Category Archives: Taxes

Who’s More Likely to Be Audited: A Person Making $20,000 — or $400,000?

If you claim the earned income tax credit, whose average recipient makes less than $20,000 a year, you’re more likely to face IRS scrutiny than someone making twenty times as much. How a benefit for the working poor was turned against them.

by Paul Kiel and Jesse Eisinger,

When Natassia Smick, 28, filed her family’s taxes in January, she already had plans for the refund she and her husband expected to receive. Mainly, she wanted to catch up on her credit card debt. And she was pregnant with their second child, so there were plenty of extra expenses ahead.

The earned income tax credit is supposed to be a boon for low-income families like Natassia Smick’s. But, as she’s found, claiming the credit often prompts a grueling, slow-moving review by the IRS.

Since Smick, who is taking classes toward a bachelor’s degree, and her husband, a chef, together earned around $33,000 in 2017, about $2,000 of that refund would come from the earned income tax credit. It’s among the government’s largest anti-poverty programs, sending more than $60 billion every year to families like Smick’s: people who have jobs but are struggling to get by. Last year, 28 million households claimed the EITC.

Smick, who lives outside Los Angeles, thought she’d get her refund in a month or so, as she had the year before. But no refund came. Instead, she got a letter from the IRS saying it was “conducting a thorough review” of her return. She didn’t need to do anything, it said. Smick waited as patiently as she could. She called the IRS and was told to wait some more.

It wasn’t until four months later, in July, that she got her next letter. The IRS informed her that she was being audited. She had 30 days to provide “supporting documentation” for basically everything. As she understood it, she needed to prove that she and her husband had earned what they’d earned and that her child was her child.

By this point, Smick was home with her baby. She set about rounding up W-2s, paycheck stubs, bank statements and birth certificates. Proving that her 4-year-old had lived at the family’s address for most of the year, as the EITC requires, was the hardest thing, but she did her best with medical records, some papers from his day care, and whatever else she could think of.

She sent it all off and hoped for a quick resolution, but the next IRS letter quashed that hope. The IRS said it would review her response by Feb. 16, 2019 — six months away. Collectors were calling about the credit card bills. She didn’t know how she’d make it that long.

Smick couldn’t understand why this was happening. All she had done was answer the questions on TurboTax. Isn’t it rich people who get audited? “We have nothing,” she said, “and it’s just frustrating knowing that we have nothing.”

It seemed there was nothing she could do. And when she called the IRS to ask how it could possibly take so long to review her documents, she remembers being told that there was nothing they could do, either: The IRS was “extremely short staffed,” the person said.

Budget cuts have crippled the IRS over the past eight years. Enforcement staff has dropped by a third. But while the number of audits has fallen across the board, the impact has been different for the rich and poor. For wealthy taxpayers, the story has been rosy: Not only has the audit rate been cut in half, but audits now tend to be less thorough.

It’s a different story for people who receive the EITC: The audit rate has fallen less steeply and the experience of being audited has become more punishing. Because of a 2015 law, EITC recipients are now more likely to have their refund held, something that can be calamitous for someone living month-to-month.

IRS computers choose people to audit, but if those taxpayers respond, a person must review the documents. With fewer employees to do that, delays have mounted in a process that was already arduous, according to several attorneys who represent taxpayers through the Low Income Taxpayer Clinic program. It regularly takes more than a year to get a taxpayer’s refund released, they said, even for those who are represented.

“If the service doesn’t have the personnel to evaluate evidence submitted in a timely manner, then they should not be initiating the exams in the first place,” said Mandi Matlock, an attorney with Texas RioGrande Legal Aid.

Generally, the more money you make, the more likely you are to be audited. EITC recipients, whose typical annual income is under $20,000, have long been the major exception. That’s because many people claim the credit in error, and, under consistent pressure from Republicans in Congress to curtail those overpayments, the IRS has kept the audit rate higher. Meanwhile, there hasn’t been similar pressure to address more costly problem areas, like tax evasion by business owners.

The budget cuts and staff losses have made this distortion starker. The richest taxpayers are still audited at higher rates than the poorest, but the gap is closing.

“What happens is you have people at the very top being prioritized and people at the very bottom being prioritized, and everyone else is sort of squeezed out,” said John Dalrymple, who retired last year as deputy commissioner of the IRS. In 2017, EITC recipients were audited at twice the rate of taxpayers with income between $200,000 and $500,000. Only households with income above $1 million were examined at significantly higher rates.

Put another way, as the IRS has dwindled in size and capability, audits of the poor have accounted for more of what it does. Last year, the IRS audited 381,000 recipients of the EITC. That was 36 percent of all audits the IRS conducted, up from 33 percent in 2011, when the budget cuts began.

“Those struggling to make ends meet are being unfairly audited while the fortunate few dodge taxes without consequence,” Sen. Ron Wyden, D-Ore., the ranking member on the Senate Finance Committee, told ProPublica. “The IRS needs more manpower to go after tax cheats of all sizes, and working Americans need a simpler way of obtaining a tax credit they’ve earned.”

The IRS declined to answer questions about its EITC audits.

The EITC has bipartisan roots. Conceived as a “work bonus” for low-income wage earners in the 1970’s and an alternative to welfare, the program has grown over the decades with the support of Republicans and Democrats. These days, the average credit is for about $2,500, but for larger families, the amount can exceed $6,000. The Census Bureau recently estimated that the EITC and the child tax credit together boost millions of children out of poverty every year, more than any other government program.

Unlike Social Security or food stamps, the EITC has no application process. Instead, taxpayers simply claim the credit on their tax returns. Millions of people get it wrong in both directions, according to IRS estimates. About a fifth of eligible taxpayers don’t seek the EITC. And almost a quarter of the $74 billion paid out this year was issued “improperly.”

That estimate of “improper payments,” about $17 billion, is the reason the EITC is such a focus for the IRS. Some tax experts — including the Taxpayer Advocate Service, an independent office within the IRS — argue the estimate is way too high. One reason is that it is based on the outcome of audits, and low-income taxpayers are much less likely to have competent representation to dispute the IRS’ conclusions.

Regardless of the precise error rate, the IRS acknowledges the primary cause of the problem is not fraud: It is the law itself. It is too complex, too easy for someone to think themselves eligible when they are not. The same child might be a “dependent,” for example, but not a “qualifying child” under the EITC, and the IRS’ instructions for claiming the credit run to 41 pages.

“My third-year law students, they sit down and study this material, and sometimes they still don’t get it,” said Michelle Lyon Drumbl, a professor at Washington and Lee School of Law.

Since the 1990s, Republicans in Congress have focused on these improper payments as a major problem and harshly criticized the IRS for failing to stop them. In 2015, the Republican Congress passed, and President Barack Obama signed, a bill that required the IRS to hold EITC refunds until Feb. 15 each year. The purpose was to give the IRS more time to match tax returns with the corresponding W-2s to avoid misstatements of income. But it also meant people who are audited are more likely to see their refund held — instead of receiving the credit and then undergoing audit. That’s a crucial difference for low-income taxpayers.

“You expect this money during tax season and you don’t get it… It tears you down,” said Paul McCaw, a forklift operator in Rock Island, Illinois. He had refunds held for several years in a row because the IRS doubted that his niece’s three young children lived with him. For years, the family struggled. Bills piled up and eviction was a constant threat. Finally, this year, with the help of a legal aid attorney at Prairie State Legal Services, Macaw, 50, was able to convince the IRS to release the refunds.

“I was just beside myself,” he said of finally getting his refunds, adding, “I caught everything all up, and I also paid a month in advance.”

Stopping faulty refunds from going out, rather than trying to recoup them through an audit is “always the better option” because it is more effective, said Jesse Solis, a spokesperson for House Ways and Means Committee chair Kevin Brady, R-Texas. Congress should continue to look for ways to reduce improper payments, he said.

Taxpayers of all kinds cheat. And IRS studies have found that EITC recipients aren’t close to the worst offenders. For certain kinds of business income, for instance, people pay only about 37 percent of the tax they owe because they simply don’t report the income. Hundreds of billions of dollars in government revenue is lost. But people who have their own businesses are audited at about the same rate as EITC recipients.

The IRS’ disproportionate focus on stopping EITC “improper payments” is misguided, said Nina Olson, the national taxpayer advocate. “What’s the difference between an erroneous EITC dollar being sent out and a dollar attributed to unreported self-employment income not collected?” she asked. Unreported business income is “where the real money is,” she said.

When EITC cheating does occur, the culprits are usually tax preparers, said Chi Chi Wu of the National Consumer Law Center. “They know the system, they game the system and ultimately the taxpayer ends up on the hook if there’s an audit,” she said. In undercover investigations by the NCLC and the Government Accountability Office, multiple preparers advised taxpayers to file bogus EITC claims.

About 60 percent of taxpayers use a preparer, but in most states, preparers are not required to be licensed, and the IRS’ ability to oversee them is limited. After the agency launched a program to certify preparers and subject them to regular compliance checks, a federal appeals court ruled in 2014 that the IRS doesn’t have that power. Congress could pass a bill to confer such authority on the agency, but it has not done so, despite some bipartisan support for the idea.

The IRS has a difficult task in auditing taxpayers who claim the EITC. Low-income families are often complicated; they’re more likely to be multi-generational than more affluent filers, for instance, or to add or subtract household members from year to year. A study by the nonpartisan Tax Policy Center found that only about 48 percent of low-income households with children were married couples, while for other households it was 75 percent.

But advocates for taxpayers say the IRS makes the situation needlessly worse. Virtually all the EITC audits are conducted by correspondence, and the computer-generated letters are far from simple. A survey by the Taxpayer Advocate Service found that more than a quarter of EITC recipients who were audited didn’t even understand that they were under audit.

“When I first got audited, I couldn’t figure out what was going on,” said Denise Canady, 62, of West Memphis, Arkansas, who at the time was earning $8.50 an hour as a home health aide. The audit sent her on a scramble to get documents from her granddaughter’s doctor, pharmacy, hospital and school that would demonstrate that the toddler had lived at her address. “A lot of people don’t want to give you old records,” she said.

She eventually found her way to Legal Aid of Arkansas, where an attorney helped bolster her case, but, a year after her audit began, she is still awaiting the outcome.

“I pray and hope,” she said.


Republished with permission under license from ProPublica, a Pulitzer Prize-winning investigative newsroom. 

You Don’t Earn Much and You’re Being Audited by the IRS. Now What?

By Paul Kiel,

The Internal Revenue Service audited nearly 1.1 million tax returns last year, but that represented just 0.5 percent of all returns. That means the chances of getting audited are fairly low.

But if you are audited, there’s a good chance it’s because you claimed the earned income tax credit. That’s a credit the federal government offers to people who work, have kids to take care of and don’t earn much money. Most households who claim it earn between $10,000 and $40,000 a year. The average credit is for $2,400, but it can go above $6,000 for larger families.

The IRS audits a lot of people who claim this credit. When that happens, the IRS blocks the refund. Some people may actually end up owing tax instead of getting a refund.

Here is an actual audit notice sent to a taxpayer last year, which was provided to us by the taxpayer’s legal aid attorney. We’ve annotated it to provide important context and added links to helpful resources for those facing an IRS audit.

If you claim the credit and are audited, there’s an excellent chance it will be done entirely through the mail. Of the 1 million-plus audits the IRS conducted last year, less than three-quarters were done by mail, with the remainder by examiners in the field. But for those who claimed the earned income tax credit, nearly all — 92 percent — were done by mail.

In the example here, the audit is ongoing, meaning the IRS hasn't yet made a final determination and won’t release the refund until the audit is closed. And the forms don’t make clear why this taxpayer, or any other, is selected for an audit. But for those claiming the EITC, the main issue is typically whether they have what's called a “qualifying child.” In other words, if you are audited, it’s usually because the IRS doubts that the child or children you claimed on your tax return actually live with you or are related to you (biologically or through adoption or marriage).

Whether a child qualifies can be confusing. This IRS FAQ can be helpful.

No single IRS employee is in charge of an EITC audit. Instead, taxpayers are told to call a service center to speak with a tax examiner. If you call, you may speak with a different person every time.

This taxpayer claimed the EITC and had been expecting a refund of several thousand dollars. Instead, because the IRS believes she doesn’t qualify for the credit, she is being told that she owes $599.53. Almost all of that amount is tax, not interest or penalties.

Since this is an open audit, she doesn’t owe the money quite yet. The tax is legally owed after she receives a notice of deficiency, which would be a separate letter. This taxpayer eventually was able to reverse the IRS’ audit finding through the help of a lawyer with the Low-Income Tax Clinic program and the Taxpayer Advocate Service.

The IRS has a full rundown of potential penalties and interest charges.

Taxpayers are responsible for notifying the IRS of their current address. So if this notice goes to an old address and isn’t forwarded, the taxpayer may lose the ability to respond to the audit notice. That doesn’t mean there’s no way to undo an IRS audit after it’s done, but it’s a lot harder.

Taxpayers can respond to audits on their own. However, your chances are much better with help. If you qualify for the EITC, then you will likely qualify for free legal help. Here is a directory of Low-Income Taxpayer Clinic locations. If, when the audit is finished, the IRS still does not agree that you qualify for the credit, the next step is usually to file a petition with the U.S. Tax Court.

To qualify for assistance from a low-income clinic, your household cannot make more than 250 percent of the federal poverty level. For example, a family of four living in the contiguous U.S., Washington, D.C., or Puerto Rico has to earn less than $62,750 per year in order to qualify. And the amount in dispute generally must be less than $50,000.

Once you receive the final notice of deficiency from the IRS, you legally owe the tax. Your best option then is to file a petition in Tax Court. If you don’t file within 90 days of receiving the notice of deficiency, you lose your chance to go to Tax Court. If you don't file a petition in Tax Court, the IRS may start to try to collect the tax you owe. You may still have a chance of undoing the audit finding through an audit reconsideration process, but that can take a very long time and your chances of success are lower.

Taxpayers who qualify for the EITC generally qualify for free legal help through the Low-Income Taxpayer Clinic program.

This letter was signed by an IRS manager in Austin, Texas. These audits are generally computer-driven with minimal human interaction. However, if you respond to an audit, it will be reviewed by a human being. But that’s also why the IRS can take as long as six months to review documentation that you submitted.


Republished with permission under license from ProPublica, a Pulitzer Prize-winning investigative newsroom.