Fewer IRS Audits Doesn't Mean It's a Tax Cheat Free-For-All
Two things can be true at the same time. Yes, IRS is conducting fewer audits. No, it is not a free-for-all for tax cheats.
In the wake of large IRS budget cuts and the significant loss of its workforce, is the agency turning into a paper tiger?
Since President Trump began his second term in office, IRS funding has declined precipitously, and there has been a sharp drop in personnel. Congress set the IRS's fiscal year 2026 budget at $11.2 billion, 9% less than the IRS's 2025 fiscal year funding, and House appropriators want to slash it further, to $10.2 billion for 2027. Additionally, the IRS has lost over 20% of its workers since January 2025 through voluntary deferred resignations and layoffs, with even more departures expected this year.
And there's been lots of chaos at the top leadership at the IRS over the past 17 months. The IRS is on its seventh commissioner since January 1, 2025. Scott Bessent, the Treasury Secretary, is also the nominal head of the IRS. But Frank Bisignano oversees all day-to-day operations at the agency. As chief executive officer of the IRS, he essentially acts as the de facto commissioner. Bisignano is doing double duty. He is also the commissioner of the Social Security Administration. Many other high-level officials have also left the IRS.
The IRS's enforcement arm is feeling the brunt of the personnel and funding cuts. Congress has rescinded most of the IRS's $80 billion windfall from 2022's Inflation Reduction Act. And some of the biggest drops in the agency's employee headcount are from its examination and collection groups. The IRS has lost one-in-four of its enforcement workers through voluntary deferred resignations, retirement and layoffs. Many of them were experienced agents and managers with deep knowledge. This lost know-how will be hard to replenish with those employees who remain. And it will only get worse for the IRS. For instance, the Trump administration's fiscal year 2027 budget request for the IRS includes an additional 18% cut in enforcement activities and projects fewer than 25,000 total enforcement employees.
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How is the IRS's budget and personnel cuts impacting IRS audits? The overall number of audits is declining. In recent years, the IRS audit rate for individuals was significantly below 1% (for example, the audit rate for 2018 individual returns was 0.3%), and we expect this figure to continue to go down, at least over the next few years.
Many filers are now escaping the audit anvil because of scarcer audit resources. Two prime examples are high-income individuals and partnerships. The number of IRS audits of individuals with $10 million or more of income has fallen from 6,786 in fiscal year 2025 to 2,264 in fiscal year 2026. The number of IRS audits of partnerships has also declined from 3,174 in fiscal year 2025 to 2,932 in fiscal year 2026. The IRS forecasts even further declines in these audits in fiscal year 2027.
AI will help the IRS filter its audit targets
But this does not mean it is a free-for-all for tax cheats. According to leaders at the IRS, there will be fewer overall audits, but the exams that are done will be more targeted.
Data analytics and artificial intelligence use are increasingly the norm in the IRS's enforcement arsenal. Data-mining software can sift through taxpayer data, expose suspicious activity and identify cases for audit. The IRS is relying more than ever on this technology to more precisely identify high-risk noncompliance and to improve efficiency.
We also expect that the IRS will go after low-hanging fruit. One example is refundable credits, such as the earned income credit, American Opportunity credit, the Affordable Care Act's premium tax credit, and the refundable portion of the child tax credit. Most of these audits are done through correspondence, meaning the taxpayer never meets with an IRS employee. They're a bit more cost-effective, since the audit is generally limited to only one or two issues. The IRS also knows that there is lots of money lost each year to erroneous claims of refundable tax credits. The IRS estimated it improperly paid $21.4 billion in refundable credits in fiscal year 2024 alone.
Taxpayers with income-matching discrepancies will also be a prime target of the IRS. The IRS's automated underreporting program matches data on information returns, such as Forms W-2 and 1099, with income amounts reported on individual tax returns. If there is a significant mismatch, the IRS will alert the taxpayer to the issue by sending out a computer-generated CP2000 notice.
High-income nonfilers have been on the list of the IRS's enforcement priorities in recent years, and we expect this trend to continue. The primary emphasis is on individuals who received income in excess of $100,000 but didn't file a tax return.
The IRS will continue to go after abusive tax schemes that it includes on its annual Dirty Dozen tax scams. For 2026, these include:
- Bogus self-employment tax credit promotions
- Overstated withholding
- Abusive noncash charitable contribution schemes, many of them involving the donations of conservation easements
- Refundable tax credits for abusive undistributed long-term capital gains on Form 2439 by investors in real estate investment trusts and mutual funds
- Misleading tax breaks touted on social media: (1) one scheme encourages employees to take the sick and family leave credit, (2) another uses Schedule H, Household Employment Taxes, to seek false refunds, and (3) a third urges filers to claim the fuel tax credit.
There are also audit red flags that could increase the chance of the IRS pulling your return for examination. We'll briefly describe a few of these red flags.
- Taking higher than average deductions. If the deductions, losses, or credits on your return are disproportionately large compared with your income, the IRS may want to take a second look at your return.
- Claiming large charitable deductions. If your charitable deductions are disproportionately large compared with your income, it raises a red flag. Also targeted are conservation easement donations and taxpayers who fail to comply with the substantiation requirements. You can find information on the substantiation rules for charitable donations in IRS Publication 526.
- Claiming substantial business losses or large deductions on Schedule C.
- Deducting a hobby loss on Schedule C, especially if you have multiple years of losses from the activity and have lots of income from other sources.
- Deducting large rental losses on Schedule C. The IRS is pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real-estate Schedule C businesses show lots of income.
This first appeared in The Kiplinger Tax Letter. It helps you navigate the complex world of tax by keeping you up-to-date on new and pending changes in tax laws, providing tips to lower your business and personal taxes, and forecasting what the White House and Congress might do with taxes. Get a free issue of The Kiplinger Tax Letter or subscribe.
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