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In a significant shift towards enhancing tax compliance, the IRS is gearing up to increase audits for wealthy individuals, large corporations, and complex partnerships, according to a strategic operating plan it released last week. This move, powered by a substantial $80 billion boost from the Inflation Reduction Act, aims to tackle tax evasion and improve overall revenue for the U.S. Treasury. The strategy not only focuses on compliance but also aims to enhance customer service and tackle existing processing delays, recover unpaid taxes by the billions, and shift the public perception of the agency as one of efficiency and fairness.
Who’s Getting Audited?
The IRS is sharpening its focus on high-wealth individuals and major business entities, intensifying audit efforts, particularly for those earning more than $10 million annually. The audit rate for these taxpayers is projected to rise from 11% in 2019 to 16.5% by 2026. This group will see a significant uptick in scrutiny as the IRS leverages new technology, including artificial intelligence, to better identify and address high-dollar noncompliance issues. "It sets an important tone and message for complex filers, high-wealth filers, that this is our focus area," says IRS Commissioner Danny Werfel.
Similarly, large corporations with assets over $250 million and complex partnerships valued over $10 million are targeted for heightened audit activity. The IRS plans to triple the audit rates for these large corporations and increase tenfold for complex partnerships, aiming to close gaps created by sophisticated tax avoidance strategies. This move aligns with the IRS's broader goal to ensure these entities contribute their fair share toward tax liabilities.
Safeguards for Middle and Low-Income Earners and Small Businesses
The IRS reassures that the new wave of audits will not impact individuals earning less than $400,000 annually. "There is no new wave of audits coming from middle- and low-income [individuals], coming from mom and pops. That's not in our plans,” Werfel says.
Small businesses, particularly those not engaged in complex tax filings or high-value transactions, are also largely exempt from the increased audit focus. The IRS emphasizes that its new enforcement strategies are designed to target high-wealth filers and complex filers, not small mom-and-pop businesses, which often face disproportionate challenges during audits.
Impact of Funding on IRS Capabilities: From Cuts to Rejuvenation
Prior to the recent boosts in the budget through pandemic-related measures and the Inflation Reduction Act, the IRS had faced significant funding reductions over the past decade. This chronic underfunding had profound effects on the agency's capabilities, particularly in the realms of enforcement and audit activities. For example, audit rates for taxpayers earning $1 million or more dropped dramatically, from a rate of 7.2% in 2011 to just 0.7% in 2019. This decline in audit rates reflects broader enforcement challenges, including reduced oversight over employment taxes, excise taxes, and estate and gift taxes, which were also notably impacted by these cuts.
The $80 billion infusion from the Inflation Reduction Act is allocated over a 10-year period and aimed at enhancing the IRS's enforcement abilities and taxpayer services. The immediate effects of this funding have been substantial. For instance, the IRS reported enhancements in customer service capabilities, significantly reducing wait times and improving the quality of taxpayer interactions.
More significantly, the increased budget has empowered the IRS to bolster its enforcement capabilities. By the end of 2023, the IRS had already recovered $520 million from audits of wealthy taxpayers, indicating a robust return to rigorous tax law enforcement.
Future Outlook and Improved Reputation
This rejuvenation of resources and focus is also intended to reshape the public perception of the IRS. By proving its ability to effectively manage and enforce tax laws—and do so fairly—the IRS aims to rebuild trust and demonstrate its critical role in maintaining the integrity of the financial system.
Werfel said the funds allowed the agency to boost its workforce to about 90,000 full-time equivalent employees, with plans to expand this number to about 102,500 in the coming years.
"That number won't even be a record high for the IRS workforce; it's well below the numbers from the 1980s and early 1990s," Werfel says.
Addressing concerns raised after the passing of the Inflation Reduction Act, Werfel dispelled fears about an excessively expanded IRS. Some concerns, notably from Republican lawmakers in 2022, speculated about the hiring of "87,000 new IRS agents to audit Walmart shoppers." In response, Werfel clarified, "This should put to rest any misconception about us bringing on 87,000 agents," or creating a “supersized IRS.”
Conclusion
As the IRS embarks on a strategic overhaul to intensify tax compliance, fueled by the Inflation Reduction Act, targeted entities such as high-net-worth individuals and large corporations should prioritize consultations with their accountants. Key discussion topics should include strategies for maintaining accurate and complete tax records, ensuring proper documentation of income sources, and understanding the implications of offshore financial activities. Additionally, exploring options for voluntary disclosure and reviewing the potential need for amended returns could be crucial. For those operating within complex partnerships, it is essential to verify that all partnership agreements and related transactions are transparent and compliant with the latest tax regulations. This proactive engagement with tax advisors will help navigate the new enforcement landscape effectively, ensuring compliance and mitigating any potential issues well ahead of IRS audits.
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