Sharper IRS scrutiny on high-net-worth taxpayers makes watching for audit triggers critical this filing season, advisors say. From closely held businesses to charitable contributions and other holdings and financial moves of wealthy clients, what’s likely to raise a red flag?
“CPA firms are all seeing a large increase in audit notices asking for a lot of details, records and explanations,” said Barbara Taibi, a partner for private client services at Eisner Advisory Group in Iselin, N.J. “The chances of an audit are much higher than only a few years ago.”
The current scope of audit risk tends to be broad “and aimed carefully at uncovering high-dollar non-compliance,” said Kris Yamano, a partner at Crewe Advisors in Salt Lake City.
“Many of our [wealthy] clients are hearing a buzz around increased audit risk for high-net-worth individuals and closely held businesses, which is good: An awareness of the risk is an important factor,” she added.
The Treasury Department has directed the IRS—which has received an infusion of billions of dollars earmarked for enforcement—to avoid increased scrutiny on small businesses or households below $400,000 in income and focus on large corporations, high-income and high-net-worth individuals, and complex pass-through entities.
“The IRS has found that investing in these types of audits has produced the highest return,” said Daniel Lutz, tax partner at Sikich in Naperville, Ill. “It will be interesting to see if that holds true. Just because there is an increase in audits doesn’t necessarily mean there will be that same increase in revenue for the IRS.”
The IRS has indicated that it will increase attention on high-net-worth individual taxpayers, especially those with income exceeding $1 million and more than $250,000 in recognized tax debt.
One issue the IRS is looking for is discrepancies on balance sheets involving partnerships with more than $10 million in assets, Yamano said. The agency is also looking harder at reports on foreign assets exceeding $10,000 and form 1099-MISC or 1099-NEC payments from construction contractors to apparent shell company sub-contractors, she said.
Large deductions or tax credits that look outsized compared to a taxpayer’s income and any unreported income are also high on the agency's list, she added.
Digital assets are also raising red flags with the agency, advisors say.
“Auditors will take on analyzing taxpayers’ cryptocurrency transactions to ensure proper reporting related to acquisition, swaps, staking and sales for stablecoins or cash,” Lutz said.
Wealthy individuals with closely held businesses are the most vulnerable to full audits, Taibi said. “Most items are now independently verified digitally by the IRS," she said. "They receive all information from W-2s, 1099 s, payment information, K-1s from partnership interests. But the area that they do not have the ability to match is income and deductions from a sole proprietorship reported on a Schedule C. The IRS needs to determine that income has not been understated and expenses overstated.”