intended to address identity theft and detect and prevent improper fraudulent refunds. The IRS uses filters, data mining models, and manual reviews to identify potentially false returns and stop fraudulent refunds before they’re paid. Returns also go through the Taxpayer Protection Program (TPP), which verifies the identity of the taxpayer.
Automated Substitute for Return program. This IRS program targets individuals who owe substantial taxes but who fail to file tax returns. The IRS estimates how much tax, penalties, and interest such individuals owe and attempts to collect it through correspondence. If this is unsuccessful, the IRS can prepare a substitute return for the taxpayer.
If all these compliance checks were counted as audits, the audit rate would be 6.2%, not 0.6%, a big difference. By only reporting traditional audits, the IRS is masking the true extent of its compliance activities, which touch millions more tax returns each year.