Federal audit rates for the wealthy dropped over most of the past decade, but that is now changing as the IRS, buttressed by a Biden administration that has made tax enforcement a priority, has pledged to increased scrutiny of high-net-worth taxpayers.

For all individual taxpayers, the average audit rate fell from 0.9% in 2010 to 0.25% in 2019, or by 72%, the Government Accountability Office said in a recent report. Taxpayers with incomes of $5 million or more were the most likely to be audited throughout the decade though still saw their audit rates drop 86%.

But in a recent report, the IRS said audit rates for incomes between $100,000 and $500,000 have risen to 0.6% this year, doubling from 2019. The agency said audits for taxpayers making more than $10 million annually quadrupled to 8%. And audit rates for the $1 million to $5 million category more than doubled to 1.3%.

That may only be the start. The Inflation Reduction Act of 2022, a legislative proposal currently being pushed forward by majority Democrats in the Senate, includes $45.6 billion for enhanced IRS enforcement (part of an $80 billion increase for the agency overall) and a billionaires’ minimum income tax that would require taxpayers worth more than $100 million to pay a minimum of 20% on their capital gains annually.

The legislation would also do away with pass-through tax deductions that have shielded investment managers from taxes.

“The IRS is increasing focus on non-compliant, high-income and high-wealth taxpayers, business partnerships and large corporations that make up a disproportionate share of unpaid taxes,” the agency’s new five-year plan promises.

“The IRS periodically announces special initiatives targeting high-net-worth individuals, but wealthy clients are often in the crosshairs of the IRS because of the complexity of their financial lives,” said James G. McGrory, a partner with Armanino LLP in Philadelphia.

David A. Shuster, managing principal and director of tax controversy services at Friedman LLP’s New York office, said that as confirmed recently by the IRS commissioner, audit rate statistics can be misleading. “There’s a greater lag after a higher-income taxpayer files a return and when that return gets picked up for audit, compared with when low-income taxpayer returns get picked up for audit or other questioning, such as for the EITC, which is generally questioned immediately if at all,” he said.

Wealthy clients who hold foreign assets, such as bank accounts, foreign trusts and foreign business interests, are especially at risk; penalties for not filing foreign information returns are severe. Wealthy individuals who own affiliated business entities—partnerships, S and C corps—and who “perhaps have significant intercompany activity may also be at risk,” McGrory said.

Other trouble areas include sole proprietorships and pass-through entities, gift tax returns and private foundations and the interactions that the HNW individual has with them. “Seems like charitable contribution deductions, especially for conservation easements, are susceptible to higher audit probabilities,” Shuster said.

“Audits of taxable estates are also on the rise and can have significant impact to the estate and its heirs,” added David Levi, senior managing director at CBIZ MHM based in Minneapolis. “Discounts for closely held businesses and other investments ... should be supported by quality appraisals that take into account both the asset being appraised as well as any limitations or other factors relevant about the ownership structure of the asset.”

The IRS generally audits back three years but could audit up to six years or longer. Behaviors that that can lengthen the statute of limitations on an IRS audit include underreporting income; overstating basis in an investment or asset; omitting foreign income, gifts and assets; or filing a fraudulent return or not filing a return at all.

“Audits of high-income taxpayers can occur closer to the end of the statute of limitations,” Levi said.

Audits can take several formats, said Jim Brandenburg, a Milwaukee-based tax partner at the professional services firm Sikich.

“Some are correspondence-type audits where the IRS may look at certain aspects of a taxpayer’s income tax return. ... In other cases, the taxpayer will encounter an audit where they will need to visit a local IRS office for a tax audit,” Brandenburg said, adding that a taxpayers's advisor may accompany them to such meetings.

Be prepared right from the start when you take a tax position, advisors said. “Even if the position is aggressive, having your justification when filing is significantly better than trying to put together documentation and support under the pressure of the exam,” Levi said.