William Stromsem, CPA, J.D., George Washington University School of Business
Increased IRS Audits on Higher-Income Returns
TXCPA supported increased IRS funding for taxpayer services and systems modernization, and some additional money for compliance. Our clients generally comply with the tax law at a high level and believe everyone should pay their fair share through well-targeted compliance efforts. However, the Inflation Reduction Act of 2022 provided $80 billion for increased funding, with $45 billion of the added funds scheduled to go for increased enforcement activities heavily focused on higher-income individuals only. To counter political claims that everyone would face more audits from 87,000 new IRS employees, Treasury Secretary Janet Yellen said that the historical audit rate would not change for those with incomes under $400,000. President Biden also used this threshold in promising that his proposed tax increases would not affect those with incomes below that level. Even so, the high level of funding for a limited number of taxpayers will cause many of our clients to be unfairly swept up in this audit boom.
Divisive Rhetoric
Rhetoric around the $400,000 threshold has been divisive; higher-income taxpayers are sometimes being characterized as tax cheats who use tax professionals and sophisticated financial devices to avoid paying their fair share of taxes and causing average working families to bear a greater tax burden. Chairman of the Senate Finance Committee Ron Wyden criticized Republican House members who wanted to cut the IRS budget, saying that they, “want to allow wealthy tax cheats to continue business as usual, paying little to no tax and asking middle class taxpayers to foot the bill.” Richard E. Neal, ranking minority member of the House Ways and Means Committee, said, “The IRS’ new operating plan fulfills an Inflation Reduction Act goal by eliminating the two-tiered tax system that has allowed the wealthy and well connected to play by one set of rules and everyone else by another.”
IR-2023-148 (Aug. 16, 2023) stated that the IRS is “…working to ensure high-income filers pay the taxes they owe. Prior to the Inflation Reduction Act… budget cuts prevented the IRS from keeping pace with the increasingly complicated set of tools that the wealthiest taxpayers use to hide their income and evade paying their share.” President Biden said, “No billionaire should be paying a lower tax rate than a schoolteacher or a firefighter. I mean it.”
With similar disingenuity, lower-income taxpayers might be disparaged, claiming that they cheat more because they cannot afford to pay taxes and they only expect to get audited, on average, about every 200 years. It could be claimed that there are more tax cheats in lower tax brackets simply because there are more taxpayers in that category—this is the same type of flawed logic that claims that higher income taxpayers underpay more tax dollars but only because they have more income. Yet, while the IRS stepped up enforcement efforts for high-income taxpayers, lower-income returns that claim the earned income tax credit will be scrutinized less despite having an IRS-estimated error rate of approximately 25% and improper EITC payments of $18.4 billion in 2018 according to the National Taxpayer Advocate.
But these characterizations on both sides are unfair and counterproductive, dividing us unnecessarily for what often seem to be political reasons.
Higher Income Taxpayers Pay the Greatest Share of Our Income Taxes
The idea that wealthy taxpayers are not paying their fair share is not supported by the facts. From 2020 statistics of income, the highest earning 1% of taxpayers pay 42.31% of federal individual income taxes and the highest-earning 10% of taxpayers pay 73.67%, while the bottom 50% of earners pay just 2.32% of federal income taxes. These relative burdens are determined by Congress using its political judgment to represent constituents and to serve the nation’s economy. It is clear that most higher-income individuals correctly pay the greatest share of our income tax revenue.
Equal Honesty
There is no evidence to claim that higher-income taxpayers are less honest than lower-income taxpayers. Higher-income taxpayers often use tax professionals to help them take advantage of tax incentives that Congress has provided, but this is not cheating. In Helvering v. Gregory (69 F.2d 809 (2d Cir. 1934)), Judge Learned Hand said, “There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands.” Clearly, there are some high-income taxpayers who go beyond tax avoidance, but there are also some lower-earning taxpayers who do not pay their fair share, for example, by working more in the cash economy.
A Fairer Case for Higher Income Audits
Finger-pointing about dishonesty is unnecessary on both sides. If taxpayers at all levels have the same propensity to be honest (or dishonest), then there is no point in castigating one group or another. The political rhetoric should be calmed, and the higher-income return audits should be justified using more honest and less inflammatory terms. Proponents should simply state that they are focusing on raising revenues and that higher-income audits are more cost-effective because they report the most income and are taxed at higher marginal rates. If increased audit credibility raises the level of compliance by 10%, this would only bring in about .25% in increased revenue for returns for the bottom half of income earners but would bring in over 7% (28 times as much revenue) from returns with the top 10th of reported incomes. (This assumes that the current audit rates do not really encourage compliance.)
Justifying higher-income audits based on supposed greed and dishonesty is unfair and is counterproductive by providing a possible rationalization to tempt others to cheat. Disparaging rhetoric is unnecessary and divisive, and we would all benefit from more civil dialogs and less rancor in discussing important national issues.