However, the paper uses questionable assumptions to determine a person’s race and does not take into account how the audits were resolved.
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A few days ago, a group of Stanford University professors and U.S. Treasury Department officials jointly published a paper stating that based on their research, Black taxpayers were 2.9 to 4.7 times more likely to be audited than non-Black taxpayers.
The paper specifically focuses on audits involving the Earned Income Tax Credit (EITC), a refundable tax credit for low-income taxpayers.
The authors make it clear that the IRS is not intentionally targeting Black taxpayers. They claim that the racial disparity in audit selection is driven by a set of internal IRS algorithms. They are probably referring to the IRS’s Discriminant Function System. This system issues what tax professionals call the “DIF score” which will determine whether the tax return should be audited. How the DIF score is calculated is a closely guarded secret.
They also claim that the IRS may be increasing EITC audits because they are more cost-effective and less labor intensive than an audit of a self-employed business. This may be due to a lack of IRS funding. Also, lower-income taxpayers may not have the time or resources to fight an audit to the end.
But there are a few issues with this paper which suggest that the authors seem to have a problem with the EITC using the racial disparity narrative.
First, the authors do not have definite data on race so they make assumptions. Since tax returns do not have race or ethnicity information, the authors look at the name and address on a tax return to determine whether the taxpayer is likely to be Black. They note that first names are more informative than last names for identifying Black individuals. The problem is that they could exclude many Black taxpayers just because they have a non-Black sounding name.
Second, it is unclear why the authors use the EITC as their target because the IRS tends to look at these returns more closely no matter who claims it. The IRS estimates that 21% to 26% of EITC claims are paid in error due to mistake or fraud. Tax return preparers are required to do a due diligence check with their clients whose numbers make them eligible to claim the credit. Past studies of EITC audit rates suggest that these audits target low-income people regardless of color and were more focused on areas with lower-income populations.
Lastly, the paper does not disclose how these selected audits were resolved and how the taxpayers were treated during the audit. How quickly (or slowly) were the audits resolved? How many of the assumed Black or non-Black taxpayers successfully defended their audit? And of particular importance is whether Black taxpayers were treated differently than others. It should be noted that some taxpayers are unable to win EITC audits due to ignorance of the law or circumstances beyond their control. They may have a harder time getting documents or may have had an unreasonable auditor. Or their tax preparer filed a false tax return. Were these taxpayers treated differently than those who committed outright fraud?
So what is the equitable fix to the IRS algorithm? The authors do not suggest reducing audits in areas where the population is predominantly Black. Instead, they state that the IRS should choose to audit a taxpayer based on the magnitude of underreported income rather than the likelihood of it. Also, the IRS should use its resources to audit more complex returns rather than simple ones.
If the IRS’s audit algorithm increasingly targets Black Americans, it should be looked into and addressed. But this paper uses questionable assumptions to determine a person’s race and does not take into account how the audits were resolved. Also, it seems to highlight the faults of how the EITC is implemented and how the audit process causes problems for taxpayers who may not have the time or the resources to fully defend their case. Perhaps the EITC should be replaced by adjusting the tax brackets so that low-income families pay no tax at all.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at email@example.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.