After getting $80 billion from last year’s Inflation Reduction Act, the IRS is poised to make good on its longstanding pledge of paying more attention to taxpayers making more than $400,000 a year.
The agency will be focusing on “segments of taxpayers with complex issues and complex returns where audit rates are minimal today, such as those related to large partnerships, large corporations, and high-income and high-wealth individuals,” according to the agency’s “Inflation Reduction Act Strategic Operating Plan,” released in April.
More than half of the agency’s new funding was allocated to enforcement, and the plan makes it clear that “the current administration wants the IRS to increase audits of wealthy individuals and large corporations,” says Rochelle Hodes, a principal at the accounting firm Crowe in Washington, D.C.
But how long will it take for the agency to step up enforcement?
“I don’t anticipate that audits are going to ramp up too quickly, as the IRS still has to hire and train agents,” says Bill Smith, national director of tax technical services at CBIZ MHM in Washington, D.C. “It does not have hundreds of experienced agents who have been sitting around waiting to get assignments. But with the IRS having a three-year window to start an audit ... they could get the hire-and-train machine cranked up in time to start audits of 2023 tax returns.”
That means 2022 returns are less likely to be affected.
Some terms of the IRS plan also need fleshing out. “The IRS refers to ‘making’ $400,000, which is not a tax term,” Smith says. “If a taxpayer has taxable income under $400,000, is that the threshold? He could have $5 million of capital gains and $4.7 million of capital losses and have taxable income under $400,000, but did he ‘make’ $5 million or $300,000?”
One question likely to come up is how much business owners take from a salary and how much from distributions at their companies, says Bruce Primeau, president of Summit Wealth Advocates in Prior Lake, Minn. “A salary is subject to payroll taxes, where distributions are not. The IRS is likely to crack down on those business owners that focus most of their cash flow out of their businesses as distributions and take too small a salary ... to minimize the amount of payroll taxes they’re paying,” he says.
Pass-through tax breaks may be another area of focus, Smith says.
“Most wealthy taxpayers have a lot of pass-through income or loss from investments,” Smith says. “Historically, the IRS has done a poor job auditing large partnerships and S corporations.”
Deductible business expenses are another potential area of interest for the IRS, Primeau says.
“Another area could be to scrutinize the expenses business owners are running through their companies, to ensure those expenses are legitimate business expenses versus personal, non-deductible expenses,” Primeau adds. “Some business owners abuse this opportunity, and my guess is the IRS will be taking a much closer look at this area.”
Advisors say clients should think carefully about risky tax moves. “You may have slipped through the audit cracks in the past, but it’s less likely you’ll do so in the future,” Smith says. “Make sure that your pass-through investments are with reputable companies who are not being overly aggressive in their tax reporting.
“If you’re on the fence with regard to the $400,000 threshold,” Smith adds, “resist doing something shady to go from $500,000 to $399,000 of income thinking that you’ve pulled a fast one on the IRS.”
Keep in mind: IRS enforcement has become a political issue. With both Republicans and Democrats in disagreement, the enforcement environment could change once again.