The voices of Tax Policy Center's researchers and staff
Sometimes, the junk mail and the bills pile up unopened on my dining room table.
The Internal Revenue Service has me beat. After the COVID-19 pandemic forced it to close its offices and return processing facilities in the spring, more than 12 million pieces of mail piled up—many in rented trailers.
And with this year’s Tax Day on July 15, more arrives each day.
What happens to people’s responses to correspondence audits when the mail isn’t opened? On April 1, the IRS suspended new examinations until July 15 and gave taxpayers more time to provide documents for audits already in progress. Nonetheless, 243,945 tax returns, mostly slotted for correspondence examinations, were in limbo as of May 23. Until those audits are closed, earned income tax credits and other refundable tax credits may be frozen.
My advice to the IRS: Close those correspondence audits immediately and pay those refunds, even though some ineligible people will get credits. Many of those audited taxpayers are eligible, and many need the money now to pay for food and shelter.
But while correspondence audits should be suspended this year, the IRS should resume them once the pandemic ends. I may be the only tax geek who likes correspondence audits.
What is a correspondence audit?
As the name suggests, a correspondence audit is conducted through the mail. When the IRS detects an anomaly on a tax return, it sends a notice to the taxpayer who must mail back documentation that supports her claim. If she can’t, she must pay more tax or lose a tax credit.
Unlike an in-person audit, correspondence audits are narrowly focused on one or just a few items. Many of those audits can occur before a tax refund is paid. Examiners who conduct correspondence audits typically have less training than those who do the in-person interviews.
Not surprisingly, correspondence audits are a lot cheaper than in-person audits
So what’s not to like about correspondence audits?
Some critics view correspondence audits as a weapon against the poor. In 2019, about three-quarters of examinations were conducted through correspondence. And half of those audits were of people claiming the earned income tax credit (EITC). Over 90 percent of EITC audits were conducted through correspondence.
Critics say mail audits are slow, and people struggle to find conclusive documentation. Over 40 percent do not respond at all and essentially forfeit their EITC. A low-income tax clinician told me her clients often were too scared to open letters from the IRS.
What is the impact on compliance? In 2019, about 88 percent of EITC correspondence audits resulted in changes to the tax return—but that statistic cannot distinguish between people who were ineligible and those who were eligible but could or did not provide proof to the IRS. One study found a drop in EITC claims after correspondence audits, possibly reflecting both deterrence of noncompliance and fewer claims by people who were eligible but worried about experiencing another audit. Yet another study found that subjects of “early” (probably pre-refund) EITC audits pay less taxes in later years, possibly because ineligible people became even less compliant after an audit. Maybe they were not worried about being audited again.
The authors of these two apparently conflicting studies agreed on one thing: correspondence audits are too impersonal.
Why do I like correspondence audits?
What one person calls impersonal, I call less burdensome—at least relative to the likely alternatives.
That was a consideration in 1997, when the Clinton Administration worked out a deal with then-House Speaker Newt Gingrich to make the child tax credit (CTC) partially refundable. In exchange, the Administration promised to reduce erroneous EITC payments by $5 billion over several years.
One Treasury Department initiative was a commitment to complete about 400,000 correspondence audits (now down to under 300,000). As part of the deal, the IRS got more money so it would not have to divert resources from audits of higher-income taxpayers or big corporations.
What were the alternatives? Subject EITC claimants to conventional in-person audits. Transform the EITC into a block grant and let state agencies administer it and set the eligibility rules and benefit amounts. Cut the EITC and not make the CTC refundable. The first option would have increased taxpayers’ hassles and the IRS’s costs. The third option would have reduced support for low-income parents. The second option would have shifted administrative costs from the IRS to other government agencies and potentially had the same effects as the first and third options if state agencies demanded additional information from all applicants and if state legislators chose to reduce benefit amounts.
Could correspondence audits be improved? Maybe. Examiners could be required to call people who do not respond or who send back incomplete documents and offer guidance, though more personal contacts would cost more. The IRS could request less documentation or be clearer about why the documentation is needed.
Could the imbalance between audits of EITC claimants and wealthier taxpayers be corrected? Definitely. The solution is straightforward. Give the IRS more money to hire skilled auditors who can examine complicated high-income returns.
Right now, the IRS is giving top priority to processing the paper returns that taxpayers mailed before and during the closure. That will delay the resolution of correspondence audits. In addition, the pandemic may make it tougher for taxpayers to gather the documentation they need to support their claims.
This year is a mess. For now, the IRS should temporarily give up on correspondence audits and just pay the refunds claimed by taxpayers. Then it needs to think about how to improve its process of correspondence audits for the longer term.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.