High-net-worth clients have probably heard that the IRS has fewer resources to pursue audits due to budget cuts. This is true, but tax reform has created a slew of potential traps that could red-flag a return.
Budget cuts have slashed the number of audits the IRS can perform and forced the agency to “put more resources toward dealing with implementing new tax laws, curbing ID theft and updating aging computer systems,” said Bob Phillips, managing principal of Spectrum Management Group in Indianapolis.
Only about 3 percent of individual taxpayers reporting more than $1 million in income were audited in 2017—some 16,300 returns, said Phillips, citing new reports. As recently as 2012, the IRS was auditing about 41,000 returns with incomes in excess of $1 million.
“IRS budget cuts from $14 billion in 2010 to approximately $12 billion in 2017 have resulted in staff reductions. IRS agent staffing was reduced by about a third ... to less than 10,000 agents for the first time since 1953,” added Glenn DiBenedetto, director of tax planning at New England Investment & Retirement Group in North Andover, Mass.
“It used to be that the low-hanging fruit was on wealthy taxpayer returns, but the manpower [needed] to audit the wealthy is substantial,” said Richard Kollauf, vice president and director of business advisory and estate planning with BMO Private Bank in Milwaukee. “There seem to be more non-wealthy audits than before.” IRS enforcement activity still produced revenues that increased about 5 percent from 2016 to 2017, he noted.
Wealthy clients who envision themselves sitting terrified in some IRS office should know that most audits are done by letter, “where the IRS is questioning one or two items on the return and wants more information on the items,” said Brian Stoner, a CPA in Burbank, Calif. “The office audit is less frequent and tends to take anywhere from half an hour to several hours.”
“Field audits are less common—and actually sitting at an IRS desk is even more uncommon,” Kollauf said. “Spending time ahead in assembling the necessary documentation and tying it out to the reporting on your return will save time and provide comfort in the tax filing. Use counsel.”
These are among the items that might trigger an audit this year, according to Stoner:
• Mortgage interest deductions exceeding some $40,000. “This could bring the taxpayer over the $1 million pre-2018 mortgage mark or way over the new $750,000 mortgage mark on a new home purchased in 2018,” Stoner said.
• Large self-employed income on schedule C, especially with huge deductions.
• Trying to deduct a hobby as a legitimate business with a large loss every year.