Disproportionate IRS Auditing of Black Taxpayers Shows Importance of Expanded Enforcement to Catch Wealthy Tax Cheats

by Will Rice

Media headlines recently blared a troubling fact: Black taxpayers are up to five times more likely to be audited by the IRS than white taxpayers. That’s the disturbing finding of an academic study conducted with the cooperation of the federal government. 

Together with other research we recently highlighted that found white people benefit disproportionately from tax loopholes, the latest finding reveals how people of color get clobbered from both sides by systemic racism in the tax system. But it’s also a byproduct of the successful GOP campaign to defund the IRS.

The good news is the problem can be solved—in fact, President Biden and the Democratic Congress have already started the process of fixing it. 

There are two big reasons for lopsided auditing of Black taxpayers. First, Republicans have been weakening the IRS for years, starving the tax agency of the resources it needs to do its job and collect what’s due. This has resulted in lower-income taxpayers—whose returns are relatively simple and who don’t have an army of lawyers and accountants to protect them—getting more IRS scrutiny even as rich and corporate taxpayers—famously tough to audit— mostly get a free pass. Because of systemic racism, Black families are disproportionately found in that low-income group.

Second is the Earned Income Tax Credit (EITC), which rewards employment and makes low-wage work pay by topping off a small paycheck with public funds. Again, Black workers are clustered in low-wage jobs and are disproportionate recipients of the EITC. 

Some EITC payments are sent to people who aren’t supposed to get to them. Those erroneous payments are less likely the result of cheating by ineligible recipients—both progressive and conservative tax experts agree—than the complexity of EITC eligibility rules: people think they qualify for the credit when they really don’t. Nevertheless, Republicans in Congress have leaned on the IRS to give EITC recipients extra scrutiny. 

You can’t just blame the racial audit gap on the IRS checking up on EITC recipients more than other taxpayers, though. Among households of all races receiving the EITC, Black households are around 3 to 4 times more likely to be audited. 

The study’s authors don’t think racist IRS agents are intentionally targeting Black families. But they do show how the automated systems that flag tax returns claiming the EITC are inadvertently programmed so that Black taxpayers are more likely to be chosen for audits. It’s a lot of math, but basically if the IRS told their computers to pluck returns based on how much projected tax revenue was at stake, and not just on a prediction of whether or not the return had been filed correctly, white EITC recipients would be audited more.    

The problem, however, is bigger than the racially disparate audit treatment of lower-income families receiving the EITC. As showcased by the IRS’s recently revealed kid-gloves treatment of Donald Trump when auditing his tax returns, the IRS has two sets of enforcement rules. One is for working families who have every penny of income reported to the government on W-9’s, 1099’s and similar forms; and another for billionaires and wealthy business owners who essentially operate on the honor system. 

Some of that deference to the powerful may be political, but a big reason for it is a simple lack of resources. Auditing a working American—all of whose income has been reported and who doesn’t have an army of accountants and tax attorneys to deflect and delay—is a lot cheaper than taking on the complex tax returns of a rich business owner with numerous sources of unreported income and the economic firepower to drag out an audit for years. 

This de facto “punish the poor, reward the rich” enforcement policy has been getting worse. In 2011, taxpayers earning $1 million or more were about six times more likely to be audited than low-income families receiving the EITC. By 2018, millionaire audits were only twice as likely as audits of EITC recipients.

A big tax break that mostly helps rich business owners is the pass-through deduction: it lets them subtract 20% of their business income before figuring out what they owe. According to the U.S. Treasury Department, that loophole will cost $57 billion in lost revenue this year. That’s not much less than the $67 billion price tag for the EITC. 

White business owners will gain eight times as much (roughly $400 billion) as Black business owners (around $50 billion) from this pass-through tax break in 2023. Meanwhile, by a roughly 5-3 ratio, Black families benefit more than white ones from the EITC. But the monitoring of these two tax breaks by the IRS tilts largely in favor of white taxpayers. 

And that makes no sense. Business income is susceptible to a lot more mistakes and fraud than wage income: as noted, there are no W-2’s or 1099’s on sales so revenue is entirely self-reported, and not always honestly;  and acceptable deductions are susceptible to wide interpretation and sometimes outright fraud. When the businesses in question are owned by a billionaire like Trump, there’s a lot of tax revenue at stake. 

Yet in 2019, the IRS only audited six out of every 10,000 returns filed by partnerships and S corporations, two of the most popular forms of business organization. Meanwhile that same year, almost 80 out of every 10,000 returns claiming the EITC were audited. That’s a 13-1 enforcement differential in favor of (largely white) business owners over (disproportionately Black) EITC recipients. 

The Democrats’ Inflation Reduction Act offers a solution to that problem by restoring adequate funding to the IRS. The agency will use the new money to go after rich tax cheats and tax-evading corporations, upgrading technology and hiring the kind of experts they need to unravel complicated business arrangements. The effort will be worth it: by one estimate, the highest-income 1% illegally evades $160 billion of taxes every single year. That’s why the increased IRS funding will be a money-maker, netting about $100 billion over the next decade. 

The newly empowered Republicans in the House made it their first order of business to vote to claw that IRS funding back, a regressive move that luckily will be blocked by the Democratic Senate and President Biden. That’s a good thing for a lot of reasons, but not least because it will allow us to create greater racial equity in our tax system.