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Recent reports indicate that the IRS is launching an audit campaign that will focus on hundreds of returns filed by high-wealth taxpayers. The initiative, which was confirmed by Douglas O’Donnell, head of the IRS’s Large Business and International Division (“LB&I”), last week, is expected to begin around July 15th, and will likely involve taxpayers with pass-through entities who may have taken advantage of changes under the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The new focus comes on the heels of a report issued by the Treasury Inspector General of Tax Administration (“TIGTA”), recommending that the IRS increase its focus on certain high-income taxpayers.
The IRS already has a global high-wealth program—sometimes referred to by tax professionals as the “wealth squad,” a group that the current IRS Commissioner once described as conducting “audits from hell.” That program was formed with a unique audit philosophy: to take a holistic approach in addressing high-wealth taxpayers in order to view the complete financial picture of the taxpayer and the enterprises that they control, including partnerships, trusts, corporations, private foundations, and other interests. The LB&I division is charged with conducting examinations under the global high-wealth program, which the IRS appears to be rejuvenating in the hoped-for wake of the pandemic.
Many global high-wealth audits involve partnerships and interests in other flow-through entities. Historically, partnerships have been subject to audit under rules created by the Tax Equity & Fiscal Responsibility Act (TEFRA) of 1982, and many of the IRS’s high-wealth audit procedures were tied to compliance with TEFRA. But the TEFRA partnership audit rules were repealed under the Bipartisan Budget Act of 2015 (the “BBA”), which generally became effective in 2018. The BBA rules thus went into effect in tandem with the TCJA, and were, themselves, designed to drastically increase the number of partnership audits.
The IRS’s new initiative also overlaps with LB&I’s recent announcement of a campaign intended to focus on taxpayer compliance with changes under the TCJA. Under that campaign, the IRS’s LB&I division is studying a select pool of returns in order to identify transactions, restructuring issues, and other subjects of focus related to TCJA compliance. Perhaps the most notable change under the TCJA for taxpayers with pass-through entities was the Section 199A deductionrelated to qualified business income—a provision that was among the most complex in the TCJA and that prompted many taxpayers to restructure their holdings. The IRS appears to be particularly interested in those restructuring efforts.
The IRS’s new focus comes on the heels of a recent TIGTA report, finding that the IRS is not adequately addressing high-income taxpayers owing billions of dollars. TIGTA is also engaged in an ongoing effort to evaluate the IRS’s efforts to ensure tax compliance with respect to high-income individuals under its 2020 Annual Audit Plan. At the same time, TIGTA has been engaged in a review to determine whether the IRS has adequately implemented the changes to the partnership audit rules under the BBA.
Particularly against continued oversight pressure, the IRS’s focus on Section 199A and its implementation of changes to the partnership audit rules under the BBA means that one thing is certain: Taxpayers and professionals can expect to see a sharp uptick in partnership audits in the coming years.