The Internal Revenue Service (IRS) is considering increasing the income threshold to identify a taxpayer as being wealthy enough to be audited by the IRS’s High-Income and High-Wealth Strategy Team. The recommendation to do so was made in a report issued by the Treasury Inspector General for Tax Administration (TIGTA), and the IRS has already confirmed that it is considering the changes.
The TIGTA report found that, in the past, the IRS might not have used its resources in the most productive way in conducting audits. For instance, the IRS identified high-income taxpayers to be those who reported total positive income (TPI – basically, gross income without regard to losses) of at least $200,000 on their IRS Form 1040, U.S. Individual Income Tax Return. During year 2014, the largest number of high-income audits was conducted on taxpayers with the TPI range of $200,000 to $399,000. In 2014, 62,159 taxpayers (i.e., 1.5 percent of taxpayers) whose TPI was within this range were audited. However, the amount of revenue collected for each hour that the IRS spent on auditing this group of taxpayers was only $605. The productivity of the IRS increased to $789 per hour spent on audits conducted on taxpayers whose TPI was within the range of $400,000 to $599,999, and to $1,058 per hour spent on audits conducted on taxpayers whose TPI was within the range of $600,000 to $799,999. Therefore, in light of the continuous declining budget allocation to the IRS, the IRS is re-evaluating the income threshold for high-income taxpayers who are more likely to be audited.
Although the IRS has not expressly stated to what extent it would raise the income threshold for the high-income taxpayers, it is likely that it would focus on the following individuals and entities:
- Individuals with TPI of more than $400,000 or more than $600,000, although it is not clear how much focus would shift away from taxpayers in the $200,000-$400,000 TPI range.
- Taxpayers with very complex tax structures. In particular, this category includes taxpayers who are in control of related entities.
- Taxpayers owning international bank accounts or who established or are beneficiaries of foreign trusts. If a taxpayer has financial interest in or signature authority over certain foreign bank accounts, then the taxpayer must file Form FinCen 114. If a taxpayer is associated with certain foreign trusts, then the taxpayer may need to file information returns. The IRS has been paying special attention to failure to file Form FinCen 114 and information returns.
- Taxpayers using personal aircraft. This has become a focus of the IRS since a personal aircraft can generate large deductions in terms of depreciation and expenses associated with the business usage of the aircraft. For taxpayers, it is important to keep a contemporaneous flight log, documenting the departing and arriving cities, the identity of each passenger and the purpose of each passenger on the flight. The IRS is looking for whether the airplane is used primarily for business purposes or personal purposes.
- Individuals and/or entities making large charitable contributions. Needless to say, the Internal Revenue Code encourages charitable contributions through the allowance of deductions for those contributions, including contributions of property. The IRS does, however, look for appropriate documentation of charitable contributions. For example, with respect to each donation in an amount of more than $250, the donor must receive a letter from the charitable organization receiving the donation stating that no goods or services were received in exchange for the donation. For donations of property worth $5,000 or more, a “qualified appraisal” establishing the value of the property is generally required.
Therefore, if a taxpayer is likely be in the high-income category or if the taxpayer might fall under one of the categories listed above, the taxpayer should engage tax professionals to make sure all individual and entity tax returns are properly completed, all information returns are filed, and, if subject to an audit, understands the most appropriate way to respond. Although no one enjoys an IRS audit, careful preparation of tax returns and contemporaneous documentation of deductions, losses and credits can reduce the likelihood that such an audit could result in a significant adjustment in tax liability. Furthermore, taxpayers should be aware of standard IRS audit procedures and understand that they have certain procedural rights when dealing with the IRS.
To review the report in full, please click here.