Audits are decreasing, but audits on the wealthy could be on the rise

The IRS' resources have diminished over the past five years. Due to budget cuts, the number of IRS enforcement officers has decreased from a high of nearly 23,000 agents in 2010 to approximately 16,000 agents presently. For this reason, audits are at historic lows with only one out of every 143 taxpayers subject to tax examination.

Obviously, the decline in IRS resources and decreased number of audits will not cause most taxpayers to lose any sleep, even with the knowledge that audits are necessary for our tax system to function properly. While most taxpayers have a lesser chance of facing an audit, there will be an increase of focus by the IRS on one particular group of taxpayers, the wealthy.

"That's where the money is."

This quote is attributed to notorious criminal Willie Sutton when asked why he robbed banks. One could surmise that the IRS targets high earners for the same reason. Currently, someone with an income of $1 million or more is roughly ten times more likely to be audited than someone with less than $200,000 in income. Early indications are that in 2017, the IRS is much more likely to focus its efforts on scrutinizing wealthy taxpayers' tax returns.

A comprehensive approach

Clearly, the IRS will not disclose its entire strategy, but it appears that the IRS will be taking a multi-faceted approach against higher-earning taxpayers. Early signs indicate that the IRS is sending automated notices to taxpayers who claim large deductions in the following areas:

  • Mortgage deductions
  • Charitable deductions
  • 529 college fund deductions
  • Deductions for so-called "hobby businesses" that are unlikely to be successful

In these notices, the IRS will request documentation to support the deductions at issue. This is only one weapon at the IRS's disposal, however.

The Global High Wealth Industry Group is a special task force within the IRS known as the "Wealth Squad." This group will carefully scrutinize a taxpayer's assets, looking closely at both domestic and offshore assets. This Wealth Squad, which is part of The Large Business and International Division of the IRS, has announced it will inspect certain types of transactions, believing them to be a source of potential tax revenue. These transactions include:

  • Energy credits
  • Taxpayers who withdrew from the Offshore Voluntary Disclosure Program (OVDP)
  • Corporations transferring funds to pass-through entities and/or shareholders
  • Basket transactions
  • S Corporation losses claimed in excess of basis
  • Repatriation of funds without reporting as income

This is far from the full list of transactions. Between the scrutiny of the Wealth Squad, the increased risk of audit, and requests for documentation, the wealthy need to have a strong tax strategy in place. Even with diminished resources, the IRS is a formidable opponent. Skilled counsel and advocacy from a tax attorney are essential when facing an audit or tax controversy.