July 31, 2019
The overall percentage of federal income tax returns audited by the IRS has been decreasing over the past several years. This is at least partly due to budget cuts, which leave the IRS with fewer resources to conduct audits. People with particularly high incomes have reportedly seen a steeper decline in audit rates than other people, but they still get audited at a higher rate than the general U.S. population.
The apparent decline in IRS audits is definitely not cause to be less careful with one’s taxes, especially for high-income individuals. The Tax Cuts and Jobs Act (TCJA) of 2017 led to significant tax cuts for many people with high incomes, but it also created opportunities for tax write-offs that are likely to catch the IRS’s attention. It may take the IRS a few years to catch up to some of these new opportunities, but they almost certainly will.
Decline in Audit Rates
In 2017, the IRS audited one out of every 160 tax returns that were filed. This was the sixth year of decline in the total number of audits, and the lowest number in fifteen years. The audit rate for individuals with annual earnings of $1 million or more was higher than the rate for the general population, at more than four percent in 2017. That same group, however, was audited at a rate of almost ten percent in 2015. This is also the lowest rate since the early ‘00s.
A report by the Transactional Records Access Clearinghouse at Syracuse University confirmed a sharp decline in audits of people earning more than $1 million. It also noted that the IRS went from a workforce of about 100,000 in 2010 to 79,000 in 2018, a decrease of over twenty percent. Employment of IRS revenue agents, who conduct tax audits, declined by about thirty-five percent during that time.
Changes Made by the Tax Cuts and Jobs Act
The TCJA became law on December 22, 2017. It makes numerous important changes to individual income taxes, including modifying income tax brackets and lowering tax rates. The lowest tax bracket still covers annual income up to $9,525, and still has a ten percent rate. The law moves the highest bracket up to $500,000 and above and reduces its tax rate to thirty-seven percent. The TCJA also increases the standard deduction and family tax credits, while eliminating personal exemptions.
Certain forms of income from business and investment activities are subject to different tax treatment under the TCJA. This potentially gives taxpayers opportunities to save on their tax bill, but it could also give the IRS opportunities for audits. For example, the TCJA allows a new deduction of qualified income from pass-through business entities, such as a limited liability company or S corporation. The law also amends § 1031 of the Internal Revenue Code to eliminate the exemption of many “like-kind exchanges” from capital gains tax. The section now only applies to exchanges of real property.
IRS Audit Risks
The IRS uses several methods to select taxpayers to audit. These include computer algorithms that identify discrepancies between the information in a taxpayer’s return and information that the IRS already possesses. Random selection is also a factor. High-income individuals still have a higher likelihood of an audit than other taxpayers. Other factors include self-employment and a large number of deductions.
If you have tax-related questions in California, the tax advisors at the Enterprise Consultants Group are available to help you. Please contact us today online or at (800) 575-9284 to discuss your case.