IRS Unveils Comprehensive Enforcement Strategy Targeting Large Partnerships and High-Wealth Individuals.On September 8, 2023, Internal Revenue Service (IRS) Commissioner Danny Werfel introduced a comprehensive enforcement strategy aimed at addressing tax compliance issues within large partnerships and among high-wealth individual taxpayers.
IRS Unveils Comprehensive Enforcement Strategy Targeting Large Partnerships and High-Wealth Individuals
This strategic initiative encompasses audits of the 75 largest partnerships operating in the United States, compliance measures related to digital assets, offshore account reporting, and the collection of back taxes owed by affluent individuals. The IRS’s approach leverages artificial intelligence (AI) and other resources made available through the Inflation Reduction Act of 2022.
Partnership Audit Strategy
The IRS has faced difficulties in developing a coherent approach to auditing partnership returns over the years, largely due to the complexity of identifying the right returns for auditing. Moreover, outdated partnership audit rules, such as those under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), have complicated the administrative process for both the IRS and taxpayers. However, Congress addressed these challenges in 2015 by enacting a new centralized partnership audit regime applicable to returns filed after 2017. The IRS is now utilizing this regime to streamline the audit process and recover additional taxes.
With the aid of AI, the IRS has identified 75 partnerships, including hedge funds, real estate investment partnerships, publicly traded partnerships, and large law firms, each with average assets exceeding $10 billion, for audit notifications by the end of the current month. These audits will encompass various subjects, including complex partnership issues, tax accounting, and international tax. The IRS has recruited new auditors and reassigned experienced auditors to tackle these audits effectively.
Technology-Enabled Audit Strategy
The IRS’s recently announced technology-enabled audit strategy is expected to enhance the agency’s understanding of compliance risks associated with complex partnerships. It will subsequently inform broader audit activities in the future. Additionally, AI will aid in identifying connections between partnerships and the individual taxpayers who control them, leading to an expanded audit focus on the wealthiest taxpayers in the nation.
Simultaneously, the IRS will employ “compliance letters” to address potential noncompliance by partnerships subject to recent reporting requirements, such as Schedule M-3 (Net Income (Loss) Reconciliation for Certain Partnerships). By using technology to compare balance sheets with other reported items on partnership returns, the IRS will correspond with approximately 500 partnerships starting in October 2023 to clarify discrepancies in reported amounts year-over-year.
The IRS has faced criticism for allocating more audit resources to low-income taxpayers than to wealthier individuals who potentially pose greater compliance risks. The new strategy aims to address this criticism by focusing on a range of potential compliance issues among high-wealth individuals. While not all details of the strategy have been publicized, the IRS is expected to concentrate its audit efforts on various areas, including:
- Estate planning strategies facilitating tax-free wealth transfers across generations.
- Use of digital assets, including cryptocurrency, for concealing wealth creation and movement.
- Examination of offshore bank, pension, and investment structures, such as the focus on Malta-based pension programs.
- Scrutiny of marketed tax avoidance or minimization programs, including conservation easements, captive insurance, and other promoted strategies.
Furthermore, the IRS has identified approximately 1,600 taxpayers with total incomes exceeding $1 million, collectively owing hundreds of millions in back taxes. Building on its success in collecting over $38 million from 175 high-wealth taxpayers, the IRS plans to deploy collection efforts as part of its strategy to bridge the gap between taxes owed and actual government receipts.
In a somewhat surprising move, the IRS used politically charged language to describe its new enforcement strategy, emphasizing its focus on “the wealthy looking to dodge paying their fair share or promoters aggressively peddling abusive schemes.” This language appears designed to garner public and congressional support for retaining the funding approved in the Inflation Reduction Act, some of which had been previously revoked during the debt-ceiling debate. The IRS coordinated the strategy’s rollout with a targeted media campaign, resulting in extensive press coverage.
The effectiveness of the IRS’s new enforcement strategy remains to be seen. Success in implementing these measures swiftly may influence Congress’s decision to maintain the remaining resources provided by the Inflation Reduction Act. Our team closely monitors the IRS’s ongoing transformation efforts in tax resolution strategies.