IRS Audits Foreseeable for Ultra-Wealthy

The Internal Revenue Service (IRS) has ramped up its efforts in recent years by expanding its audits of the wealthiest individuals. Particularly over the last five years, the IRS audit rates increased on average 10% and the percentage of audits for those with income over $1,000,000 nearly doubled.

In 2009, the IRS established a specialized task force to audit the ultra-wealthy, named the Global High Wealth Industry Group (GHWIG). The task force, overseen by the IRS’s Large Business and International Division, was created to observe and investigate business entities, trusts and assets controlled by high net worth individuals.

The main goals of the GHWIG are to assess tax compliance among the ultra-wealthy, defined as those who have income and assets totaling $10 million or more, and then to uncover the veracity of the tax system. The audits of the nation’s wealthiest taxpayers have been on the rise. As a result, the IRS forecasted earlier this year that those who fall into this ultra-wealthy category are 30% more likely to be audited.

As we’ve recently read in the Pacific Coast Business Times’ issue of the Region’s Richest, some of the nation’s most affluent individuals have established deep roots on the Central Coast and built their successes throughout the local landscape. With the chance of being audited much higher for those making more money, an increase in financial audits in our region is foreseeable.

When creating the GHWIG, the IRS Commissioner, Douglas Schulman, stated that many high net worth individuals operate under sophisticated business, finance and investment arrangements that are perfectly legal, while others attempt to cover aggressive tax strategies. The task force concentrates on ferreting out such practices amongst those with significant wealth to ensure that all taxpayers are abiding by tax laws.

According to recent reports, there are certain red flags that make the ultra-wealthy more likely to be audited by the GHWIG. The following highlights the IRS’s red flags that may prompt these audits:

• You Own a Business: When sole business proprietors report their taxes on Schedule C forms, there is an increased ability to manipulate numbers, hide income and skim profits. The IRS critically assesses Schedule C forms, so it is advised to always report all earnings accurately.
• You Have a Home Office: Many taxpayers deduct the cost of working from home, which is perfectly acceptable. However, if you qualify for a home office deduction–your office is your primary work place–be weary of the costs you document. If you attempt to deduct areas of your home that you use for work, but also serve other functions, the IRS may find reason to audit your statements. Instead, be cautious about the expenses you deduct and keep supporting expense reports for such costs.
• You Have Foreign Assets: Beginning this year, taxpayers are required to report any foreign bank accounts and foreign assets–including pension funds and foreign stocks–that total more than $50,000. The IRS is attempting to put an end to hiding income in overseas accounts; thus, the agency will waive certain penalties and jail time for those who provide information about foreign assets and accounts that they had previously not disclosed. If you fail to provide information about foreign assets, the IRS may become skeptical of your involvement with foreign accounts and your likelihood of being audited increases.
• You Guess on Investments: Previously, the IRS only required that brokers provide the agency with the date a stock was sold and how much gross proceeds were received from the investment. That method often left people guessing about basis and providing incorrect information on their Schedule D capital gains and losses statement–intentionally or not–which resulted in less taxes paid. Now, the IRS is double checking numbers and dates with brokers, including some basis information, to ensure that taxpayers pay the appropriate amount of tax. If the data does not match, an audit is likely.
• You Give to Charity Often: Taxpayers who donate to charitable causes frequently, or in large quantities, are sometimes tempted to exaggerate the amount of money or items they donated. However, it is advised to be conservative, realistic and very specific when deducting the amount of charity you provided. If your donation amount is over $250, it is necessary to have supporting documentation from the receiving charity. The IRS becomes skeptical of charitable deductions when there is a lack of supporting documents and when the donation amounts are unusually high in comparison to income.
• You Selected an Inexperienced Tax Preparer: When a tax preparer lacks experience and is therefore not equipped to prepare sophisticated tax returns, it increases a taxpayer’s chances of getting audited. If your accountant claims far-fetched deductions and credits without proper documentation, you are still legally responsible for those fraudulent acts. It is wise to select an experienced accounting firm to ensure that your deductions are legally applicable to your return and you do not pay more than you owe.

Although the above situations are red flags for the GHWIG and reflect scenarios pertinent to the ultra-wealthy, all taxpayers should be diligent about obtaining and maintaining evidence which supports the income and deductions reported on their tax returns.

If you are selected for an audit by the IRS, Bartlett, Pringle & Wolf, LLP (BPW) has extensive experience preparing and presenting IRS-requested information in a manner that demonstrates our client’s tax compliance. During preparation of an income tax return, we build each client file with audit defense in mind so that an IRS or state agency audit can be handled efficiently and effectively. This includes keeping source documents such as third-party reporting, charitable donation acknowledgement letters, client prepared financial statements and other supporting documents, spreadsheets and research used for each return. Contemporaneous documentation is the strongest evidence that can be used to support tax positions taken.

Our history of successful audit resolution is primarily due to our expertise and internal review of each return that is generated by BPW. In addition, we work closely with each IRS or state auditor so that information requests are as specific as possible. We can then provide the information needed in a clear and timely fashion. In most cases, we serve as the representative of our clients, so that they do not need to get involved with the process at the detail level. Instead of being adversarial, we understand that the auditors have a job to do, and by working together with them, we are able to resolve inquiries and move the process to completion.

Although there are many reasons why a return can be selected for an audit, including those listed above, we understand that being audited by the IRS is not a welcome surprise. We recommend contacting your tax professional should you receive an audit notice so that an audit professional is involved from the very beginning of the process. By doing this, you will not only alleviate some of your stress, but you will know that the matter is being handled effectively and efficiently.

If you have any questions about state or federal income tax audits, please contact me at (805) 963-7811 or bforeman@bpw.com.