Study finds Blacks more likely to face IRS tax audits

A comprehensive study conducted by economists from Stanford University, the University of Michigan, the University of Chicago and the Treasury Department resulted in a detailed report that concluded the IRS is about three times more likely to audit Black taxpayers compared to other taxpayers.

The study states, "Despite race-blind audit selection, Black taxpayers are audited at 2.9 to 4.7 times the rate of non-Black taxpayers."  

The study found the most likely causes of this racial disparity are IRS algorithms that disproportionately flag returns that claim refundable tax credits like the Earned Income Tax Credit (see story).

In fact, according to the study, "The main source of the disparity in differing audit rates by race among taxpayers is the Earned Income Tax Credit." 

Resource constraints result in less complex returns being audited

Due to resource constraints, resulting from continual budget cuts and the loss of roughly 40% of its experienced agents, the IRS has focused on auditing less complex returns. Less complicated returns are more likely to go through a correspondence audit because these tax examinations are for a single year, involve no more than a few issues, and can be conducted (and resolved) by mail by reviewing a few relevant documents.

Some 70% of IRS audits are done by mail, and 50% involve EITC claimants. 

Compared with labor-intensive field audits — which require an in-person examination at the taxpayers' place of business or their tax professional's office — correspondence audits of returns claiming the EITC are easier to flag, cost very little, and require minimal effort by IRS staff. 

The burden of correspondence audits on EITC claimants is more likely to fall on lower-income individuals whose tax returns are less complex and less likely to lead to challenges, including litigation.

It's important to note that the study did not find bias at the individual tax enforcement agent level. IRS agents do not know the race of the individuals they are auditing, but it did find that the IRS disproportionately audits people who claim the EITC, a refundable tax credit targeted to assist low- to moderate-income workers. 

And the disproportionately large number of audits focused on the EITC magnified an additional issue — that the largest source of disparity occurs among EITC claimants. While Black taxpayers accounted for 21% of EITC claims, they were the focus of 43% of EITC audits.

How did the study determine taxpayer race?

Although there have been questions about whether the IRS uses its audit powers equitably, privacy concerns and the confidentiality of the service's algorithms in choosing the returns for audit made it difficult to determine. That changed when President Biden signed Racial Justice Executive Order 13985, requiring all federal agencies to assess how their programs impact racial and ethnic equity. 

Applying that order to the IRS tax return audit program, economists at the Treasury Department collaborated with the Stanford RegLab team to analyze over 148 million tax returns and approximately 780,000 audits for tax year 2014 (an overall audit rate of 0.54%).

Even with all the data they received, the research team could not know the race of the taxpayers in the data set. They created an approach to predict whether a taxpayer identified as black. 

Key study findings

The authors determined that, even where audit selection processes are largely automated to ensure no intentional discrimination in audit selection, these processes can significantly impact racial disparity in audit selection. There are several reasons for this, most importantly that by designing algorithms that select for underreported refundable credits rather than the total amount of underreported tax, the racial disparity continues. 

If the algorithm focused audit selection on the amount of underreported tax, rather than specific issues like EITC, the racial disparity in audits would be significantly reduced.

Next steps for the IRS

The study's authors do not offer formal recommendations for making the IRS audit selection algorithm more equitable. Instead, they document the likely effects of alternative policies, providing the IRS with several potential alternatives for reducing the racial impact of its audit selection system, including:  

• Predicting and focusing on the magnitude of taxpayers' underreported income rather than just the likelihood of it;
• Viewing dollars as equal whether they are to be paid in refundable credits or received in taxes; and,
• Using IRS resources to audit more complex returns rather than focusing only on the simpler ones that are much less expensive to audit.

Now that the equity implications of how the IRS selects audits are known as a result of this study, the research team suggests the IRS should tweak its confidential audit selection algorithm. 
"Racial disparities in income are well known, and what the IRS chooses to focus on has big implications for whether audits complement, or undercut, a progressive tax system," according to one of the study's authors. 

Treasury Department response

In response to the study's findings, a Treasury spokesperson said that "equitable enforcement of our tax laws is a top priority for the administration."

The spokesperson added, "Resources provided by the Inflation Reduction Act will enable the IRS to upgrade technology and hire top talent to go after wealthy tax evaders."

Separately, the IRS has indicated it is continually reviewing its algorithm models and enforcement policies to ensure the tax law is administered in a fair and equitable manner.