IRS Takes Aim: Sweeping New Compliance Efforts Announced
The IRS recently announced the start of a “sweeping, historic” effort to restore fairness to the tax system, made possible by funding from the Inflation Reduction Act (“IRA”). Their plan to restore fairness in tax compliance focuses on shifting more attention to high-income earners, partnerships, large corporations, and promoter’s abusing our nation’s tax laws.
The changes will be driven with the help of improved technology, including Artificial Intelligence (“AI”). AI will allow the IRS to be more efficient, helping the agency to identify returns for audit in key areas. Using this technology, the IRS believes they can better detect tax cheating, identify emerging compliance threats, and improve case selection tools to avoid burdening taxpayers with “no-change” audits.
IRS Commissioner Werfel has emphasized that audit rates will not increase for those earning less than $400,000 a year.
The key elements of this new effort are as follows:
- Prioritization of high-income collection cases – The “High Wealth, High Balance Due Taxpayer Field Initiative” will intensify work on taxpayers with total income above $1 million that also have more than $250,000 in tax debt. The IRS plans to have “dozens” of agents focusing on these high-end collection cases in fiscal year 2024.
- Expansion of pilot program focused on largest partnerships – In 2021, the IRS launched its Large Partnership Compliance (“LPC”) program with examinations of some of the largest and most complex partnership returns in the filing population. The IRS is now expanding the LPC program to additional large partnerships. AI will be used to help select the partnership returns for examination, and they expect to open examinations of 75 of the largest partnerships, which represent a cross-section of industries (including hedge funds, real estate investment partnerships, large law firms and publicly traded partnerships). These partnerships, on average, have over $10 billion in assets.
- Greater focus on large partnerships with balance sheet discrepancies through compliance letters – The IRS has identified taxpayers filing partnership returns (with over $10 million in assets) which show significant discrepancies between end-of-year balances compared to beginning-of-year balances the following year. The number of discrepancies has been increasing over the years, and many of these taxpayers are not attaching the required statement to explain the difference. This new effort began in October with compliance letters and will focus on “high-risk large partnerships” to quickly address the balance sheet discrepancy.
- New unit being established to focus on large and/or complex passthrough entities – The IRS recently announced plans to establish a new work unit to focus on large and/or complex passthrough entities. This new unit will be housed in the IRS Large Business and International (“LB&I”) division. Passthrough organizations include entities such as partnerships and S-Corporations; these entity types are not subject to the corporate income tax, but the income from these entities is “passed through” to the income tax returns of their individual or corporate owners and taxed at that level. Partnerships and S-Corporations are frequently used by higher-income groups and can be extremely complex. The IRS expects this new work unit to “formally stand up” sometime late next year.
In addition to the new efforts discussed above, the IRS has also set forth some additional priority areas it will focus on in fiscal year 2024.
- Digital assets – The IRS continues to expand its efforts related to digital assets after an initial review showed the potential for a 75% non-compliance rate among taxpayers identified through records from digital currency exchanges.
- FBAR violations – A U.S. person that has a financial interest in a foreign financial account is required to file a Report of Foreign Bank and Financial Accounts (“FBAR”) if the aggregate value of all the foreign financial accounts is greater than $10,000 at any time during the year. Based on an analysis of filing patterns, the IRS has identified hundreds of possible FBAR non-filers with account balances that average over $1.4 million, and plans to audit the “most egregious potential non-filer cases” in fiscal year 2024.
- Labor brokers – The IRS has identified a scheme that has already been seen in Texas and Florida. According to the IRS, there have been instances where construction contractors are making payments to, and issuing Form 1099-MISC/1099-NEC to, an apparent subcontractor. However, the subcontractor is a “shell” company that has no legitimate business relationship with the contractor. The payments made to the shell companies are exchanged at Money Service Businesses, or deposited to accounts in the name of the shell company, before being returned to the original contractor. The IRS will be focusing in this area with both civil audits and criminal investigations.
Besides the priorities noted above, the IRS will also focus on protecting taxpayers from a variety of scams and schemes. While the IRS compliance work will be increasing on the wealthy, it is often average taxpayers with modest income who are targeted by scammers and fraudsters. The IRS plans to raise consumer awareness on these issues, as well as continue efforts to combat identity theft.
In order to successfully drive their initiatives forward, Commissioner Werfel emphasized the need for continued funding for the IRS. While the IRS may feel like a low priority for taxpayers, Werfel believes it’s a mistake not to fund the agency. In 2022, the IRS collected more than $4.9 trillion in gross revenues (including taxes, penalties, interest and fees), which accounts for about 96% of the funding that supports the federal government’s operations.
Source: IRS.gov
Courtney is a Tax Principal in CLA's Real Estate industry group and has more than 17 years of experience providing accounting, tax and consulting services to real estate owners, operators and developers. She also consults with high net-worth individuals and owners of closely-held businesses on all aspects of tax planning.
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