Under President Biden's administration, wealthy individuals may face a much greater risk of getting audited by the IRS. The president's agenda is reflected in recent legislation introduced by Democratic lawmakers to expand the IRS's audit capabilities as part of a broader tax overhaul. The focus on high-wealth taxpayers is also reflected in the IRS's announcement of new campaigns launched by the Large Business and International ("LB&I") division targeting high-wealth individuals with especially complex tax returns and a campaign launched by the Small Business/Self-Employed division targeting high-income nonfilers.

Civil Audits for High-Net-Worth Individuals

Both parties of Congress have recognized the significant "tax gap" that exists in our county, but neither side seems to know what to do about it. However, in June 2020 LB&I announced that the IRS would start a civil audit campaign targeting high-income taxpayers. The IRS maintains a specialized, experienced group of examiners solely focused on conducting audits of high-income/high-wealth taxpayers—the Global High Wealth Industry ("GHW") group of the LB&I division (commonly referred to as the IRS "Wealth Squad"). The Wealth Squad is skilled at examining complex domestic financial affairs, offshore accounts, foreign trusts, and entities controlled by the taxpayer, including partnerships, corporations, foundations, and trusts.

The Wealth Squad

GHW examines the complete financial picture of high-wealth individuals and the enterprises they control. In announcing the formation of the Wealth Squad, then IRS commissioner Douglas Shulman stated, "For a variety of reasons—including valid business reasons—many high wealth individuals make use of sophisticated financial, business, and investment arrangements with complicated legal structures and tax consequences." The IRS believes these practices often mask aggressive tax strategies.

What Is the Wealth Squad Looking For?

The Wealth Squad audit focuses on the taxpayer's entire economic picture and assesses tax compliance across all income sources. GHW audits are generally very broad and comprehensive—consisting of a key case, generally an individual income-tax return and related income-tax returns of an entity where the individual has a controlling interest, such as a C corporation, S corporation, partnership, private foundation, or trust.

The Wealth Squad will likely place particular focus on foreign assets, such as

  • foreign bank accounts;
  • offshore retirement accounts;
  • foreign trusts;
  • business interests in entities holding foreign accounts; and
  • overseas inheritance.

The Wealth Squad also looks at accounts held in foreign banks subject to reporting under the Report of Foreign Bank and Financial Accounts ("FBAR") rules and the books and records of any companies in which the taxpayer holds a financial interest. The IRS will often employ a matching program to review across different accounts and reporting documents. Taxpayers should be aware that the IRS has broad authority to summons books and records to ascertain the correctness of tax returns.

The Wealth Squad may also request copies of all tax opinions received, details of any fees paid for tax or estate planning, a description of the planning and whether a confidentiality agreement was signed, and copies of any marketing materials received regarding the planning. These requests may implicate the attorney–client privilege, and disclosure should be made only after fully evaluating the impact of waiving any privileges.

During the civil-audit process, if the Wealth Squad uncovers badges of tax fraud, the Internal Revenue Manual dictates that the revenue agent make a fraud referral to the IRS Criminal Investigation ("CI") division. Some key indicators of fraud include:

  1. false statement about a material fact pertaining to the examination;
  2. attempt to hinder or obstruct the examination;
  3. omission of entire sources of income;
  4. inability to explain substantial increases in net worth, especially over a period of years;
  5. inability to explain sources of bank deposits substantially exceeding reported income;
  6. concealment of bank accounts, brokerage accounts, and other property;
  7. failure to file a tax return, especially for a period of several years, despite evidence of receipt of substantial amounts of taxable income;
  8. claiming fictitious or substantially overstated deductions;
  9. claiming substantial business-expense deductions for personal expenditures;
  10. multiple sets of books or no records;
  11. false entries or alterations made on the books and records, backdated or postdated documents, false invoices, false applications, false statements, or other false documents or applications;
  12. false statement about a material fact pertaining to the examination;
  13. attempt to hinder or obstruct the examination; for example, failure to answer questions, repeated canceled or rescheduled appointments, refusal to provide records, threatening potential witnesses, including the examiner, or assaulting the examiner; and
  14. failure to make full disclosure of relevant facts to the accountant, attorney, or return preparer.

High-Income Nonfilers

In February 2020 the IRS announced a new campaign that would focus on high-income nonfilers.1 According to the IRS's campaign announcement, "U.S. citizens and resident aliens are subject to tax on worldwide income. This is true whether or not taxpayers receive a Form W-2 Wage and Tax Statement, a Form 1099 (Information Return) or its foreign equivalents. Through an examination treatment stream, this campaign will concentrate on bringing into compliance those taxpayers who have not filed tax returns."

On December 3, 2020, Eric Hylton, the commissioner of the Small Business/Self-Employed division, authored IRS Announcement CL-20-08 to explain the high-income-nonfiler program. Previously, Hylton worked for many years in CI. According to Hylton, in 2019 the IRS sent notices to taxpayers who made more than $100,000 and had not filed a tax return before 2019 to ensure that they understood their obligation to file and pay income taxes. Most of those taxpayers responded and have either filed or paid their tax obligations. However, for those nonfilers who did not respond, Hylton stated that the IRS has an "ambitious strategy to bring them into compliance with our nation's tax laws and help address the tax gap." Some of the high-income-nonfiler cases are being handled by the IRS's new Office of Fraud Enforcement. Hylton described the Office of Fraud Enforcement as a group that "connects the dots across all IRS divisions, and sometimes across federal agencies, to confront emerging threats and bring offenders to justice with both civil and criminal penalties." The office is also reviewing high income non-filer cases that will be referred to the IRS Criminal Investigation Division to potentially be pursued criminally. Accordingly, the nonfiler campaign may result in some high-income-nonfiler cases being referred to CI for potential criminal offenses, including failure to file, tax evasion, and tax fraud.

Both Congress and the IRS have demonstrated a desire to tackle the "tax gap" by identifying nonfilers and selecting for audit more high-wealth taxpayers. If a taxpayer is a high-wealth taxpayer or falls into the category of a high-income nonfiler, it is important for the taxpayer to come into compliance with the IRS as quickly as possible.

Footnote

1. See IRS release on increasing visits to high-income nonfilers (Feb. 19, 2020), https://www.irs.gov/newsroom/irs-increases-visits-to-high-income-taxpayers-who-havent-filed-tax-returns; IRS, "Large Business and International Active Campaigns," https://www.irs.gov/businesses/corporations/lbi-active-campaigns.

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