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IRS shifting compliance focus onto high-income earners, partnerships, and large corporations
September 2023
In brief
The IRS on September 8 announced in IR-2023-166 that it is shifting its compliance focus and enforcement efforts onto high-income earners, partnerships, and large corporations.
The agency plans to leverage its Inflation Reduction Act funding to use improved technology, including artificial intelligence (AI), in order to (1) help exam teams better detect tax avoidance efforts, (2) identify emerging compliance threats, and (3) improve case selection tools to avoid burdening taxpayers with “no-change” audits. The agency also plans to target priority areas, such as digital assets, Report of Foreign Bank and Financial Accounts (FBAR) violations, and labor brokers, and improve audit and taxpayer protection in fiscal year 2024 (FY24).
Action item: The IRS’s renewed focus on high-income earners, partnerships, and large corporations already has led to increased audit activity for these categories of taxpayers and likely will continue to do so. In light of this increased enforcement effort, taxpayers potentially affected by these changes should consider reviewing return filings to prepare audit-ready files in the event of possible IRS examinations.
In detail
Key elements of the IRS’s efforts to reverse the sharp decline in audit rates for wealthy individuals, partnerships, and other high-income earners, without increasing audit rates for individuals earning less than $400,000 a year, include the following.
Expanding high-income/high-wealth and partnership compliance work
Prioritizing high-income cases
The IRS’s High Wealth, High Balance Due Taxpayer Field Initiative is intended to intensify work on taxpayers who have more than $1 million in total positive income and $250,000 in recognized tax debt. Building off its earlier successes resulting in collections of $38 million from more than 175 high-income taxpayers, the agency plans to contact more than 1,600 taxpayers and deploy dozens of revenue officers to focus on these high-end collection cases.
Leveraging AI to focus on largest partnerships
In 2021, the IRS launched the first stage of its Large Partnership Compliance (LPC) program to identify high-risk issues and apply resources to examinations of some of the largest and most complex partnership returns. The agency is leveraging AI in the expansion of its LPC program to select for examination additional large partnerships that historically have been subject to limited examination coverage. The agency plans to use machine learning technology developed by data scientists and tax enforcement personnel to identify potential compliance risk areas around partnership tax, general income tax and accounting, and international tax to select returns for examination.
By the end of September, the IRS plans to open examinations of 75 of the largest partnerships in the United States, each with an average of more than $10 billion in assets, representing a cross-representation of industries, including hedge funds, real estate partnerships, publicly traded partnerships, large law firms, and other industries.
Focusing on partnership issues through compliance letters
The IRS has identified indicators of potential noncompliance by partnerships with over $10 million in assets by analyzing ongoing discrepancies on their balance sheets. The agency has found that an increasing number of partnership returns have shown millions of dollars of discrepancies between one year’s end-of-the-year balances compared to the next year’s beginning-of-the-year balances.
The IRS plans to focus its efforts on high-risk large partnerships that fail to attach to their returns required statements explaining these balance sheet differences. Beginning in October, the agency plans to request from 500 partnerships information regarding these discrepancies, resulting in the addition of some of these partnerships to the audit stream based on their responses.
Targeting priority areas for FY24 compliance work
The IRS has launched numerous compliance efforts to address certain issues, including ‘abusive’ micro-captive insurance arrangements and syndicated conservation easement arrangements, that have received extensive public attention. Some of the agency’s additional FY24 priority focus areas that touch on wealthy taxpayers include the following.
Expanding work around digital assets
The IRS plans to continue its expanded efforts around digital assets, including its work through John Doe summons efforts and the August 25 release of proposed broker reporting regulations. See our Insight, Treasury issues extensive proposed regulations with broad scope around digital asset information reporting, for more information.
The IRS plans to develop more digital asset cases for further compliance work and continue its Virtual Currency Compliance Campaign after an initial review showed the potential for 75% noncompliance among taxpayers identified through production of digital currency exchange records.
Increasing scrutiny around FBAR violations
A US person with a financial interest in a foreign financial account must file an FBAR if the aggregate value of all foreign financial accounts is more than $10,000 at any time. The IRS plans to audit what it considers the most egregious potential non-filer FBAR cases after its analysis of multiyear filing patterns identified hundreds of possible FBAR nonfilers with balances averaging over $1.4 million.
Observation: In an agency memorandum dated July 6, 2023, the IRS issued guidance updating its FBAR examination policies in response to the Supreme Court's decision in Bittner v. United States. The updated guidance eliminates the FBAR penalty mitigation procedures for nonwillful violations and instructs IRS examiners to recommend a $10,000 penalty in each reported instance (subject to their discretion based on the facts and circumstances). Thus, taxpayers with unreported foreign bank accounts or unfiled FBARs may find themselves subject to more costly asserted penalties, even if those violations are deemed to be nonwillful.
Focusing on labor brokers
The IRS has identified instances in Florida and Texas where construction contractors are making Form 1099-MISC, Miscellaneous Income, and Form 1099-NEC, Nonemployee Compensation, payments to “shell” companies that appear to be subcontractors but in fact may have no legitimate business relationship with the contractor. The agency has found that monies paid to these shell companies are exchanged at money service businesses or flowed through accounts in the name of the shell company and returned to the original contractor. The IRS plans to increase both civil audits and criminal investigations in this area to (1) improve compliance, (2) level the playing field for contractors complying with the rules, and (3) ensure proper employment tax withholding for workers.
Improving audit fairness and protecting taxpayers
Improving audit fairness for individuals claiming the earned income tax credit (EITC)
The IRS plans to implement new audit fairness safeguards for individuals claiming the EITC. The agency found that audit rates of individuals receiving the EITC remain at high levels while rates dropped for taxpayers with higher income, partnerships, and more complex tax situations.
Protecting individuals and businesses from aggressive scams and schemes
The IRS plans to continue its work to alert consumers about emerging scams and schemes targeting taxpayers with more modest incomes. Building off efforts like the Dirty Dozen, the agency plans to warn taxpayers of scams around recent tax law changes or other events that can confuse taxpayers into claiming refunds around sick and family leave and false fuel tax credit claims.
Protecting taxpayers against identity theft
The Security Summit includes representatives of the IRS, state tax agencies, and the tax community, including tax preparation firms, software developers, payroll and tax financial product processors, tax professional organizations, and financial institutions, who have joined together to combat identity theft refund fraud. Since 2015, this private-public sector coalition has worked to build internal defenses and share information to protect taxpayers against identity theft attempts to steal tax refunds. The IRS plans to continue the Security Summit’s focus on raising taxpayer and tax professional awareness on how to protect themselves and their data from identity theft with this fall’s National Tax Security Awareness Week.
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