IRS Backs Off Audits of Low-Income Black Americans Who Get A Giant Tax Benefit

The Internal Revenue Service plans to dial back its audits of low-income recipients of a multi-billion-dollar tax benefit, scrutiny that has put Black taxpayers disproportionately under the microscope.

The pivot means more firepower for the nation's tax collector to go after high-income tax cheats, its new priority.

The shift has been in the works ever since Stanford University researchers found that Black taxpayers are 3 to 5 times more likely to be audited compared with other taxpayers, largely due to their receipt of the benefit, a generous tax credit. The reason wasn’t overt racism, the study’s authors wrote in January, but rather flaws with the secret computer algorithms the IRS uses to spot potential tax cheats.

The benefit in question, the earned income tax credit (EITC), is one of the nation’s largest entitlement programs. Last year, it sent roughly $64 billion to 31 million low- and modest-income households, according to IRS data. Meant to reward work, it’s the largest cash-based safety net in the United States, credited with lifting millions of people out of poverty.

But the program is plagued by massive fraud and errors. Nearly one third of more than $57 billion paid out over 12 months ending last September — or $18.2 billion — was sent to recipients that should not have been, the tax agency’s official watchdog reported in May. The IRS has long estimated the erroneous payment rate as a lower but still substantial 21%-26%.

Recipients of the tax credit account for one in three audits of all individual taxpayers, according to the IRS’s overseer, the Treasury Inspector General for Tax Administration. Which means that freeing up auditors translates into more manpower for the IRS’s new focus on high-income earners, including hedge funds, law firms, real estate companies and wealthy tax cheats. The Treasury Department has estimated that in 2019, the top 1% of the highest earners, with average income of around $2 million, were dodging $163 billion a year in taxes.

To announce the shift away from audits of credit recipients, IRS Commissioner Daniel Werfel sent the U.S. Senate Committee on Finance a letter Monday saying that the agency and its overseer, the Treasury Department, had “validated” the Stanford study’s findings — including one that Black EITC recipients were 2.9 to 4.4 times as likely to be audited as non-Black EITC claimants.

Werfel’s letter said that “we will be substantially reducing the number of correspondence audits focused specifically on certain refundable credits, including the Earned Income Tax Credit.” Correspondence audits are conducted by IRS agents through mail and by phone, not in-person visits.

The letter echoed a missive Werfel sent in May to Senate Finance Committee Chair Ron Wyden, an Oregon Democrat, in which he said the IRS was “deeply concerned” about the Stanford study’s findings. 

“The realignment to focus on high-end tax evasion and any bad actors who contribute significantly to the tax gap will therefore help reduce this disparity” between Black EITC claimants and other taxpayers, Werfel wrote in his most recent letter, referring to the estimated $600 billion a year in taxes that are owed but go unpaid.

Black individuals comprise 13.6% of America’s population of more than 333 million. They account for 21% of all EITC claims but have been the focus of 43% of all EITC audits, the Stanford study found. A single Black man with dependents who claims the credit is nearly 20 times as likely to be audited as a non-Black married taxpayer claiming the benefit.

In his most recent letter, Werfel said the IRS was targeting scammers who rope unwitting taxpayers into claiming the credit in exchange for a fee.

The federal agency is battling that type of fraud on multiple fronts. On Sept. 14 it suspended new claims for the employee retention tax credit, a pandemic-era lifeline that has been plagued by a “tsunami” of fraud by sketchy promoters.

Asked to comment on Tuesday, an IRS spokesman quoted Werfel’s Monday letter, saying that “we are devoting more resources to addressing unscrupulous preparers who are leading their customers to underreport income or overclaim credits,” including the EITC.

The earned income tax credit is famously complex. Recipients must meet income from work and family size guidelines. This year, a single earner with three children making no more than $56,838 can earn a credit of $7,430, the maximum possible. The benefit is particularly valuable because it’s “refundable,” meaning it reduces any taxes owed and sends whatever is left over as a check to the claimant.

The rules for how children qualify are byzantine: A child has to be either under age 19 at the end of the year and younger than than the person claiming the credit, or under age 24 at the end of the year, a full-time student for at least 5 months of the year and younger than than the claimant. Children of any age who are permanently and totally disabled also qualify. 

The child must live with the person claiming the credit for more than half the year. Under the tax code, time spent away from home due to illness, hospitalization, juvenile detention, military service or kidnapping counts as time at home. In cases where multiple taxpayers qualify to claim the same child, “tie-breaker” rules govern who takes priority.

“The real solution is for the statutory standards to be simplified,” said Mark Everson, a former IRS commissioner. “The problem with these refundable credits is that people put down what they want.”

In his letter Monday, Werfel said an initial round of changes “improves the accuracy of the automated risk scoring process by adjusting how IRS considers information about where children live.”