The Distribution of IRS Enforcement Activity Funded by the Inflation Reduction Act of 2022

INSIGHTi

The Distribution of IRS Enforcement Activity
Funded by the Inflation Reduction Act of 2022
September 6, 2022
P.L. 117-169, commonly referred to as the Inflation Reduction Act of 2022 (IRA 2022), provides $79.6
billion to the Internal Revenue Service (IRS) and related agencies through FY2031, which is intended to
supplement normal annual appropriations. Of that amount, the law dedicates $45.6 billion to bolstering
enforcement activities. This funding represents a 69% increase over the amount of funding the
Congressional Budget Office (CBO) estimated the IRS would receive for enforcement through annual
appropriations for fiscal years 2022-2031. (For more information, see CRS Insight IN11977, IRS-Related
Funding in the Inflation Reduction Act.)
On August 10, Secretary of the Treasury Janet Yellen directed the IRS not to use any of these additional
resources “to increase the share of small business or households below the $400,000 threshold that are
audited relative to historical levels.” Under such a policy, the share of tax returns subject to audits—also
called “examinations”—would not rise “relative to historical levels” for 98-99% of individual income tax
filers.
The Tax Gap
Audits are meant to ensure compliance with the tax code. The IRS estimated that the average annual
unpaid tax burden from 2011 to 2013 (the most recent estimate)—also known as the “tax gap”—was $381
billion, or 14.2% of the true total tax liability, after accounting for enforcement activity and other late
payments. That sum includes $271 billion in individual income taxes, $77 billion in employment taxes,
$32 billion in corporate income taxes, and $1 billion in estate taxes.
About 80% of the gross tax gap (before enforcement and late payments) results from misreporting
income. The IRS estimates that about 1% of income subject to substantial information reporting and
withholding is misreported to the IRS. This category includes wage and salary income, as employers
withhold taxes from workers’ paychecks and report workers’ earnings to the IRS. In contrast, filers
misreport about 55% of income that is not subject to withholding or third-party reporting, such as
earnings from sole proprietorships, rents, and royalties. Academic research suggests that high-income
taxpayers misreport more of their income than lower-income filers, but data limitations make such
estimates highly uncertain.
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Trends in Audit Rates
In FY2019—the last fiscal year prior to the COVID-19 pandemic—the IRS spent 28% less in inflation-
adjusted dollars on enforcing the tax code than it had in FY2010. It also employed 34% fewer
enforcement staffers, measured in full-time equivalents. (Between FY2019 and FY2021, inflation-
adjusted enforcement spending rose by 3% and staffing by 5%.)
The Government Accountability Office (GAO) determined that the share of individual income tax filers
who faced audits fell from 0.9% in calendar year 2010 to 0.25% in 2019, which the IRS attributes to the
decline in funding and staffing. Audit rates declined for filers of all income levels. However, the
likelihood of an audit fell by 86% for those with positive income over $500,000, 61% for households with
income below $25,000, and 58% for filers who claimed the Earned Income Tax Credit (EITC). The
likelihood of facing an audit still generally rose with income after these changes, except that
predominantly low-income EITC claimants faced a higher audit rate in 2019 (0.77%) than filers with
$500,000-$1 million in positive income (0.53%).
GAO found that the revenue raised per work-hour of an audit is lower for most high earners than it is for
EITC recipients. This estimate accounts for the revenue collected and the cost of the audit itself, but not
for the cost of the collections process or the potential for audits to encourage voluntary compliance.
The IRS told GAO that audits of high-income filers are typically more complex than audits of lower
earners. The auditing process for higher-income filers can also take longer, as they are more likely to
respond to requests for information than lower earners. Recommended tax bills resulting from audits of
high-income filers are often harder to collect and more likely to get abated than for other audits due to
their size.
Implementation of the $400,000 Threshold
One question that Secretary Yellen’s order poses is how to define the “historical level” of audit rates.
Since audit rates have fallen over the past decade, a range of rates could be considered a consistent
benchmark.
Another question is whether the $400,000 threshold applies to the amount a filer claims to have earned, or
the amount of “true” income the IRS concludes the filer earned after conducting enforcement activity. If
taxpayers believe they are less likely to face an audit if they report an income below $400,000, they may
have a stronger incentive to do so. However, the IRS could inadvertently fail to comply with this directive
if it audits more people reporting less than $400,000 in income and finds less underreporting than
expected.
The IRS may struggle to quickly hire and train specialized agents to audit high-income taxpayers. CBO
lowered its estimate of the revenue that enforcement spending in IRA 2022 will raise through FY2031
from $204 billion to $180 billion to account for the Secretary’s directive and the removal of IRS hiring
flexibilities from the law before its passage. The interaction between these two changes had a larger
revenue effect than either did individually.
Other Potential Effects on Filers Below the Threshold
Even if the IRS does not increase the rate of audits against those earning less than $400,000, it could
increase the amount of nonaudit enforcement actions it performs. These actions include correcting math
errors and verifying that filings are timely and match income reported to the IRS by third parties.
Officials have suggested that other funding included in IRA 2022 could make the IRS less likely to audit
compliant taxpayers earning under $400,000 per year. IRS Commissioner Charles Rettig recently claimed

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that funds in the law for taxpayer services and information technology (IT) will help taxpayers comply
with the tax code voluntarily, presumably by helping the agency answer taxpayers’ questions before
filing. Secretary Yellen also suggested investments in the IRS’s IT could improve the targeting of audits,
making compliant taxpayers less likely to face an examination.

Author Information

Brendan McDermott

Analyst in Public Finance




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