After getting $80 billion from last year’s Inflation Reduction Act, the IRS is poised to make good on its long-standing pledge of paying more attention to taxpayers who make more than $400,000 annually.
The agency will be focusing on “segments of taxpayers with complex issues and complex returns where audit rates are minimal today, such as those related to large partnerships, large corporations, and high-income and high-wealth individuals,” according to the new Internal Revenue Service Inflation Reduction Act Strategic Operating Plan.
More than half of the agency’s new funding was allocated to enforcement and the plan makes it clear that “the current administration wants the IRS to increase audits of wealthy individuals and large corporations,” said Rochelle Hodes, principal in the Washington National Tax Office of the accounting firm Crowe in Washington, D.C.
One question is how long it will take for the IRS to step up enforcement.
“I don’t anticipate that audits are going to ramp up too quickly, as the IRS still has to hire and train agents,” said Bill Smith, national director of tax technical services at CBIZ MHM’s National Tax Office in Washington, D.C. “It does not have hundreds of experienced agents who have been sitting around waiting to get assignments. But with the IRS having a three-year window to start an audit … they could get the hire-and-train machine cranked up in time to start audits of 2023 tax returns. A taxpayer’s 2022 return is less likely to be impacted by the funding and increased audit activity.”
Some terms of the IRS plan also need fleshing out. “The IRS refers to ‘making’ $400,000, which is not a tax term,” Smith said. “If a taxpayer has taxable income under $400,000, is that the threshold? He could have $5 million of capital gains and $4.7 million of capital losses and have taxable income under $400,000, but did he ‘make’ $5 million or $300,000?”
Wht are some of the possible tax issues for wealthy clients down the road? “The balance some business owners have between taking a salary versus distributions from their company,” said Bruce Primeau, a CPA and president of Summit Wealth Advocates in Prior Lake, Minn. “A salary is subject to payroll taxes where distributions are not. The IRS is likely to crack down on those business owners that focus most of their cash flow out of their businesses as distributions and take too small a salary … to minimize the amount of payroll taxes they’re paying.
Pass-through tax breaks may be another area of focus, Smith said.
“Most wealthy taxpayers have a lot of pass-through income or loss from investments,” Smith said. “Historically, the IRS has done a poor job auditing large partnerships and S corporations. … I expect this will be a big focus.”
Deductible business expenses are another potential area of interest for the IRS, Primeau said.
“Another area could be to scrutinize the expenses business owners are running through their companies, to ensure those expenses are legitimate business expenses versus personal, non-deductible expenses,” Primeau added. “Some business owners abuse this opportunity, and my guess is the IRS will be taking a much closer look at this area.”
The IRS has just released proposed regulations on micro-captive insurance company investments that expand what constitutes a transaction of interest and the corresponding reporting. “I expect similar proposed regulations regarding syndicated conservation easements,” Smith said. “These are low-hanging fruit for audit purposes, and they are primarily used by taxpayers over the $400,000 threshold.”
Advisors said clients should think carefully about risky tax moves. “You may have slipped through the audit cracks in the past but it’s less likely you’ll do so in the future,” Smith said. “Make sure that your pass-through investments are with reputable companies who are not being overly aggressive in their tax reporting.
“If you’re on the fence with regard to the $400,000 threshold,” Smith added, “resist doing something shady to go from $500,000 to $399,000 of income thinking that you’ve pulled a fast one on the IRS.”
Advisors added that IRS enforcement has become a political issue, so the enfocement environment could change once again.
Scrutiny on the wealthy “is supported by Democrats in Congress,” Hodes said. “The Republicans, on the other hand, have questioned how the IRS intends to use the funds it received under the IRA and have indicated an to intent claw back that funding. … It’s unlikely that both sides will agree on appropriate funding of the IRS and that the issue of funding [and] enforcement priorities will remain hot topics for the candidates during the run up to the 2024 election.”