Tax Evasion Crackdown: IRS Bolstering Resources for Scrutinizing Partnerships, High-Income Earners

IRS Commissioner Danny Werfel assured Americans that the new hires will be “focused on higher-income and complex tax areas like partnerships, not average taxpayers making less than $400,000,” however a watchdog report recently revealed that the agency does not have a clear definition of “high-income,” failing which, the no-targeting-under-$400,000 claim is suspect.

Pass-through entities—general partnerships, sole proprietorships, limited partnerships, limited liability partnerships, limited liability companies, and S Corporations—are businesses that do not pay tax on their revenues. Instead, income is passed on to business owners, who file taxes based on their individual tax rates. Pass-through entities help proprietors avoid the issue of double taxation when the income is taxed at the business level, and then at the individual level when they receive dividends.

“This new unit will leverage Inflation Reduction Act funding to disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe,” said Mr. Werfel, with operations expected to begin sometime late next year.

On Sept. 8, the IRS announced a “sweeping, historic” change involving the introduction of AI and enhanced technological prowess in assisting tax agents to “detect tax cheating, identify emerging compliance threats and improve case selection tools.” All initiatives are assisted by the 2022 Inflation Reduction Act (IRA) funding boost.

IRS’ AI initiative is said to focus efforts on complex tax structures and large partnerships. The agency admitted that audit rates for high-earning categories had seen “sharp drops” over the past decade.

“With the help of AI, the selection of these returns is the result of groundbreaking collaboration among experts in data science and tax enforcement, who have been working side-by-side to apply cutting-edge machine learning technology to identify potential compliance risk in the areas of partnership tax, general income tax and accounting, and international tax in a taxpayer segment that historically has been subject to limited examination coverage.

“By the end of the month, the IRS will open examinations of 75 of the largest partnerships in the U.S. that represent a cross section of industries, including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms and other industries. On average, these partnerships each have more than $10 billion in assets,” said the agency.

The agency claims that since the beginning of 2022, chatbot services have assisted over 13 million taxpayers in avoiding wait times by providing tax resolutions.

The tax agency said that it plans to have dozens of agents focusing on “high-end collection cases in FY 2024. The IRS is working to expand this effort, contacting about 1,600 taxpayers in this category that owe hundreds of millions of dollars in taxes.”

During fiscal year 2022, millionaires “did have the highest odds of being audited. However, if one ignores the fiction of auditing a millionaire through simply sending a letter through the mail, the odds that millionaires received a regular audit by a revenue agent (1.1 percent) was actually less than the audit rate of the targeted lowest-income wage-earners whose audit rate was 1.27 percent!” the report said.

The rate of income tax audits per 1,000 individuals stood at 12.7 for the lowest-income wage earners and 2.3 for everyone else. This made low-income wage earners the taxpayer class with, by far, the highest audit rates—clocking around five and a half times more than everyone else.

Known as “micro-captive transactions,” these types of insurance arrangements allow small businesses to benefit from tax breaks via creation of insurance companies—captive insurance companies—to cover potential losses or liabilities.

The agency proposed listing these insurance arrangements as “listed transactions” or abusive tax transactions.

Even if tax law allows businesses to create “captive” insurance companies to protect against insurance risks, the agency claims these are “abusive tax shelters.”

Regarding digital asset taxation, the IRS plans on increasing scrutiny of digital currency exchanges, crypto transfers, trading platforms, and related payment processors.

The IRS has accused high-income taxpayers of avoiding disclosure and related taxes through making use of foreign bank accounts. The agency is expected to audit numerous individuals as “IRS analysis of multi-year filing patterns has identified hundreds of possible FBAR non-filers with account balances that average over $1.4 million.”

“Beginning Jan. 1, 2024, businesses must e-file all Forms 8300 if they’re required to file at least 10 information returns other than Form 8300,” said the IRS on Aug. 30. For instance, if a business files five Forms 1099-INT and five Forms W-2, they should e-file all their returns electronically for the year, including Forms 8300. If a business files less than 10 forms, excluding Forms 8300, they can opt not to e-file. The $10,000 can be in a single transaction or multiple entries.

This initiative is reportedly done to counter money laundering. Penalties are applicable in case a business has filed Form 8300 by paper even though they are required to e-file and have not secured a waiver or religious exemption.

In case of late returns, businesses should file a late Form 8300 in the same way they would a timely one. Penalties would be applicable for late filing as well.

Moreover, “Taxpayers who were paid over $600 by payment apps and online marketplaces or received any amount by payment cards could receive a Form 1099-K, Payment Card and Third Party Network Transactions, starting January 2024, for payments received in 2023. This includes anyone with a side hustle, sole proprietors, and anyone selling goods and services online. It’s important to remember that taxpayers should report their income, unless it’s excluded by law, regardless of whether they receive a Form 1099-K or any other third-party reporting document.”

In the same press release, the agency issued warnings to “delinquent millionaires” exploiting tax loopholes. “IRS will continue to pursue millionaires who do not pay their taxes as the agency ramps up enforcement capabilities through the Inflation Reduction Act.”

The examples provided by the agency included high-income individuals claiming benefits in Puerto Rico who were “attempting to avoid U.S. taxation on U.S. source income” without meeting proper residence or criteria requirements in the U.S. territory.

Besides Puerto Rico, the IRS is also targeting offshore funds based in Malta, a European country located near Italy.

The IRS is now investigating conservation easements, which have claimed tax benefits, but broken rules of the agreement through property development.

They have issued warnings against taxpayers who have developed these properties in a manner inconsistent with section 501(c)(3).

The IRS is commissioned with extraordinary federal powers to police the finances of the private citizen. Without committing to similar high levels of integrity, the agency can easily commit oversights that have severe adverse impacts on the lives of the people.

Public concern has been growing over the militarization of IRS agents. It remains to be seen whether IRS agents, new and old, will increase their efforts in investigating potential tax fraud within high-income categories or will resort to harassing the average low- and mid-income citizen with a plethora of new regulations and complicated tax rules.

vIA