A watchdog report casts serious doubt on the ability of the Internal Revenue Service (IRS) to make good on its pledge to focus its tax enforcement efforts on high-income tax evaders but not increase audit rates on Americans earning under $400,000 because IRS enforcers are still using an outdated $200,000 high-income threshold as their default.
The Treasury Inspector General for Tax Administration (TIGTA), which is the watchdog overseeing the IRS, recently carried out a review to assess the IRS’s strategy to train employees hired specifically to audit high earners and big businesses that underreport income.
The tax agency’s new hires come on the back of a recent $80 billion IRS funding boost, which Republicans warned would be used to increase audits on working-class Americans, even though Treasury Secretary Janet Yellen vowed that the IRS wouldn’t increase tax audit rates above historical levels on people earning less than $400,000.
Following the review, the watchdog issued a report titled, “The IRS Needs to Leverage the Most Effective Training for Revenue Agents Examining High-Income Taxpayers.”
The report’s headline recommendation (one of six) is that the IRS should leverage the know-how built up in its Large Business and International (LB&I) division to train newly hired revenue agents on examining high-income taxpayers.
But behind the relatively innocuous-sounding title of the report (and its rather anodyne headline recommendation) is a scathing criticism of the IRS for lacking a clear definition of “high-income” earners—despite the very same watchdog asking the IRS to look into developing one years ago.
No Clear Definition of ‘High-Income’
The TIGTA faulted the IRS for still not having a clear definition of “high-income” for tax compliance efforts even after the watchdog recommended in 2015 that the IRS reevaluate the appropriate income thresholds for its high-income and high-wealth strategy.“The high-income terminology is being used loosely inside the IRS with no common understanding of what the term means,” the watchdog said.
One of the watchdog’s recommendations was for the IRS to establish a definition for high-income taxpayers for examination compliance purposes and that, “at a minimum, the IRS should accept the Treasury secretary’s $400,000 directive as the new high-income floor on which IRS leadership can focus enforcement efforts.”
The IRS disagreed with the watchdog’s recommendation. It asserted in a statement included in the TIGTA report that a “static and overly proscriptive” definition of high-income taxpayers for audit purposes “would serve to deprive the IRS of the agility to address emerging issues and trends.”
The watchdog commented on the IRS' pushback, saying that the definition need not be “static” and income thresholds should be adjusted based on economic and complexity factors—otherwise there’s a risk that the agency will break its pledge not to audit more Americans earnings less than $400,000.
“When the high-income thresholds are set too low, the result can be higher numbers of inefficient examinations,” the watchdog said. “When the definition is too low, the base of taxpayers earning those incomes is wider so that the IRS does many more audits in that category in order to achieve desired audit coverage.”
The watchdog said that, under the circumstances of a lack of a clear definition of “high-income,” the IRS would not only be conducting more audits on lower-earning Americans (contrary to its pledge not to) but it would also be less effective at its stated goal of closing the tax gap.
That’s because audits of lower-income taxpayers “are less productive because there is less opportunity for tax avoidance at lower incomes.”
The Epoch Times asked the IRS for comment on the watchdog’s pushback to the tax agency’s rejection of its recommendation on adopting a definition of “high-income,” but the IRS merely pointed to its original justification already included in the report.
$200,000 Examination Code Threshold
The watchdog also found that the IRS continues to rely on old tax examination activity codes adopted half a century ago with the Tax Reform Act of 1976, which used a $200,000 threshold to measure high-income returns.“This amount is equivalent to more than $1 million in 2023, but the IRS still uses $200,000 as the default high-income threshold,” the watchdog said.
As part of its 150-page strategic operating plan, the IRS said it would deploy various cutting-edge technologies, including data analytics and artificial intelligence tools, to improve its understanding of the tax filings of high-income and high-wealth individuals and address potential tax noncompliance.
But the watchdog said that, besides lacking clear and consistent definitions around what constitutes “high-income,” the IRS continues to use $200,000 as the main threshold in its examination activity code schema “even though it is no longer a reasonable standard for high earners given inflation since 2005.”
Generally, the IRS uses the examination activity codes to plan the number of tax-related examinations, although since 2019 its LB&J division has been using a modified planning method based on resource allocation.
The watchdog said that in response to the TIGTA recommendation in 2017 to reevaluate its income thresholds, the IRS “made no changes,” citing “internal data analysis results and resource constraints.”
This lack of action puts the IRS in a difficult position if it hopes to meet its pledge not to raise audit rates above historical norms for Americans earnings less than $400,000.
“Because $400,000 will be an important threshold, the IRS needs to update the examination activities codes for individual tax returns,” the watchdog said.
Currently, “there is no way to identify the complete population of taxpayers that meet the criterion of $400,000 or more specified by the current Treasury Secretary,” the watchdog added.
The IRS partially agreed with the watchdog’s recommendation to refine its examination activity.
“The IRS agreed to identify the best method to identify and track high-income examinations as part of the work being undertaken to implement the Treasury Secretary’s directive to not increase audit rates for households making less than $400,000 and small businesses,” the IRS said in a statement included in the report.
But the watchdog said this isn’t good enough.
“The IRS’s partial agreement and planned corrective action will not satisfy the intent of our recommendation, and additional actions are needed,” TIGTA said in comment.
“The IRS should establish examination activity codes for additional TPI increments which will help the IRS identify noncompliance at different income levels,” the watchdog added. TPI stands for “taxpayer profile increment.”
Asked for comment on the watchdog’s rejection of the IRS’s response to its recommendation, the IRS simply pointed to its original response included in the report.
The watchdog report suggests that the lack of clear definitions of “high-income” and outdated examination codes undermine the IRS' ability to keep its promise not to raise audit rates on Americans earning over $400,000.
It comes as the IRS recently announced a major tax enforcement crackdown that will increase scrutiny on high-income earners.
A key focus of the new “sweeping, historic” initiative are individuals who report over $1 million in income and have over $250,000 in recognized tax debt.
