IRS Correspondence Audits Frustrate Taxpayers; Disproportionately Impact Lowest Wage Earners
Kati Kiefer is the clinic director and qualified tax expert of the Low Income Taxpayer Clinic at Legal Aid Society. Reach her directly at (502) 614-3161 or kkiefer@yourlegalaid.org.
By Kati Kiefer
For many taxpayers, the most important role of the IRS is the timely issuance of their refunds. That hasn’t happened for millions of taxpayers over the last three years, according to the National Taxpayer Advocate’s 2022 Annual Report to Congress. Such delays hit low-income families especially hard, as their tax refund may serve as a lifeline to afford reliable transportation, a housing rental deposit, or deferred medical care. If their refund is pending for an audit, the financial pain becomes worse for low-income taxpayers. Most will experience a much longer delay, an automated auditing process with little to no human interaction, and in some cases, total disallowance of their refund. Refunds that include refundable tax credits, such as the Earned Income Tax Credit (EITC), are not issued by the IRS until late February, despite opening tax return filing in January.
Various factors within and outside IRS control have contributed to processing delays, many of which were exposed during the pandemic. This article focuses on delays caused by correspondence audits, and how such audits disproportionately burden low-income families.
Correspondence Audits
A correspondence audit, simply put, is an examination of tax conducted by mail. Over the past several decades, correspondence examination has become the primary method of auditing individual taxpayers, accounting for up to 85% of all IRS audits. During the pandemic, IRS relied almost exclusively on correspondence examinations. In theory, the issues involved in a correspondence exam cover a single tax year and should be easily resolved with simple documentation. In practice, however, the process tends to be exasperating and time-consuming for taxpayers, dragging out for months and even years in appeal cases.
Correspondence audits were originally intended for less complex matters. They are now used to examine dependent tax credits, the Earned Income Tax Credit (EITC), self-employment income, and other issues that tend to involve complicated factual situations. Compliance contacts, which the IRS does not consider audits (e.g., math error corrections, automated underreporter notices, wage verification, and non-filer programs), are also conducted through the automated correspondence examination system.
Most of the correspondence exam process is automated for individual taxpayer audits. Unlike other IRS audits, correspondence audits are not assigned to a single examiner who works the case and serves as the taxpayer’s point of contact for questions. Unless the taxpayer responds to the audit notice, a correspondence exam will progress systematically through each stage of audit, often without human intervention, until the Notice of Deficiency is issued. When taxpayers do attempt to call the IRS, often they are frustrated by hour long wait times and the inability to reach a live person. As a result, assessments issued by default are not uncommon. IRS data shows that in 2021, 42 percent of correspondence audits were closed without any response from the taxpayer.
Impact on Low-Wage Earners
While many taxpayers experience difficulties with correspondence audits, low-income taxpayers are at a distinct disadvantage. First, audits of refundable credits, such as the Earned Income Tax Credit (EITC) and Child Tax Credits, are conducted exclusively by correspondence. Consequently, low-income earners claiming the EITC on their return suffer the highest rate of IRS correspondence audits.
For context, the Earned Income Tax Credit (EITC) was established in 1975 to offset the effects of payroll taxes on working poor families and to incentivize lower-paid work. Administered through the federal income tax system, the EITC is a refundable tax credit; if the amount of the credit exceeds the taxpayer’s income tax liability, the taxpayer receives a refund from the IRS for the difference. It is, in effect, the largest wage subsidy program for low-income households in the United States. Only 82 percent of Kentuckians eligible for the EITC claimed the credit on their 2019 return.
EITC compliance efforts on the part of the IRS, which focus on correspondence auditing, are seemingly inconsistent with the objectives of the EITC. Advocates for low-income taxpayers have criticized the EITC correspondence exam process as contrary to taxpayers’ right to challenge the IRS and be heard, the right to quality service, and the right to be informed. The research backs up this assessment. In 2019, an IRS operational audit sampled EITC correspondence audits from 2008 to 2015. The report found that between 76 and 80 percent resulted in a complete denial of the EITC. In only 15 percent of those audits was EITC ineligibility confirmed. It is important to note that if the IRS determines that a taxpayer claimed the EITC against the rules, the taxpayer may be banned from claiming the EITC for two years and face additional penalties.
Second, the correspondence auditing process, which is designed to expend the least amount of resources on the largest number of examinations, offers the lowest level of service to the taxpayers who are most in need of assistance. Documentation forwarded to the IRS in response to a correspondence audit is reviewed by tax examiners, not IRS agents. While tax examiners receive training on EITC and other correspondence audit issues, they are not required to have accounting skills. In my experience, this has resulted in a hardline stance on the types of documentation accepted to resolve EITC issues at the audit level. If an appeal is possible, I have found more success when the same documentation is reviewed at a higher level, such as the Independent Office of Appeals or IRS Office of Chief Counsel.
Role of Low Income Taxpayer Clinics
The effects of a problematic EITC correspondence audit system are felt throughout our community. A 2019 IRS report concluded that EITC correspondence audits affect real economic activity, finding changes in the likelihood of employment in the years after being audited. The downstream consequences of an unagreed audit also result in additional costs to the IRS in the form of audit reconsiderations and appeals involving the Independent Office of Appeals or IRS Office of Chief Counsel, as well as to low-income taxpayer advocates serving the community.
The Low Income Taxpayer Clinic at Legal Aid Society provides free legal assistance and representation to eligible taxpayers facing EITC audits, collection issues, and other IRS disputes. Navigating IRS issues may be challenging for low-income taxpayers, who are more likely to experience lower literacy rates and limited English proficiency. Many of our clients contact us during tax season for advice about an IRS notice they have received, or answers to why their refunds are delayed. In some cases, the IRS is unable to provide information until several months after the return was filed. Issues arising from dependent claims and EITC audits often require creative documentation to establish complex factors, such as marital or legal status, housing situation, and relation to others within their household. Some of our clients are unbanked, which may limit the ability to substantiate income and expenses.
The role of Low Income Taxpayer Clinics in helping people overcome IRS issues is significant. In 2021, LITCs throughout the nation represented over 20,000 taxpayers dealing with an IRS controversy and advised an additional 15,000 taxpayers. They helped low-income taxpayers in securing more than $6.7 million in tax refunds and reducing their tax liability by more than $62 million. Low Income Taxpayer Clinics could not have reached this many people without the assistance of the 1,200 volunteers who contributed more than 46,000 hours of their time.
The success of our Low Income Taxpayer Clinic is tied closely to our community partnerships and pro bono volunteer network. If you are an attorney, certified public accountant, or enrolled agent interested in pro bono tax work, please contact the Legal Aid Society at (502) 584-1254 or click here.