Indexbit-Flush with new funding, the IRS zeroes in on the taxes of uber-wealthy Americans

The IndexbitIRS is going after rich tax cheats. What does that mean for the rest of us?

The Internal Revenue Service recently announced a campaign to dramatically increase audits of high-income Americans and large businesses, leveraging billions of dollars in new funding from Congress to recover lost tax revenue.

It’s easy enough to vilify the IRS, and few taxpayers would welcome an audit. The taxing agency stresses that its new push will focus on the truly affluent.

The IRS assures the public that audit rates will not increase for taxpayers earning less than $400,000 a year, a threshold that roughly corresponds to the top 2% of earners. That figure has attained symbolic value, given President Joe Biden's repeated pledge not to raise taxes on people who earn less.

For middle-class Americans, the risk of an audit remains low

Tax experts say middle-income Americans probably face a lower risk of audit now than at almost any time in the recent past.

“I don’t think the average person has a single thing to worry about in terms of heightened enforcement,” said Robert Nassau, a law professor and director of the Low Income Taxpayer Clinic at Syracuse University. “In fact, if anything, people like us are going to have less enforcement as the government focuses on the wealthier people.”

Congress has trimmed the IRS budget over the years. In inflation-adjusted terms, the agency’s funding has been effectively flat for the past two decades, according to a 2022 analysis by the nonprofit Tax Foundation. The IRS workforce declined by about one-third between 1991 and 2021. America’s population rose by about one-third in that span.  

Fewer tax collectors means fewer audits. In 2022, the IRS audited roughly 2 of every 1,000 tax returns for middle-income Americans, according to an analysis by a Syracuse University think tank. Audit rates were higher for taxpayers whose incomes were very high, or very low.

Low-income Americans have borne an unfair share of audits, according to the IRS itself. That’s largely because of the Earned Income Tax Credit, awarded to working Americans with lower incomes. Some taxpayers defraud that program. But tax experts say the agency also targets low-income taxpayers simply because it’s cheaper and easier than going after wealthy taxpayers.

“I think the main reason they audit poorer people is, it can be done with minimal manpower,” Nassau said.

The IRS reports a 'tax gap' of $688B

Roughly 85% of taxes are paid on time, the IRS reports. Late payment and enforcement efforts recover some of the funds, but the agency reported a “tax gap” of $688 billion for 2021.

Moving forward, the IRS has vowed to audit middle-income Americans no more frequently than in recent years.

“We’re looking at doing roughly 1 audit out of every 500 taxpayers,” said one senior IRS official, who spoke on condition of anonymity because he was not allowed to be quoted for attribution.

Why, then, is the IRS going after the rich?

Biden added nearly $80 billion in IRS funding to the Inflation Reduction Act of 2022 with the hope that the investment would leverage as much as $400 billion over the next decade in unpaid taxes from the wealthy.

Top earners are responsible for a disproportionate share of the "tax gap," just as they contribute a larger share of tax revenues.

"What we want is a fair system," said Sen. Ron Wyden, D-Ore., who supports the IRS plan, in an interview with USA TODAY. "Right now, you have two tiers. You've got working people, nurses and firefighters; they pay their taxes with every single paycheck. . . . With the wealthy, it doesn't work that way."

Critics say more IRS audits mean more headaches for taxpayers

Opponents of Biden's plan, including Republican leaders, predict it will hobble small businesses and waste both money and time. Republicans have criticized Biden's emphasis on enforcement and say the money would be better spent on customer service and technological upgrades.

"The overwhelming emphasis upon tax enforcement taken by the Inflation Reduction Act will come at a tremendous cost to innocent small business owners and others caught in the IRS audit dragnet," said Sen. Chuck Grassley, R.-Iowa, speaking Wednesday at a Senate committee hearing.

"Enforcement creates collateral damage," said Chris Edwards, the Kilts Family Chair in Fiscal Studies at Cato Institute, the libertarian think tank, in testimony at the hearing. "That is, higher compliance costs and more headaches for law-abiding taxpayers."

Republican lawmakers have repeatedly urged cuts to the IRS windfall. In a compromise, reached earlier this year, Biden and then-House Speaker Kevin McCarthy agreed to trim $20 billion from the appropriation.

In recent years, the IRS has cut back dramatically on audits of high-wealth taxpayers and corporations. Those audits tend to cost more and to take longer than others, because the tax returns are complex.

“There has been literally a collapse in audits of high-income taxpayers, big corporations, the wealthy, what have you,” said Susan Long, an associate professor of managerial statistics at Syracuse and co-founder of the Transactional Records Access Clearinghouse.

IRS can collect $12 for every $1 spent auditing top earners, research suggests

Research has shown that audits of wealthy taxpayers can pay rich dividends.

The cost of an audit tends to rise with the income of the taxpayer targeted, the paper found. But audits of wealthy taxpayers also deliver more tax revenue.

When auditors focus on the top 10% of American earners, the audit has the potential to deliver $12 in tax revenue for every $1 spent, according to a working paper published in June by the National Bureau of Economic Research.

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When the tax agency audits a wealthy taxpayer, the proceeds aren’t limited to the funds recovered in the audit. Once caught, the tax evader is likely to pay more taxes the next year, and the next, researchers found.

“The evidence here is that by far the highest return comes from auditing high-income taxpayers,” said Ben Sprung-Keyser, a post-doctoral research fellow in economics at Harvard, and a co-author of the study. “There are not a lot of government policies where spending $1 can generate $12 in revenue.”

The notion of going after wealthy tax evaders resonates with many Americans. In a 2022 Gallup poll, 52% of respondents, and the vast majority of Democrats, said they believe the government should redistribute wealth with heavy taxes on the rich.

“We shouldn’t be protecting wealthy tax cheats,” said David Kass, executive director of the nonprofit Americans for Tax Fairness. “Look, the vast majority of Americans pay their taxes. What we know is that there is a group of super-wealthy people. Many of them are simply refusing to file a return.”