Senate Democrats on Sunday passed a massive spending package dubbed the “Cut Inflation Act” that is now on its way to the House for a vote, including nearly $80 billion in Internal Revenue Service (IRS) funding.
According to a Congressional Research Service (CRS) report, more than half of that $45.6 billion will be allocated to “tax enforcement activities such as hiring additional law enforcement agents, providing legal support, and investing in technology to investigations.”
Closing the “tax gap”
The Treasury Department says the IRS will seek to hire an additional 87,000 agents with the ultimate goal of closing the “tax gap” in unpaid federal taxes, currently valued at $381 billion a year.
An $80 billion investment in the IRS is expected to return an additional $204 billion in revenue through 2031, and opponents of the bill have raised the question of whether low- and middle-income Americans can be audited.
Is the middle class the target of an IRS audit?
IRS Commissioner Charles Rettig noted in a recent letter to the Senate that the additional funding “has absolutely nothing to do with increased audit scrutiny of small businesses or middle-income Americans.”
Critics argue that historically this has not happened. Although the overall number of audits has decreased since 2015, they have disproportionately benefited those with high incomes.
According to the 2021 report of the Inspector General of the Treasury for Tax Administration, the total number of inspections decreased by 44% between 2015 and 2019. But the number of inspections of high-income taxpayers fell significantly more than those of low-income taxpayers.
While for individuals reporting taxable income of $1 million or more, the audit rate dropped by 75% between 2015 and 2019, low-income Americans who received the Earned Income Tax Credit (EITC) were audited only 33% lower over the same period.
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How will an IRS audit change with an $80 billion cash injection?
Another problem is related to the huge scale and scope of funding. How to effectively allocate $80 billion and hire 87,000 new agents without increasing the chance of audit errors?
In an interview with CNBC, Lawrence Levy, CEO of tax firm Levy and Associates, noted that “new auditors can go through a six-month training program and get cases worth several hundred thousand dollars, not tens of millions. You’re not going to give a new intern to General Motors, for example. It just won’t happen.”
If true, this information suggests that audits of low-income Americans will grow at a much faster rate than audits of higher-income individuals and corporations.
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Common audit triggers and how you can prepare
Regardless of the potentially increased focus on IRS inspections and enforcement, there are things you can do to reduce the risk of an inspection or be prepared in the event of an inspection.
Some common audit triggers include unrecorded income that does not fit a W-2 or 1099 form, large cash deposits, and disproportionate itemized deductions for your income level.
The IRS makes sure tax returns don’t look “normal”. For example, if you made $50,000 and donated $40,000 to charity, this could be a wake up call for IRS auditors.
One audit trigger that will continue to bother many middle-class Americans is self-employment. Whether it means a part-time job that generates additional income or a full-time business with employees, the complexities of the tax code mean that there is a higher chance that taxpayers reporting self-employment income have made a mistake and are therefore more likely to be subject to scrutiny.
Levy notes that even in the case of an audit, “one of the best ways to avoid headaches in the future is to keep accurate records with detailed accounting records and keep all receipts.”
Andrew Herrig is the founder of Wealthy Nickel, where he writes about personal finance, jobs and entrepreneurship. As an avid real estate investor and owner of several businesses, he has a passion for helping others create wealth and shares his family’s experiences on his blog. Andrew’s advisory board has been featured on CNBC, Entrepreneur, Fox News, MSN and more.