How to Navigate the IRS Audit Surge: Tips for Taxpayers

June 25 , 2024

The IRS audit surge is driven by new funding aimed at cracking down on tax evasion. Wealthy individuals and large corporations are the primary targets. This article explains why this surge is happening, who will be most affected, and how to stay compliant.

Key Takeaways

• The IRS is undergoing a significant transformation with $80 billion in new funding, focusing on increasing audits, particularly for wealthy individuals, large corporations, and complex partnerships to bolster compliance and revenue.
• The Inflation Reduction Act has been crucial in reinvigorating the IRS, enabling improvements in technology, taxpayer services, and enforcement capabilities, although ongoing funding concerns remain.
• Despite the increased focus on high-income and large entities, small businesses and taxpayers earning under $400,000 will not see a rise in audit rates, but should still maintain organized records to prepare for any potential audits.

Understanding the IRS Audit Surge

Over the years, budget cuts and a reduction in personnel have notably weakened the IRS’s enforcement capabilities. Notwithstanding, recent developments are paving the way for a significant transformation. The IRS now gears up to increase audits in a bid to target tax noncompliance and bolster government revenue. This initiative is aimed at deterring violations of tax laws and marks a pivotal shift in the Treasury’s enforcement strategy.

This surge in enforcement is fueled by a substantial $80 billion in new funding aimed at reviving the agency, which has faced numerous challenges, including depleted ranks, customer service issues, and processing delays. The infusion of funds has already led to tangible improvements, such as the collection of $520 million from wealthy taxpayers who hadn’t filed their taxes or still owed money.

IRS Commissioner Danny Werfel has emphasized the importance of this transformation, describing it as a ‘generational imperative’ necessary to serve the nation and its taxpayers effectively. The IRS, with its renewed focus, has dispatched over 125,000 compliance letters to high-income non-filers since 2017. The intention is to overturn a decade-long decline in audits for the wealthy and complex entities by bringing in new talent.

Who Will Be Targeted by Increased Audits?

Not every taxpayer will be equally affected by the impending surge in IRS audits. The emphasis will be on wealthy individuals, large corporations, and complex partnerships – all entities with significant assets and intricate financial operations. This targeted approach aims to address the substantial tax gap driven by income sources held by the wealthy, particularly business income.

Audit rates are set to markedly increase for:

• Wealthy individuals with total positive income over $10 million
• Large corporations with assets exceeding $250 million
• Complex partnerships holding assets over $10 million

This strategic focus ensures that the IRS’s resources are directed towards areas with the highest potential for tax noncompliance.

Wealthy Individuals

Wealthy individuals, defined as those with a total positive annual income exceeding $10 million, are at the forefront of the IRS’s increased audit efforts. The audit rates for this group are expected to rise significantly, from 11% in 2019 to 16.5% by 2026, representing a 50% increase.

This heightened scrutiny aims to ensure that wealthy taxpayers comply with their tax obligations and contribute their fair share to the U.S. Treasury. Tax professionals working with high-income individuals should be prepared for increased interactions with IRS auditors and ensure that all client records are meticulously maintained to withstand the enhanced scrutiny, especially in cases of potential tax controversy.

Large Corporations

Large corporations, especially those with assets exceeding $250 million, will also face a significant increase in audit rates. The audit rate for these corporations was 8.8% in 2019 but is expected to rise to 22.6% by 2026, nearly tripling the current rate.

The IRS has expanded its large corporate compliance program, targeting corporations with average assets of $24 billion. This increased oversight aims to:

• Ensure that large corporations comply with tax laws
• Accurately report their financial activities
• Reduce the tax gap
• Increase federal revenue.

Complex Partnerships

Complex partnerships, particularly those with assets over $10 million, will see a dramatic rise in audit rates. The IRS plans to increase the audit rate for these partnerships to 1% by 2026, nearly a ten-fold increase from previous years.

To support this initiative, the IRS has announced the opening of more than 3,700 positions nationwide aimed at enhancing compliance for complex partnerships and large corporations. This strategic focus on high-value partnerships underlines the IRS’s commitment to ensuring that all taxpayers, regardless of the complexity of their financial arrangements, meet their tax obligations.

The Role of the Inflation Reduction Act (IRA)

The Inflation Reduction Act (IRA), enacted in August 2022, has been a crucial element in the IRS’s recent resurgence.The act provided $80 billion in additional funding, which has been instrumental in enhancing taxpayer services, improving tax compliance, and modernizing technology.

This funding directed has enabled the IRS to implement significant changes, including answering more taxpayer calls, improving customer service operations, and collecting substantial amounts from wealthy taxpayers who previously owed money. However, the IRS faces ongoing funding challenges, including the potential depletion of Business System Modernization funding by fiscal year 2026, which could impact future improvements.

IRS Workforce Expansion

In recent years, the IRS workforce has undergone significant changes. The agency’s workforce has expanded, from roughly 73,000 workers in 2019 to an approximate 90,000 full-time equivalent employees. It plans to further expand to over 100,000 workers over the next few years.This expansion is crucial for handling the increased audit workload and enhancing enforcement capabilities.

Contrary to some claims, the IRS is not hiring 87,000 new agents; rather, the new hires are mainly replacing retiring employees. The new recruits will primarily be high-graded revenue agents focusing on audits of high-income earners and large entities, ensuring that the IRS can effectively target areas with the highest potential for tax noncompliance.

Strategic Operating Plan Objectives

Five key objectives outlined in the IRS’s Strategic Operating Plan are:

1. Dramatically improving services to help taxpayers meet their obligations
2. Quickly resolving taxpayer issues
3. Focusing enforcement on complex and high-dollar noncompliance
4. Delivering cutting-edge technology
5. Attracting and retaining a highly skilled workforce.

These objectives reflect a stark contrast from previous years, emphasizing a more taxpayer-centric approach while ensuring that high-income individuals and large entities comply with tax laws. The plan also aims to protect taxpayers from scams and schemes, such as identity theft and fraudulent tax credits.

Technology and Tools for Enhanced Tax Enforcement

The IRS is harnessing advanced technology and tools like artificial intelligence (AI) and advanced analytics to fortify tax enforcement. These technologies help the IRS better detect tax evasion and identify emerging compliance threats, ensuring that tax laws are enforced more effectively.

One notable initiative is the Large Partnership Compliance program, which uses AI to pinpoint the highest risk issues within large partnerships. Additionally, the IRS has enhanced the Tax Pro Account, allowing tax professionals to manage client authorizations and view tax information online, further streamlining the compliance process.

What Small Businesses Need to Know

Small businesses and taxpayers earning under $400,000 can breathe a sigh of relief as audit rates will not rise. The IRS has made it clear that the focus of increased audits will be on wealthier individuals and larger entities, ensuring that the majority of U.S. taxpayers are not unduly burdened.

However, small businesses should still be prepared for potential audits by organizing their records meticulously. This includes keeping well-organized and ready for review:

• receipts
• bills
• canceled checks
• legal papers
• loan agreements

Employing accounting software can streamline the record-keeping process, ensuring that all financial documents are accurate and easily accessible. Regularly reviewing your financial statements and consulting with a tax professional can further mitigate the risk of errors and potential audits. By staying proactive and maintaining meticulous records, small businesses can navigate the audit process with greater confidence and ease.

How to Avoid Common Audit Triggers

Steering clear of common audit triggers can substantially mitigate the risk of undergoing an IRS audit. Some common audit triggers to avoid include:

• Math errors
• Leaving questions blank
• Not signing the tax return
• Reporting a net annual loss, especially a small one, as it may indicate underreported income.

By being mindful of these triggers and taking steps to avoid them, you can reduce your chances of being audited by the IRS.

To avoid drawing attention, ensure that you do not:

• make excessive deductions, such as overestimating charitable donations or home office expenses
• omit income from side jobs or freelance work
• provide detailed explanations for any sudden changes in expenses

Following these tips can help keep your return off the auditor’s radar.

Preparing for an IRS Audit

Preparation for an IRS audit entails comprehending the type of audit and arranging your records in a corresponding manner. The IRS notice will specify whether the audit is conducted by mail or in person.

If the audit is in person, it’s crucial to check the IRS ‘Audits in Person’ Get Help page for a comprehensive summary of actions to take. Taxpayers have the right to hire an attorney, CPA, or enrolled agent to represent them, ensuring that they are well-prepared and adequately represented during the audit process.

Potential Consequences of an Audit

Facing an IRS audit can have severe consequences, ranging from fines to jail time. If discrepancies are found, the IRS may impose penalties, which can include monetary fines or even criminal charges. In cases of significant underreporting of income or fraudulent activity, individuals could face civil fraud penalties amounting to 75% of the underpayment due to fraud. More serious offenses, such as tax evasion, can result in up to five years of jail time and fines up to $100,000 for individuals or $500,000 for corporations.

Filing a false tax return or concealing offshore bank accounts can also lead to prison sentences and substantial fines. Criminal tax evasion is treated as a felony and can significantly limit future employment opportunities due to a permanent criminal record. These potential consequences highlight the importance of accurate and honest tax reporting, emphasizing the need for proper tax compliance to avoid such severe repercussions.

The Future of IRS Audits

As we look to the future, the IRS aspires to:

• Assure fairness in its audit processes
• Concentrate on high-income taxpayers and large entities
• Reduce the audits focused on low-income taxpayers
• Ensure that audit rates do not increase for those earning less than $400,000 a year.

There will be a major expansion in high-income and partnership compliance work, with a focus on detecting discrepancies in partnership balance sheets and ensuring compliance. This strategic direction underscores the IRS’s commitment to closing the tax gap and ensuring that all taxpayers meet their obligations.

Summary

In summary, the IRS is embarking on a significant transformation, driven by increased funding and a strategic focus on high-income taxpayers, large corporations, and complex partnerships. The Inflation Reduction Act has played a pivotal role in this resurgence, providing the resources needed to enhance taxpayer services, improve compliance, and modernize technology.

As the IRS ramps up its enforcement efforts, it’s crucial for taxpayers to stay informed and prepared. By understanding the audit process, avoiding common triggers, and organizing records meticulously, you can navigate the upcoming changes with confidence. Stay compliant, stay prepared, and ensure that you meet your tax obligations to avoid potential consequences.