For the past decade, the IRS has become increasingly concerned with the upward trend in both the quantity of taxpayers who do not file required tax returns (non-filers) and the amount of tax that is foregone because of noncompliance. These issues create a significant difference between what taxpayers should pay and what they actually pay on time, commonly referred to as the “Tax Gap.” After study and review, the IRS determined that high-income taxpayers comprise a large percentage of the amount of the tax gap, even though they represent a small fraction of the taxpayer population.
In an effort to close the tax gap, the IRS announced a compliance initiative that targets high net worth taxpayers with interests in foundations, partnerships and other pass-through entities. Executed through a series of IRS audits, the initiative will be ongoing and does not have an expiration date. The IRS’s Large Business and International Division formed the Global High Net Worth Group (“GHW”), commonly referred to as the “Wealth Squad.” to conduct these audits. The Wealth Squad takes a holistic approach to examinations, which may involve examining entities controlled by the high net worth taxpayer.
The American Families Plan, proposed by the Biden Administration, calls for an additional $80 billion in funding for IRS enforcement activities. There does not currently appear to be broad Congressional support for this level of funding however a significant increase in funding is expected.
High net worth individuals of interest to the Wealth Squad are those with one or more of the following characteristics:
- Majority ownership or significant influence over an entity or entities
- Control or substantial influence over a private foundation
- Substantial charitable contribution deductions
- International tax filings or international transactions
- Family offices
- Self-employment income or employment tax issues
- Information return filing requirements
- Expense deductions for the use of yachts and airplanes
- Uses complex tax planning to significantly reduce taxable income
What can be done to mitigate the risk of an examination in the current or future years?
- Maintain good records and be able to substantiate the business purpose of every deduction and tax basis in property
- Satisfy all formal requirements relating to entity formation and registration
- Keep separate ledgers to easily segregate business activities
- Compile a complete list of commonly targeted assets such as foreign bank accounts, foreign trusts, and foreign business interests and ensure proper reporting has been prepared and filed
- Understand gifting practices and have records available of gifts reported on gift tax returns and those not reported
- Use business credit cards for business purposes only
- Do not try to move expenses around and play the audit game
- Be wary of tax promoters who promise large tax deductions
- Be honest and open regarding the extent and location of your assets and accounts– understand that the IRS can summon records from third parties and can share information with other countries
- Determine issues that could trigger an examination of the tax return and consider filing an amended return, if necessary
- Ensure there is a business purpose for transactions with related private foundations
- Conduct proper due diligence on any transaction with a related tax benefit, including documenting any legal or accounting opinion
Reach out to your RSM tax advisor for additional detailed information and guidance.