William R. Stromsem, CPA, J.D., Assistant Professor, George Washington University
While volunteering at a low-income taxpayer clinic, I observed a client whose prior-year return had been completed by a commercial preparer. When we refused to include her claim of 21,000 business miles for which she had no records and for a job that seemed unlikely to generate this mileage (occasional catering server working almost entirely in one city), she was indignant. She said she would go back to her old preparer who understood how the system works. When we cautioned her about penalties, she said that everyone does this and at low income levels, no one ever gets audited. Clients at all income levels can be tempted to play the audit lottery and with lower audit rates, the game is getting better for the players!
Number of Audits Declines Again
On May 18, the IRS released its Data Book containing information about audits conducted in 2018 and again the IRS’ audit credibility has to be considered. Of the approximately 150 million individual returns filed in 2017, the IRS audited just under 900,000 in 2018 for an average of .6%. Or, looked at another way, the average individual filer should expect to be audited only once every 167 years. This does not include CP-2000 notices for math errors or matching problems. Most of the audits (74.6%) were correspondence audits, which generally cover a very limited set of issues. The Data Book does not include information about civil and criminal penalties resulting from audits, but these have always been statistically low and provide little deterrence from playing the lottery.
For high-income individuals with adjusted gross income over $10 million, there is a 6.66% chance of being audited, and for those with income of under $25,000, it is .69%, raised somewhat by returns that claim an Earned Income Tax Credit (EITC), where the audit rate is 1.4% because of the complexity of the credit and IRS concern about fraud. In between the high and low, the audit coverage doesn’t exceed .53% until income rises to $500,000. It then goes to 1.1% for incomes from $500,000 and up to $1 million and jumps to 2.21% for incomes from $1 million to $5 million. Depending on level of income, taxpayers who filed a Schedule C had between .9% and 2.4% rate of audit. There are a variety of other factors analyzed in the links below.
Audit rates are embarrassingly low. C corporations had an average audit rate of .9%, although corporations with assets of $5 million or more had a much higher audit rate, from 4.6% to 49.3% depending on level of income. Average S corporation and partnership audits plunged to .2% in 2018, meaning that an average S corporation or partnership might expect to be audited approximately once every 500 years! (Note: this rate will likely increase with the new partnership audit rules.)
Tables in the Data Book cover specific issues:
Late in 2018, the IRS published the
Most taxpayers are honest, and this is basic to our self-assessment system of taxation. The Comprehensive Taxpayer Attitude Survey showed that 85% of Americans continue to say that it is not at all acceptable to cheat on taxes. However, for those who might be tempted, the IRS needs to have a credible audit potential, and we see this being eroded year after year. CPAs have a great stake in maintaining a credible audit potential. To the extent that we ask our clients to follow the law, they may be paying a disproportionate share of taxes. If clients perceive us as requiring a higher level of compliance, they may at some point prefer to self-prepare or go to a return preparer who is less competent (or ethical). If audits are reduced, our representation and controversy work is also reduced.