In focus - Increasing IRS audits in private tax

When the Inflation Reduction Act was passed, the US government earmarked significant increased funding for the Internal Revenue Service (IRS). The impact of this is expected to be felt in the financial year 2024. As we approach the end of the current year, it might be useful to consider what we can expect as a result of this increased funding.

As we have always made clear, increased funding for the IRS is to be welcomed where it can enable the IRS to invest in better technology, better training, and more staff – all of which will significantly help address historic service issues and improve the interaction of the IRS with both ourselves and our clients.?It is worth referring back to an EY US edition tax news update regarding an IRS announcement on 8 September 2023 which provided some more details of what might also be expected.

In September 2023, the IRS announced that for the financial year 2024, they would be introducing a coordinated enforcement strategy involving audits of the largest partnerships and high-wealth individuals. The additional focus and priority on FBAR (FinCEN Form 114) filing is important for individual taxpayers with overseas accounts. There has been a considerable amount of press attention on these forms and the associated penalties, with the Supreme Court issuing an opinion on the appropriate maximum penalties for non-wilfully failing to file the form. Although this was resolved in the taxpayer’s favour, it still confirmed that $10,000 (indexed for inflation) can apply to late or incorrect forms per year.

This new approach to audits is a dramatic shift in auditing philosophy by the IRS.?Historically, passthrough entities had an audit rate of c.0.5% which has recently dropped to 0.2% according to the 2022 IRS report. Although this sounds low (and it is), the audit rate was not much higher in 2010.?During that time, the audit rate for partnerships was only 0.5% and for S corporations it was 0.4%.?Any focused efforts on passthroughs would represent a significant increase of current audit activity.

A recent analysis of audits focused on larger taxpayers revealed that while the audits of complicated returns are more costly to administer, they do raise more revenue per audit dollar spent. Therefore, the proposed uptick in audits at the higher income bands would, in theory, generate more revenue which would then in turn encourage more audit activity. The IRS has pledged that audit rates will not increase for those earning less than $400,000 a year. We do however expect to see increased audit activity of high-income taxpayers and those with complex situations, including those reporting income from partnerships and other entities. Taxpayers residing overseas often pay substantially less tax than US resident taxpayers due to foreign tax credits claims. We do not yet know if a large foreign tax credit claim alone will trigger an increased audit risk.

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As always, we are happy to talk to discuss with you what steps can be taken to prepare for greater scrutiny and challenges. This can be as straightforward as ensuring your recordkeeping is thorough and supports all your tax return information. This can also involve a greater analysis of where the risk areas are, what the alternative treatments could be, and what options are available to you.

We will be working closely with our colleagues in the US and around the world, coordinating with our National Tax Department to better serve our clients.

If you would like to discuss this further, please reach out to the individuals below or your usual EY contact.

Author:

Carol Hipwell, Partner, EY Private Client Services

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