Audit rates for those making less than $400,000 annually hit historically low levels in 2018 and will be used as the benchmark for maximum audit rates for that group “for at least several years,” IRS Commissioner Daniel Werfel said.
Werfel made the pledge April 19 at a Senate Finance Committee hearing after he and Treasury Secretary Janet Yellen were criticized by Republicans for not defining previous promises that future audit rates wouldn’t exceed “historic rates” for lower-income filers.
In his first appearance before the committee since his February 15 confirmation hearing, the new commissioner also pointed to improved telephone responses by the agency during the filing season, emphasized the need for a confirmed chief counsel, and addressed the agency’s efforts to clear a backlog of claims for the employee retention credit.
Republicans worry that the $79 billion in Inflation Reduction Act (P.L. 117-169) funds the agency received, more than half of which is earmarked for enforcement, will lead to much higher audit rates for small businesses. Democrats insist that the funds will be used to hire accountants, lawyers, data scientists, and others to help the outgunned IRS even the playing field with well-represented corporations, partnerships, and high-income individuals.
The IRS breaks down audit rates by income, but the closest figures available for the sub-$400,000 income group are for those reporting incomes of less than $500,000, which Werfel said could be used as “a proxy” for now. According to data released April 14, 1 in 301 filers in that group was audited in 2018 — far fewer than the 1 in 222 for 2017 returns. Before a long period of flat budgets, the audit rate for the group was 1 in 116 for 2011 filings.
The IRS will work to provide clarity on what the sub-$400,000 audit rates are, Werfel said. “We’ll revisit that in a few years and see where we are,” he told reporters after the hearing. “But even if we started to move and ramp [up audits] in that area, it would take years to get to any historical average because of how low 2018 is.”
Finance Committee ranking member Mike Crapo, R-Idaho, said in a statement that “it is encouraging” that Werfel defined the standard. “It is also important to remember the pledge is an unenforceable promise by an administration that might not be around in two years, while the $80 billion IRA funding lasts for 10 years,” he added.
Werfel noted that the IRS has just 2,600 enforcement personnel responsible for covering 390,000 high-income individuals, corporations, and complex partnerships whose returns can be 100,000 pages or more. It will be this group that receives the initial enforcement focus, he said.
Werfel also said that since the April 5 release of the IRS’s strategic operating plan on spending its newly assigned funds, the agency has provided a raft of information to the taxwriting and appropriations committees. That includes a more precise version of the three-year hiring plan and a 10-year look at spending.
The committee later released an IRS-provided compendium of plans for the Inflation Reduction Act-provided funds and estimates of full-time employment.
‘Victory Lap’
Before 2019, the IRS annually published audit rates broken down by income groups, but then it switched to the system it now uses that collects data over three years. The data for 2018 returns include audits closed or in process during 2019, 2020, and 2021.
Despite worries that more enforcement dollars will lead to more audits on small businesses, more than half of the 504,097 audits of 2018 returns that the IRS reported undertaking among those making less than $500,000 per year were conducted on filers making less than $25,000 per year. Audit rates for low-income filers are high because of what the IRS reports are high error and fraud rates on returns claiming the earned income tax credit.
“I just wanted people to realize that small businesses around the country — mom-and-pop shops, clothing stores, auto repair shops — they have nothing to fear in terms of a wave of new audits coming,” Werfel told reporters. “It’s just not coming.”
Senate Finance Committee member Steve Daines, R-Mont., criticized Werfel for taking a “victory lap” for the agency’s improved customer service during the past season, noting the use of the “highly misleading” level-of-service metric used by the IRS, which has come in for criticism recently.
But Werfel noted that the same metric that earned the agency an avalanche of criticism for answering just 15 percent of its phone calls in the 2022 filing season measured an 87 percent answer rate for the just-concluded 2023 season. The average wait time of 27 minutes last year was cut to four minutes this year, he said.
“It’s absolutely critical for the American people to understand that when we are funded at the right level, then we can be there to answer the call — that they don’t have to wait for 25, 30 minutes on the phone wondering if they’re ever going to get through,” Werfel responded to Daines. “That’s why we want to celebrate this.”
Finance Committee Chair Ron Wyden, D-Ore., said the funding increase that Democrats passed for the IRS called for improvements in service, and that has been met with the “smoothest filing season in many years.”
Now it’s time to move on to the second reason for the increased funding, Wyden said. “Looking ahead, at the top of our agenda needs to be reducing the tax gap. This is money that is owed to American taxpayers,” he said.
The IRS’s official figure for the tax gap is $540 billion per year, but Wyden noted that former IRS Commissioner Charles Rettig said the shortfall could actually be as large as $1 trillion per year. “These estimates are so far apart because sophisticated, wealthy tax cheats excel at hiding in the shadows,” he said.
‘We Need a Nomination’
Werfel also told the committee about the problems associated with not having an IRS chief counsel and efforts to reduce the backlog of ERC claims.
The IRS has gone 27 months without a chief counsel, the agency’s top lawyer. Werfel called the position “absolutely critical” and said he hopes that the Biden administration nominates someone for it soon. There are only two positions at the IRS that must be confirmed by the Senate — Werfel’s and the chief counsel’s.
“It’s really important that we have a chief lawyer at the IRS. . . . Every one of these issues actually has complicated legal elements,” Werfel said, using the recent flap over the deductibility of state inflation relief payments as an example. “We have to work with other Senate-confirmed general counsels across government; not having a Senate-confirmed general counsel is an impediment.”
“We need a nomination,” Wyden agreed.
Finance Committee member Mark R. Warner, D-Va., said he was hearing complaints from Virginia businesses about the backlog for ERCs.
While Werfel didn’t quantify the backlog, he said he hopes that the IRS can process 40,000 ERC filings per week — double what the agency has been accomplishing. “Now that filing season has ended . . . we can redeploy people off the phones,” he said.
Making the task more difficult is that the claims are paper-based, frequently amended, span multiple years, and have a high potential for fraud, Werfel said.
Werfel also told the committee that a feasibility study on creating a free electronic filing system for taxpayers is “on track” to be completed by mid-May and that he would provide by the committee’s May 9 deadline the IRS’s response to a study that found that Black taxpayers were disproportionately audited.