Will IRS Audits Increase Due to the Inflation Reduction Act?
In case you aren’t looking to read further, the short answer is most likely. But what does that mean for you and your small business? For those looking to get a bit more information, here’s why. As many are aware, President Biden recently signed the Inflation Reduction Act into law. As part of the new law, $80 billion in funding is authorized for the IRS over the next ten years, with $45 billion of that earmarked for enforcement.
To put that into context, the next largest single line item was Operations support at $25.3 billion, followed by Business System Modernization at $4.75 billion and Taxpayer Services at $3.18 billion.
To avoid turning this blog into a political debate about votes along party lines, etc., I’m breaking it down into two parts. The first part is to provide some statistics and context behind the IRS and the current state of affairs. The second part will discuss the potential concerns of individuals and business owners.
IRS’s Current State of Affairs in 2022
Currently, the IRS has 8 million unprocessed returns from 2021. In addition, IRS statistics showed that of all phone calls to the IRS placed by taxpayers and professionals, only 11% were answered in 2021. Since 2010, there has been a 17% reduction in the IRS workforce, and the significant delays reflect this. Just think, perhaps you waited a bit longer for a refund, or perhaps are waiting to hear about a payment plan?
Now, we’ve all heard the stories of an “army of 87,000 IRS agents” being hired and some have gone so far as to say all of them will be armed. While the number may seem daunting, let’s provide some context. First and foremost, not all 87,000 agents are being assigned to enforcement. Furthermore, the IRS is anticipating it will lose between 50,000 to 80,000 workers over the next 5 years.
Essentially, the IRS is planning a strategy to replace its current workforce, not expand it drastically. On the surface, and according to the Treasury Department’s May 2021 report, these added agents are necessary to “rebuild and revitalize” the agency.
While the above provides some logic to the changes, let’s look at what this may potentially mean. According to the Government Accountability Office, between 2010 and 2019, audit rates for individuals dropped from 0.9% to 0.25%, with individuals making under $25,000 and individuals making over $200,000 receiving higher-than-normal scrutiny.
Additionally, it is estimated that there is currently a $600 billion tax gap, which is defined as the difference between what taxpayers owe and what they actually pay. Given that tax gap, and over 50% of the budget being allocated to enforcement, there should be no question that audits and other enforcement activities will increase over the next few years.
What an Increase in IRS Audits Means for You
Many Americans took some comfort when the Biden Administration suggested the increase in audits would not impact those making less than $400,000. However, the government failed to “put their money where their mouth is”, and when an amendment was proposed to include protection for those earning less than $400,000, it was voted down. Thus, everyone is fair game.
How do you protect yourself from getting audited by the IRS? If you still have concerns that you may fall under that less than 1% of taxpayers that are audited, it is important to protect yourself. First and foremost, maintain your records and report everything accurately. The IRS uses a mathematical approach to select audits and it is common for round figures to trigger this more than exact (ex: $500 for office supplies as opposed to the exact figure of $487). Understand what the IRS is targeting in any given year and educate yourself accordingly.
Currently, the IRS is cracking down on cryptocurrency and electronic payment platforms such as Venmo, PayPal, etc. Knowing how these items are being reviewed and how to report earnings from them properly can save you a major headache. Lastly, if you are unsure how to classify something or are uncomfortable, seek the help of a tax professional. The cost associated with these professionals is almost certainly less than the cost associated with an audit or other penalties and interest.
In summary, the addition of IRS staffing and the allocation of funds to the IRS seems to be status quo and shouldn’t in and of themselves create mass panic. But the simple fact is that the IRS has a need to increase its enforcement and now has the budget to support the same, so while we shouldn’t overreact, we shouldn’t be naïve either. Take extra precautions and protect yourself and small businesses.
Keith D. Hackenberg, JD, CAMS is the Chief Strategy Officer of Liberty Data, Inc., a world’s leading compliance data solution company supporting small and enterprise businesses. Prior to joining Liberty Data, Keith practiced as a corporate compliance and tax attorney representing both individuals and businesses before the IRS during audits and enforcement actions.