In a significant move, the Internal Revenue Service (IRS) has announced a shift in its audit focus, targeting large partnerships and high-income taxpayers. This decision comes in the wake of the Inflation Reduction Act funding, which has empowered the IRS with the tools and resources to improve fairness in the U.S. tax system.
1. The New Shift in Auditor Focus
The IRS has made it clear that it will be intensifying its scrutiny on large, complex partnerships, leveraging artificial intelligence (AI) to aid in this endeavor. As IRS Commissioner Daniel Werfel recently stated to reporters, “The complex structures and tax issues present in large partnerships require a focused approach to best identify the highest risk issues and apply resources accordingly.”
The IRS has already identified 75 partnerships for audit, which will be notified in the coming weeks. These partnerships, on average, have assets exceeding $10 billion and span various industries, including hedge funds, real estate investment partnerships, publicly traded partnerships, and large law firms.
2. The Larger Tax Compliance Picture
This shift is part of a broader effort by the IRS to restore fairness in tax compliance. The agency aims to divert more attention to high-income earners, partnerships, large corporations, and promoters who might be abusing the nation’s tax laws. This initiative is driven by advanced technology and AI, which will enable the IRS to detect tax evasion schemes more efficiently and identify emerging compliance threats.
3. Protecting the Low-Income and Working Class from an Increased Chance of Audit
While the IRS is ramping up its efforts against high-income taxpayers and large partnerships, it is also ensuring that audit rates for those earning less than $400,000 a year do not increase. Moreover, the IRS is implementing new fairness safeguards for those claiming the Earned Income Tax Credit (EITC), a provision designed to assist workers with modest incomes.
4. Additional Compliance Efforts
The IRS has outlined several other areas of focus for the fiscal year 2024:
- High-Income Cases: The IRS will target taxpayers with an income above $1 million and a recognized tax debt of more than $250,000.
- Digital Assets: There will be expanded efforts surrounding digital assets, given the potential 75 percent non-compliance rate among taxpayers involved in digital currency exchanges.
- FBAR Violations: High-income taxpayers who utilize foreign bank accounts to evade taxes will face increased scrutiny.
- Labor Brokers: The IRS has identified schemes where construction contractors make payments to “shell” companies, which are then funneled back to the original contractor.
5. Protecting Everyone from Scams
The IRS is also committed to protecting taxpayers from scams and fraudulent schemes. Efforts will be made to raise awareness about emerging scams, especially those that exploit recent tax law changes or other events that might confuse taxpayers. Additionally, the IRS will continue its work with the Security Summit initiative to protect against identity theft.
The IRS’s recent announcements signal a significant change in its approach to tax compliance. With the backing of the Inflation Reduction Act and the integration of advanced technologies, the IRS is poised to ensure that the tax system is fair for all, holding the wealthy accountable while safeguarding the interests of the working class.
What income level gets audited the most?
In the United States, the IRS uses various methods to select individuals and businesses for examination or audit. The IRS enforces the U.S. Federal tax law primarily through the examination of tax returns that have the highest potential for noncompliance. This identification is determined using risk-based scoring mechanisms, data-driven algorithms, third-party information, whistleblowers, and information provided by the taxpayer. The objective of an examination is to determine if income, expenses, and credits are being reported accurately.
One of the methods the IRS uses is the Discriminant Index Function System (DIF) to analyze tax returns for oddities and discrepancies. Once a tax return has been processed through DIF, it is given a score. If the DIF score is high enough, indicating a significant number of oddities or discrepancies, that tax return may be selected for examination. Additionally, tax returns are subjected to an evaluation called the Unreported Income Discriminant Index Function System (UIDIF). This evaluation assesses tax returns based on various factors to determine a return’s potential for unreported income. Returns with high UIDIF and DIF scores may be selected for examination.
Furthermore, the IRS selects a certain number of income tax returns to be audited each year through random selection.
Historically, higher income levels have been more likely to be audited, but the exact focus can vary based on IRS priorities and available resources in any given year.
What are the odds of getting audited in 2023?
Fortunately for individual taxpayers, the already low audit rates for middle and low-income earners are not expected to rise this year. Moreover, the IRS plans to allocate a significant portion of its new budget to enhance the experience for taxpayers.
What are the most common IRS audit flags?
Some of the most common IRS audit flags include:
- Discrepancies Between Reported Income and W-2s/1099s: If the income you report doesn’t match the income reported to the IRS by employers or clients, it can trigger an audit.
- High Deductions: Claiming significantly higher deductions than what’s typical for your income can raise suspicions.
- Claiming 100% Business Use for a Vehicle: It’s rare for someone to use a vehicle exclusively for business, so this can be a red flag.
- Hobby Losses: If you report losses from what might be considered a hobby rather than a legitimate business, the IRS might take a closer look.
- Foreign Bank Accounts: Not reporting a foreign bank account can lead to severe penalties if willful.
- Rental Property Losses: The IRS often scrutinizes claimed losses from rental properties.
- Home Office Deductions: Claiming a home office deduction when you don’t meet the strict criteria can be a red flag.
- Round Numbers: Reporting rounded numbers on your tax return can indicate estimations rather than precise figures.
- Earning a Lot or Very Little: Very high earners are more likely to be audited, but those who report no income or very little income can also be on the radar.
- Consistently Reporting Losses: If you’re always reporting a loss, especially for a business, the IRS might question the legitimacy of your activities.
Always make sure the claims and deductions on your tax return are legitimate and can be substantiated with proper documentation. Ask for professional tax help if you need it.
What does the IRS consider high income?
From recent IRS press releases, it’s evident that the IRS is targeting individuals with incomes over $1 million and partnerships or entities with assets in the billions. However, the specific threshold that the IRS considers as “high income” can vary based on the context and the specific tax provision or program in question.
Who is the IRS targeting for audits?
Here are some guidelines based on IRS releases as of September 8, 2023:
- High-Income Taxpayers: The IRS is placing emphasis on taxpayers with total positive income above $1 million that have more than $250,000 in recognized tax debt. The IRS is planning to intensify work on this group of taxpayers.
- Large Partnerships: The IRS is expanding its Large Partnership Compliance (LPC) program. The partnerships under examination have assets of over $10 billion on average. This includes hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms, and other industries.
- FBAR Violations: High-income taxpayers continue to use Foreign Bank accounts to avoid disclosure and related taxes. A U.S. person with 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 foreign financial accounts exceeds $10,000 at any time. The IRS has identified potential non-filers with account balances averaging over $1.4 million.
- Partnership Discrepancies: The IRS has identified ongoing discrepancies on balance sheets involving partnerships with over $10 million in assets.