Over the past 15 years, the IRS has attempted to ramp up its scrutiny of wealthy individuals.
In 2009, the IRS created its Global High Wealth Industry Group, known more familiarly as the “Wealth Squad.” This group starts with an examination of a “key case,” which is typically a wealthy person’s individual tax return, and expands its examination to all tax returns associated with that individual, including the individual’s interests in partnerships, trusts, subchapter S corporations, C corporations, gift tax or estate returns. The broad and complex nature of these examinations requires a significant amount of time and a large team of IRS personnel from various departments, including attorneys and experts in valuation, financial products and international matters.
Although the “Wealth Squad” has not been especially successful, in 2019 and 2020 the IRS announced new efforts to increase its focus on pass-through entities, high net worth individuals and individuals with high income.
Recently, following billions in new funding promised under the Inflation Reduction Act, the IRS released IR-2023-166 announcing new and revitalized tax enforcement efforts. Like earlier efforts, many of these programs, such as the ones described below, will focus on the wealthiest filers, including high-income individuals, partnerships and large corporations.
1. Large Partnership Compliance (LPC) Program – A collaborative effort between data science experts and tax experts to develop artificial intelligence (AI) and other technology is allowing the IRS to identify areas of potential compliance risk in one of the most complex areas the agency audits – large partnerships. The IRS hopes this collaboration of expertise and AI technology will help it better understand how large, sophisticated partnerships operate to improve case selection and auditing functions.
The IRS has used this technology to select 75 of the country’s largest partnerships, with average assets over $10 billion each, for sophisticated examinations beginning this fall. These partnerships span multiple industries, including hedge funds, real estate investment partnerships and publicly traded partnerships. The examinations will look closely at the partnership’s operations and tax filings over multiple years. If the examinations reveal major compliance issues, we can expect the IRS to continue this focus in the future.
2. Compliance Audits for Partnerships – Better technology and more revenue officers have allowed the IRS to start focusing on another indicator of possible noncompliance found in tax returns for larger partnerships – discrepancies between partnership balances at year-end and beginning balances for the following year, particularly when tax returns did not include the required explanation statements. The IRS will mail compliance letters to approximately 500 of the country’s largest partnerships this fall. Depending on the result of this outreach, these partnerships could be added to the IRS list for examination.
3. High Wealth, High Balance Due Taxpayer Field Initiative – For fiscal year 2024, the IRS will dedicate dozens of revenue officers to focus on collection cases for approximately 1,600 taxpayers with incomes above $1 million and with at least $250,000 in tax debt.
4. International Tax/FBAR Violations – The IRS has used its new technology to analyze years of filings looking for patterns that show taxpayer nonfiling of a required Report of Foreign Bank and Financial Accounts (FBAR). IRS instructions require that this report must be filed for a U.S. “person” (individual, corporation, partnership, LLC, trust or estate) who has “a financial interest in or signature or other authority over at least one financial account located outside the United States” in the event that “the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.”
The IRS indicated it has identified hundreds of taxpayers, with accounts averaging over $1.4 million each, who have possibly failed to file an FBAR. The IRS plans to audit “the most egregious” cases in fiscal year 2024.
5. Virtual Currency Compliance Campaign – The difficulty in tracing cryptocurrency transactions makes it difficult for the IRS to determine if taxpayers are using them to hide taxable income. To circumvent this issue, the IRS has been serving John Doe summonses on cryptocurrency dealers looking for information about U.S. taxpayers whose identities are unknown. These summonses force cryptocurrency dealers to produce documents identifying U.S. taxpayers and information regarding their cryptocurrency transactions. IRS analysis of tax returns in conjunction with the records from digital currency dealers shows a possible 75% non-compliance rate with tax laws regarding digital assets, and the IRS expects to step up examinations in this area in fiscal year 2024.
It will take time to determine if the results of these new enforcement efforts yield enough additional revenue to warrant additional funding into the future, but individuals with partnerships and foreign or digital assets should be prepared for possible IRS scrutiny. To prepare for or respond to intensified IRS enforcement efforts, reach out to your Warner attorney or to Erin Lasenby at firstname.lastname@example.org or 313.546.6133.