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Efforts to Address Equity and Efficiency in EITC Audits

In recent years, taxpayer audits by the Internal Revenue Service (IRS) have gained renewed attention due to funding and policy changes at the agency. The 2022 Inflation Reduction Act (IRA) allocated an additional $80 billion to the agency, partially for initiatives aimed at reducing the estimated $688 billion annual tax gap. Yet, how the IRS determines which taxpayers to audit and conducts those audits has implications for fairness and equity in tax enforcement.

While part of the IRS’s mission is to enforce the law with “integrity and fairness to all,” the unintended consequences of pursuing efficiency—primarily through focusing on simpler, electronic audits—can have an outsized impact on low-income tax filers. This has historically resulted in the agency disproportionately auditing claimants of the Earned Income Tax Credit (EITC), a tax credit designed to support low- and moderate-income workers by incentivizing workforce participation. These audits have significantly impacted people of color, especially Black filers, who are more likely than their white counterparts to claim the EITC. In recent correspondence to Congress, IRS Commissioner Daniel Werfel acknowledged this issue and announced that the agency would adjust resources to focus collection and compliance efforts on high-income taxpayers. This was also reflected in the IRS’s 2023 Strategic Operating Plan.

EITC Audits and Improper Payments

While higher-income taxpayers are more likely to be audited—those with incomes above $1 million face higher audit rates than all others earnings less— EITC claimants are audited at 5.5 times the rate of the rest of the population. This is due in part to its improper payment rate as well as efficiency factors:

  • The EITC’s improper payment rate has increased in recent years (from 24% in 2020 to 32% in 2022). Improper EITC payments are those received by people who are either ineligible for the credit or receive more than they should by law. Some improper claims are fraudulent, but many are honest mistakes by individuals confused by the EITC’s complicated eligibility rules.
  • The average audit of an EITC recipient can be closed in five hours. Meanwhile, high-income tax returns are far more complex to audit; for those with income over $10 million, an audit may take several years and require a live caseworker, thus decreasing the hourly return on investment.
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Source: TRAC, Syracuse University

Racial Disparities in EITC Audits

Audits can place a significant financial burden on individuals—especially low-income workers eligible to claim the EITC—given that their tax refunds are often frozen during the process. Furthermore, eligible individuals may be denied the EITC if they cannot navigate the complex audit process successfully. These adverse encounters can dissuade eligible EITC claimants, particularly those in vulnerable communities.

A 2023 Stanford University study assessed comprehensive microdata from the Treasury Department on approximately 148 million tax returns and 780,000 audits conducted between 2010 and 2018. It found that Black taxpayers are, in general, 2.9 to 4.7 times more likely to be audited than non-Black taxpayers.[1] Nearly 80% of the difference occurred due to Black EITC claimants being audited at higher rates than white EITC claimants. (Only 15% of the disparity was due to EITC claimants being audited at higher rates than non-EITC claimants.) These findings are significant given that the IRS does not use racial data in their audit selection methods.

Commissioner Werfel confirmed the initial findings of the study and reiterated that the IRS does not directly include race in its audit algorithms. The agency relies on modern machine learning methods to select taxpayers most likely to incorrectly report income. While this streamlines the process, critics warn that the audit algorithms in place could pose unintended consequences for marginalized groups. They emphasize that the algorithms prioritize underreported income over other factors that are less correlated with race, such as the extent of underreporting.

To meet its goal of enforcing the law with “integrity and fairness to all,” the IRS should continue to take steps to improve transparency and accountability and help ensure that audit selection algorithms do not use factors highly associated with race.

[1] Since the IRS does not include racial data in audit selection, Stanford researchers estimated the bounds of audit rates of Black taxpayers and presented the results as a range.

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