Jenny Johnson is a Partner in our Chicago office
Tax administrations around the world are focusing their attention on high net worth individuals – and the IRS is no exception. In the fall of 2009, the IRS formed the Global High Wealth Industry Group, commonly known as the "wealth squad," to conduct unified, holistic examinations assessing the tax compliance of the entire web of entities controlled by a high wealth taxpayer or family group. The targets are taxpayers with tens of millions of dollars in either assets or income, and the audits are unbelievably comprehensive and burdensome.
Formation of the wealth squad is a game-changing move for the IRS. Historically, IRS examinations focused on a single type of return for a single taxpayer, which missed compliance issues buried within layers of limited liability companies, partnerships, trusts, private foundations and other related entities. Now, the wealth squad is coordinating examiners and specialists to analyze the complex domestic and foreign arrangements created by the sophisticated advisers who assist wealthy individuals and families. Exams start with the taxpayer's 1040 and then fan out to look at family member returns, as well as private foundations, retirement plans, and business entities.
As of May 2011, the wealth squad had formed seven exam groups that can engage other operating divisions to assist with their audits as needed, including flow-through specialists, international examiners, economists, appraisal experts to advise on valuation issues and technical advisers to provide industry or specialized tax expertise.
Although the wealth squad got off to a relatively slow start (only two returns audited in 2010), it is picking up steam (11 returns audited in the first six months of 2011 with a target of 122 returns for the 12-month period). While the wealth squad had been focusing its efforts on refining a screening process and developing examination practices, it is now moving out of the planning stages to more aggressively execute its mission in 2012. The criteria the wealth squad will be using to screen and select taxpayers for examination are unknown, but likely involve an analysis of income, assets and complexity.
Be Proactive: Take Steps Now to Prepare for an Audit
Individuals and families who are in the IRS target zone of tens of millions of dollars in assets or income can take affirmative steps now to minimize the potential for disaster if they get selected for a wealth squad audit. Taxpayers who are potentially in the sights of the wealth squad should consider doing the following: (1) prepare the current year tax return with attention to detail, making sure all positions are well-documented; (2) review any significant transactions from the last three years to make sure they are correctly documented and consider appropriate ways to document any transactions that are not properly documented; (3) review tax filings from prior years, considering the impact of adequate disclosure on the statute of limitations; (4) review and re-evaluate aggressive tax positions in light of current legal developments and risk tolerance, and determine whether it makes sense to modify the position going forward, amend prior returns, or be prepared to concede a certain position very early in a potential audit; (5) implement an appropriate document retention policy and effective document storage system; (6) ensure that everyone is following proper protocols for preserving the attorney-client privilege; and (7) identify any conduct that the IRS could find in an exhaustive audit – whether or not related to tax reporting – that could expose the client or others to criminal liability or significant civil liability and seek advice from competent counsel to manage those risks.
All review of prior transactions, documentation, tax positions or other conduct should be led by a qualified attorney whose advice to the taxpayer will be privileged. That attorney can engage accountants or other professionals to assist with this work, but it is very important for the review process and the advice it generates to be covered by the attorney-client privilege because the goal of the review is to identify risks and evaluate potential solutions – not to provide the IRS with a road map to all of the taxpayer's weaknesses if the taxpayer does get audited.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
