The Future of IRS Audits: What to Expect Under the Inflation Reduction Act

Issue# 1117

The Future of IRS Audits: What to Expect Under the Inflation Reduction Act

As part of the recently passed Inflation Reduction Act, the IRS has been allocated $80 billion over the next ten years. Yes, billion with a “b”! About half of these funds will be used for enforcement. While the IRS has pledged not to use these funds to increase audits of small businesses and individuals making under $400,000 a year, we can expect overall audit rates to increase.

You might be wondering about your chances of being audited. Currently, audit numbers are at an all-time low. However, taxpayers whose returns deviate from the norm or contain "large, unusual, or questionable items" may still be singled out for audit. Statistics show that the IRS tends to audit taxpayers with certain characteristics.

Audit Likelihood

1. Individuals vs. Businesses:

• In 2017, the IRS reported a 1 in 184 (0.542%) chance of being audited for all taxpayers.

• For individual returns (Form 1040), the likelihood was 1 in 161 (0.623%).

• Corporations (C Corps and S Corps) and partnerships were audited less frequently, with an audit rate of 1 in 224 (0.445%).

2. Individual Returns:

• The IRS focuses its audit resources on areas where taxpayers have historically been non-compliant: international taxpayers, high-wealth taxpayers (gross income over $1 million), and sole proprietors or single-member LLCs grossing over $100,000.

• Traditional wage earners with traceable income reported on a W-2 face much less scrutiny. In 2017, taxpayers making under $200,000 who did not claim the Earned Income Tax Credit were the least likely to be audited, making up about 65% of all taxpayers.

3. Business & Specialty Returns:

• The IRS is more likely to audit large corporations with over $10 million in assets, estate tax returns, and excise tax returns.

• Trust income tax returns, S-Corps, and partnerships were the least likely to be audited.

Alternative IRS Review Methods

Audits are not the only way the IRS can question the accuracy of a tax return. In recent years, the IRS has increased their automated return checks through matching programs. One example is the automated under-reporter program, where the IRS matches income reported on tax returns with IRS information (W-2s, 1099s, etc.) to identify discrepancies. If there’s a mismatch, the IRS automatically sends a notice requesting additional information. You are over three times more likely to receive a notice from the IRS due to this program than an audit.

When combining the automatic matching program with the IRS audit rate for individuals, the chances of the IRS challenging an individual taxpayer’s return increase to 1 in 35 (2.857%).

Cost of an Audit

If you are audited, it is likely to be costly. IRS data shows that over 90% of individual audits result in a tax change. The average additional tax owed is over $6,000 for a mail/remote audit and nearly $22,000 for a more intensive IRS field audit.

Notices from the automatic matching program can also be costly. In 2017, the IRS collected $6.7 billion in additional tax from the 3.3 million matching notices it sent, averaging about $2,000 per notice.

In addition to the additional tax for audits and notices, there are accuracy penalties, which can add 20% to the tax bill.

How to Avoid an Audit

To avoid IRS scrutiny, most taxpayers should ensure that all wage and income documents (W-2s, 1099s, etc.) are accurately reported on their tax returns. Tax preparers cannot obtain IRS informational statements before the end of tax season, so they must rely on their clients to provide all applicable documents.

By ensuring complete and accurate reporting, you can reduce the likelihood of IRS scrutiny.

Disclaimer: This article is for informational purposes only and does not constitute financial, legal, or tax advice. It is always recommended to consult with a qualified professional or financial advisor to make decisions regarding your individual financial situation. The information provided in this article is based on the laws and regulations in effect as of 2023 and may be subject to change. Ahmad Yama Bassam, the author of this article, is the managing partner at A.Y. Bassam & Co. LLP, A Professional Tax, Accountancy, Business Advisory & Payment Solutions Firm, based in California.

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