What Is The Average Audit Rate By Income Level?

In a great display of public income profiling, the IRS recently highlighted they are increasing their audit rates for income levels above $200,000.  If you study the chart carefully, you will see that after $200,000, your audit rate percentage goes up anywhere from 3X to 30X the average audit rate for those making less!

I’ve said this before, and I’ll say this again, the average income for maximum happiness is $200,000 a year per person because $200,000 is the income level which provides maximum financial reward without drawing discrimination from the government or general public.  Any income above $200,000 gets assaulted like a rabid pit-bull against a defenseless baby bunny!

Average Audit Rates By Income In America

IS INCOME PROFILING OK?

We all can agree that racial profiling is not OK.  Therefore, is income profiling OK?  Are we really going to allow the government to try and make the lives of the wealthier incrementally more miserable?  By doing so, we are saying that those who make more in our free country are more likely to cheat on their tax returns.  Wouldn’t those who have more money feel less of a need to cheat on their taxes since they already have enough?  Maybe.

However, if you are super rich, you’ve got the finest accountants money can buy who know these stats and who will ensure that in case of an audit, they will do everything possible to make sure things are clean because too much is at stake, including their own jobs!

From a rational point of view, given our tax code is 10,000+ pages long, we can assume that errors will be made across the entire income spectrum.  The flat tax above a certain income level is clearly the most efficient way to go.  Given limited resources at the IRS, it is rational for IRS agents to go after bigger fish to descale, slaughter, and eat vs the little minnows.  Better bang for the buck.  However, once again, is this right?

Recommendation: I’ve been using H&R Block’s Premium Tax Software to do my own taxes for the past 11 years. It’s inexpensive and very easy to use for novice to advanced tax filers. The software always updates with the latest tax rules so you’re never behind. They also have audit protection service as well.

Regards,

Uncle Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. David M says

    1) Some percent of the audits are triggered by red flags that the IRS computers spot like, large numbers of dependents, high percentage of income donated to charity, home office deduction, low net income for $ of revenue in a certain industry, etc. Not sure what percentage this is – however if its a large percentage this could be what is causing the audit rate to go be as is shown above.

    2) Other audits are more random – for these types of audits, I think everyone should have a chance to be audited. However, I do not think it should be random – why because if its random you will be auditing mostly low income wage earners -were likely you are not going to find much extra tax due. I think these random audits should be weighted to take into consideration the cost benefit ratio related to the cost of the audit and the average/mean extra revenue generated based upon each audit of people in a specifice income category.

    Above is my opionion if we stayed with the current tax code.

    However, I am 100% in favor of totally throwing out the current tax code and implimenting a flat tax.

    If I could rewrite the tax code there would be a standard deductions and exemptions for the number of people in the family and no other deductions, exemptions, credits, loopholes, etc for individual wage earners.

    Yes, I would be willing to do away with the sacred charitable and mortgage interest deductions!!!!

    I know I’m simplifying things, but what I’m saying is we should do away with as much of the current tax code as possiible.

    For business I would also like to see it as simple as possible – I realize it can never be as simple as it is for a individual that only has a salary and interest BUT it certainly can be made simpler. One thing I would like to see that the income on your audited financial statement is what you pay taxes on.

    “Wouldn’t those who have more money feel less of a need to cheat on their taxes since they already have enough?” This is a great sentence – what I would like to see happen is that the tax code is so simplified it would virtually eliminate the possibility for cheating by all – high income and low income earners.

      • David M says

        I agree with you – they will never go for and one reason is they need to continuously raise cash. If the tax laws are simplified and going to stay that way – it takes away a lot of reasons for people/corporations to donate to Congress.

        • says

          Exactly. Not only would tax hikes become more clear – no more moving the lines on deductions, etc. for net revenue increases – but corporate welfare through the tax code would be gone.

          I think the best way to get to a flat-tax is to end withholding. Let tax withholding expire and let everyone, not just the self-employed and business owners, calculate their tax burden and physically write a check out to the IRS and state revenue departments. That would change public opinion in a heartbeat, I think.

          You said in your original comment that you would be willing to ditch the mortgage interest deduction (I would too) but I really think that is THE reason why the flat tax is unpopular. Real estate agents would hate an end to that deduction. As would the middle class, who generally receive nothing from the deduction other than the delusion that they always reach the standard deduction.

          I still think federal taxes, both income and FICA, should be rolled together into a new flat tax. FICA is a tax on hiring, and truthfully, a modest increase in net taxes is an easy pill to swallow if it comes alongside complete tax overhaul. FICA is, in my view, one of the many reasons for the wealth gap. Specifically, lower income workers contribute more of their annual income to an “investment” (Social Security) with a much lower rate of return than most any other debt or equity investments.

    • says

      It would be sad to see Charitable Foundations go under and the housing market take a dive again. You sure it’s worth it?

      The level in which cheating fades and maximum revenue is achieve is around a 20% flat tax according to a US Treasury study. Seems to make sense. At 20%, why bother cheat?

      • David M says

        I hear you – if it REALLY would be bad then better minds than me could determine what should stay and what should go. What I think should happen is as much as POSSIBLE deductions, exemptions, credits, etc, should be deleted. By doing this we could create a flat tax and possibly the rate could be 20% as you have proposed.

        I was hoping that people would still give money to charity because they think its worth giving even if they do not get a charitable deduction – since they will have a lower tax rate and thus have more after tax dollars that they could give to charity if they wish.

        The problem with Keeping this or that exemption, deduction, credit, etc, is that if you keep some your probably going to end up keeping all or at least most. If we eliminated all and lowered the tax rate – hopefully people would get on board and accept this as being fair.

  2. says

    Income profiling, for the sake of finding tax cheats, is okay in that it is economically the most intelligent way to look for holes in the system.

    Car insurance companies, for example, don’t bother to fight small claims. I ended up getting into an small accident in which my insurance company paid out $30,000 (90% medical and disability, 10% real property damage) because fighting it is more expensive than just writing the check for the costs incurred. Had the other party claimed $500,000 in medical expenses, I’m sure their loss protection algorithms would have kicked in, and legal battles would have been waged for years.

    Additionally, it’s probably far easier to verify the income records of people who make more money. Wealthier people who earn $500,000 in a calendar year probably have a CPA on call, or at least a bookkeeper, who is already familiar with both tax law and the individual’s current situation. In such a case, it would be far easier to audit a wealthier individual than someone who doesn’t have the same resources.

    • says

      Yikes on the $30,000 JT! Glad there was insurance to pay for their damages.

      The question though, is income profiling ethically right?

      If you have the best accountant on the planet, isn’t that a losing battle to go against?

  3. says

    I don’t think “cheating” is the right word. The tax code has a lot of gray areas. Most of those gray areas exist towards the top of the income spectrum: home offices, small businesses, real estate deductions, etc. There are naturally going to be a lot more mistakes made around those gray areas than around more black and white areas such as a W2 employee taking the standard deduction. I mean, it’s almost impossible to make a filing mistake if you get a W2 from your employer and take the standard deduction, so there are naturally going to be far fewer audits of those people. Most of the discrepancies are caused by honest mistakes or misinterpretations of the tax law, not the result of cheating.

    Likewise, those with either no reported income or low reported income have higher audit rates because of the prevalence of the cash-only economy at those levels.

    • says

      Good points Kyle.

      However, I will argue that mortgage interest deduction, K1s, home office deductions are easy as pie thanks to TurboTax, H&R At Home etc. You just plug these variables in and voila. And if you are super rich, you have the best accountants in the world to do your taxes for you to make sure they are clean and maximized.

  4. Untemplater says

    I goofed one thing on my taxes a few years ago and got audited. I was fine to pay for the taxes I should have paid but was PO’d at the ridiculous amount of penalties they tacked on. I’m not sure how they found my goof but I learned my lesson to triple check everything! If I was super wealthy and payed a lot for a good accountant I’d be mad at the government for assuming I would have cheated or goofed something on my returns even with a professional doing everything. I suppose the returns of someone making 6-7 figures tends to be way more complicated. Dunno.

  5. says

    I would agree that I don’t think it is right but we all know how that goes in life. I think you said it right with those who make a lot more also have or should have better resources. When I was in investments and banking I certainly saw that many of my clients were able to save more and pay less then I did and they were making 10x over.

    rabid pit-bull against a defenseless baby bunny….now that’s perspective.

  6. says

    BMI would be a better indicator if you are looking for one attribute that would suggest someone is sloppy or lazy. But an indicator to determine if someone is a cheater? I guess the thought is that lower income people are too dumb to cheat. If that’s the case, the rich should be flattered.

    • says

      Isn’t part of the cause for stealing and cheating due to a need for survival? How else can we explain higher inner city crime in lower income neighborhoods?

      I stole candy when I was a kid bc I was bad and had no money.

    • David M says

      I think it is more that the lower income person does not have the OPPORTUNITY to cheat.

      If you work for someone and make $30,000 in salary and have $5 in intersted income for example. It is very difficult to cheat on your taxes.

        • David M says

          I accept the point you are making, I think tipped workers should be audited more than non tipped employees. I hope that and absolutely believe that the IRS should use a formula to impute a reasonable amount of tips for non tipped employees.

          I believe most Americans would not agree with me – however, in this situation I think the employee should have to prove the IRS number is not reasonable. Yes, I’m saying the tipped employee would be guilty until proven innocent.

  7. says

    Although I am in favor of a flat tax, I do not think I will ever see it happen. There are too many vested interests that keep it from happening. One reason the IRS targets higher income earners is they have a better chance of finding a bigger mistake. Higher income may mean a tax shelter that is questionable or some other mistake. It makes more sense because of what is at stake to push the envelope in gray areas of the tax code.
    Supposedly, the IRS has statistics to prove why they go after certain categories of taxpayers. I guess if they could prove that there are more tax cheats who are overweight, it would be okay to go after them too. :)

  8. says

    Most people in the lower income brackets have only wage income which is fully reported to the IRS by employers. In general, they don’t itemize deductions either, as the standard deduction is larger for large parts of the country. At higher income levels, the taxes get more complex, and to a point, compliance is voluntary. For example, those with a small business may be doing their own taxes, or may use an accountant for the business bookkeeping, but report a different set of books for taxes. There are a lot more ways to hide income and increase deductions are higher levels of income and when you are itemizing. It just makes sense to go look for the biggest bang-for-the-buck area, which are the more complex area. Plus, that way the government gets to assess penalties and interest for not correctly interpreting the 10,000 pages of tax code that they won’t even offer advice on most of the time.

    • says

      I think it’s kind of a conspiracy. Send you a bill from 5 years go, while taking on 6% interest a year for those 5 years and pay, or else, GO TO JAIL! Sounds like a racket to me!

  9. says

    A flat tax is great policy but horrible politics. There is a constituency that wants high marginal rates to make the ‘rich pay’, even though the evidence shows that they raise less revenue. Rates have been relatively low for 30 years, and the amount of taxes collected has gone up and the number of rich people has increased. Look at the mainstream reporting on this, they spin this as the rich “took all the income”, whereas very few stories talk about how the lower rates encouraged compliance and wealth creation that wouldn’t have otherwise occurred.

  10. says

    My family was audited a few years back and it was such a pain. The only reason was because there are too many kids in my family to fit on one sheet of paper, so we always have to add another one – and this particular year they lost the paper! We made it through just fine but I would hate if that was a regular happening for us. On the other hand, the very wealthy do have access to the best accountants, like you said, so it wouldn’t be quite the same experience for them. The only real damage would be a possible fine if there was a problem, or the public humiliation if they were a celebrity or something.

    • says

      Doh! I think there is ZERO humiliation of being audited, b/c the tax code is too complicated!

      I bet if I get audited, there would be a GREAT chance the IRS finds me more money back!

      Hope you didn’t have to pay too big a fine.

      • says

        No, we didn’t have to pay a fine because they realized it was their mistake. It was really stressful, though. The tax code is ridiculous! I like the idea of a flat tax over a certain income, although that would put a lot of high-end accountants and advisers out of work :(

        • David M says

          Their smart people they will find other jobs – no worries!

          O ya, you were making a hypothetical assumption that we went to a flat tax, something that politicians are never going to put into place.

      • David M says

        I think the same thing would happen to me.

        My wife is self employed and I do the taxes – I only tax deductions that I’m certain are 100% above board. I think the IRS auditor would come up with some deductions that he/she thinks I was entitled to take.

    • David M says

      Any chance you want to elaborate regarging how is was “such a pain”?

      Seems like unless the IRS went out of its way be difficult this should have been a very simple and painless audit.

      • says

        Well, since it was the only audit I’ve ever been through, I can’t really compare the actual difficulty of the process. I will say that we had to gather old tax returns, social security information, and several other cumbersome documents to prove that we were in fact all real people and that we didn’t just show up out of no where. I’m sure there are much worse auditing experiences, but as far as I’m concerned any interaction with the US government has never been the friendliest or most efficient process :)

      • says

        One of the main things is stress, worry, and fear. I had a notification sent to me once b/c I forgot to input the COST BASIS of my stock trades. The amount owed was over 6 figures! I realized what I did wrong, sent them my info, and they confirmed a couple months later all was good, and no penalties. Now that was kinda stressful, even though I knew I didn’t owe that money. What if….

  11. says

    On the surface you make a good point, but if you think about it the stats make sense. The average low income earner files a simple 1040EZ, while high income earners have a laundry list of 1099s, 1098s, Schedule Cs, and other forms. There is not much to audit on someone that only has one income source. Big earners have a lot more to look at.

  12. Anonymous Student says

    One of my finance professors in high school was an adjunct professor who actually full time was running a holding company that basically took small stakes in various small businesses in our state. He told us that he’s been audited every year for the past 15 years. The number of time the IRS found any problems? Zero.

    He says it’s a pain – but he says to blame the IRS and not the agents that arrive. They’re just doing their job, my professor has said he’s actually become good friends with the agent over the years.

    He also says the flat tax will never be imposed because it would not only put the IRS out of a job, but also lots of accountants who, as you pointed out, serve to help wealthy people structure their money for the IRS.

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