The IRS has pledged to intensify scrutiny on many wealthy taxpayers and their complex dealings, foreign and digital assets and other suspected areas of low compliance.
But is there anything wealthy clients can do in response?
“There is increasing awareness among high-net-worth families of the potential for increased IRS audits,” said Rob Kovacev, Washington, D.C.-based tax controversy partner at Miller & Chevalier and a former senior litigation counsel at the Tax Division of the U.S. Department of Justice. “Tax professionals should be warning their high-net-worth clients, including those who haven’t been audited in years, if ever.”
Kyle Hafstad, estate planning advisor at Exencial Wealth Advisors in in Plano, Texas, said it’s important to let clients know that following the rules is the best way to deal with the increased scrutiny.
“We remind them that staying compliant is and always has been a priority, regardless of the number of IRS agents, and that the lack of agents has made actually dealing with the IRS over the last few years even more challenging,” he said.
Clients who earn income through complex business structures, such as partnerships and corporations, are the most likely to draw attention from the IRS, said Sophia Duffy, associate professor of business planning at The American College of Financial Services in King of Prussia, Pa.
“Often, these businesses own other, smaller subsidiaries, making the flow of income even more complex,” she said. “Auditing these taxpayers is extremely time-consuming and requires a high level of expertise.”
Advisors said there are other planning tools that could trigger an audit.
“First, outright taxable income avoidance: trusts that have been labeled irrevocable spendthrift trusts and marketed as a way of outright income tax elimination, not deferral,” Hafstad said, adding that the IRS has already invested in gathering information “and challenging 831(b) small captives,” he said. “This will most likely continue as they seek to ensure legitimate insurance is being provided and risk sharing is actually occurring. They may also look to challenge larger family partnerships and entities.”
Duffy said the IRS seems to be zeroed in on business entities, at least for the time being.
“[Clients] may have heard that taxpayers earning over $400,000 per year will be specifically targeted, but it appears the IRS is only focusing on complex business entities for now, including publicly traded partnerships, hedge funds, REITs, large law firms and so on,” Duffy said. “They’re starting with the highest partnership asset values—over $10 billion for audits and $10 million for non-compliance.”
Bruce Primeau, president of Summit Wealth Advocates in Prior Lake, Minn., said the people “most ripe for additional scrutiny” are business owners who run personal, non-deductible expenses through their corporate entities. “I’m convinced this activity continues to take place. My advice is the same – operate within the confines of the law, as it just isn’t worth getting caught,” he said.
Kovacev said the IRS is now treating wealthy families “like a sophisticated business enterprise and scrutinizing their taxes across all tax areas.
“Expect a family to be audited individually at the same time as the businesses it owns [and] its international business interests are audited in coordination with foreign tax authorities, the private foundations it funds are audited and so forth,” he added.
Artificial intelligence will allow the IRS to be more aggressive in its scrutiny, advisors noted. “AI technology is already being used to analyze data and flag partnerships for audit and compliance risks,” Duffy said. “The use of this technology will super-charged the IRS by performing analyses of vast amounts of data, much more rapidly and accurately than can be done by individual IRS staff.
“This means that clients who formerly flew under the radar may now be flagged,” she said.