The nation's top tax man offers us shallow reassurance that 87,000 new Internal Revenue Service agents will refrain from targeting middle-class families and small businesses for audits.
Last week, IRS Commissioner Charles Rettig touted a directive by Treasury Secretary Janet Yellen promising to avoid an increase in audit levels for households earning less than $400,000 "relative to recent years." Yellen further directed that "any additional resources" given to the agency should not be used to increase these audit levels. Needless to say, a "directive" does not hold the force of law, nor do the empty intentions of the commissioner or secretary. But even holding them at their word, families and businesses have good reason to be concerned.
Audit rates are now lower relative to historical or recent years. Thus, audit rates for small businesses and middle-class families could increase without technically conflicting with the IRS and Treasury statements. In addition, even if the IRS abides by this nonlegally binding threshold of $400,000, more families will be ensnared each year due to inflation rapidly pushing their incomes (although not their purchasing power) over this threshold.
The commissioner also said that the agency’s 87,000 new hires will be focused primarily on "badly needed, meaningful service improvements at the IRS." Yet the legislation authorizing these hires stipulates that the funds be used to deliver a 69% increase in enforcement—as distinct from operations support, taxpayer services, and business systems modernization. Some of these new agents will be armed. Even if only 1% of the new hires join the IRS Criminal Investigation area (as claimed by the commissioner), this represents 870 new armed agents, a 41% increase over the current 2,100.
Of course, an agent doesn’t have to be armed to intimidate a family or small business owner. An audit by an unarmed agent can portend bankruptcy, emptied checking accounts, a freeze on assets, hundreds of hours of time responding, and tens of thousands of dollars in legal and accounting fees.
The threat stems from the stress caused by the increased possibility of an audit, the expense of an audit, and the difficulty of complying with a tax code so complex that five tax experts could provide five equally legitimate opinions on what is owed to Uncle Sam.
Historically, the majority of individual audits have targeted those with less than $75,000 in reported adjusted gross income. The total number of audits targeting S corps, sole proprietors, pass-through entities, and partnerships exceeds those targeting large C corps. Make no mistake, even if the suggested $400,000 threshold were to be observed, small businesses would incur a substantial audit risk. Many businesses with just a few employees take in more than $400,000—even if only a slim profit results due to tight margins.
For tech startups, $400,000 in net income is the norm, even for those with just two to four employees. And for small businesses generally, those with just six employees typically see annual profits near $400,000. An audit expense could easily eat through months' worth of revenue or net income in CPA and legal fees.
An audit is expensive, even if you have been paying all taxes owed and even if the IRS ends up refraining from hitting you with an additional bill. The fees for lawyers and accountants can easily exceed $20,000.
Rettig can coo about service improvements. But the IRS track record indicates that we're in for a big tax shakedown.
This piece originally appeared in the Washington Examiner