The IRS’s attention on high-income filers has sharpened in recent years, fueled by increased funding and a renewed commitment to address tax compliance at the highest income levels. For high-income individuals, this means a higher likelihood of audits and more intense scrutiny of financial reporting. As the IRS prioritizes audits in this space, it’s crucial for high-income taxpayers to understand which areas are under scrutiny and implement effective strategies for documentation and compliance. In this article, I’ll highlight the IRS’s primary focus areas, outline potential audit triggers, and discuss best practices for staying on top of reporting and compliance requirements.
The IRS’s Renewed Focus on High-Income Filers
In response to recent funding boosts and public pressure to address tax compliance disparities, the IRS has committed to focusing more of its resources on high-income individuals and complex financial structures. This includes those earning over $400,000 annually, as well as high-net-worth individuals with complex income sources, such as investment portfolios, business interests, and foreign holdings.
The IRS’s increased funding has allowed for new hires, technological advancements, and more rigorous examination techniques. As a result, high-income filers can expect not only a greater chance of audits but also a more sophisticated approach to uncovering unreported income, aggressive deductions, and intricate tax avoidance schemes.
Key Areas of Scrutiny for High-Income Filers
To navigate this new environment, understanding the IRS’s focus areas is essential. High-income individuals should be aware of the following red flags and prepare to support their filings with detailed documentation.
Unreported or Underreported Income
High-income individuals often have multiple income sources, including wages, investments, business income, rental properties, and international holdings. The IRS uses advanced data-matching technology to ensure all sources are properly reported. Even minor discrepancies can trigger an audit, so high-income filers should review all income streams meticulously.
Audit Trigger: Failing to report income from any source, even inadvertently, can lead to penalties and interest. The IRS may also target unreported cryptocurrency gains, given the rise in crypto investments and the requirement to disclose these holdings on tax returns.
Foreign Assets and Accounts
The IRS has intensified its scrutiny of foreign accounts and assets, particularly in light of the Foreign Account Tax Compliance Act (FATCA) and other international information-sharing agreements. High-income filers with offshore investments, foreign bank accounts, or foreign real estate should ensure they’re in full compliance with reporting requirements, including the Foreign Bank and Financial Accounts (FBAR) and Form 8938 (Statement of Specified Foreign Financial Assets).
Audit Trigger: Missing or incomplete disclosures of foreign assets can lead to substantial penalties. Even minor errors on FBAR or Form 8938 filings are viewed seriously, with penalties ranging into the tens of thousands per account or asset.
Partnership and S Corporation Income
Partnerships and S corporations allow for pass-through taxation, where income and losses flow through to individual tax returns. Given the complexity of these arrangements, the IRS frequently scrutinizes partnership allocations, income distributions, and the basis calculations high-income filers use to claim losses.
Audit Trigger: Discrepancies in K-1 forms, aggressive use of deductions, or unusual loss claims are red flags. The IRS has focused particularly on “abusive” partnership arrangements that shift income improperly to avoid higher tax rates.
Capital Gains and Losses
High-income individuals with extensive investment portfolios should pay special attention to capital gains and losses. The IRS has a keen interest in capital loss claims, including the offset of ordinary income and the use of “wash sales” to create artificial tax benefits.
Audit Trigger: Repeated, large capital loss claims may raise IRS attention, especially if they appear timed to coincide with significant income. The wash-sale rule, which disallows claiming a loss if the same or a substantially identical security is repurchased within 30 days, is frequently targeted.
High-Dollar Itemized Deductions
The IRS scrutinizes large itemized deductions for high-income filers, particularly those related to charitable contributions, mortgage interest, and unreimbursed business expenses. Charitable contributions must be documented with precision, especially for non-cash contributions such as property, art, or other valuables.
Audit Trigger: Unusually high charitable deductions, especially non-cash items, can attract IRS interest. Documentation is crucial, as high-income filers must have appraisals and acknowledgment letters to substantiate deductions on property or high-value items.
Use of Trusts and Estate Planning Strategies
Trusts and other estate planning vehicles are often used by high-income individuals to transfer wealth while minimizing estate and gift taxes. However, certain trust structures are under heightened scrutiny, particularly grantor trusts, family limited partnerships, and similar structures that can blur the lines between personal and trust-owned assets.
Audit Trigger: The IRS frequently audits high-value trusts and entities used for wealth transfer. Trusts must maintain strict separation from the individual’s assets, and all transfers should have proper documentation to avoid IRS challenges.
Best Practices for High-Income Filers to Ensure Compliance
To navigate the increased IRS focus, high-income individuals should proactively assess their compliance and implement best practices for documentation and filing. Here are key steps to ensure your tax position is well-supported and less vulnerable to IRS challenges:
Keep Comprehensive Records and Documentation
For each potential area of scrutiny, maintain thorough and organized records. This includes:
- Copies of all income statements (W-2s, 1099s, K-1s, etc.)
- Detailed records of all investment transactions, including cost basis information and capital gains calculations
- Documentation of foreign accounts, with thorough records for FBAR and FATCA filings
- Detailed charitable donation records, including appraisal reports for non-cash contributions
Review Foreign Compliance Obligations Annually
If you have foreign accounts or assets, review all compliance obligations each year with a tax advisor who specializes in international tax. FATCA and FBAR reporting can change, and penalties for noncompliance are severe, so it’s essential to stay current and accurate with these filings.
Coordinate with Your Investment Advisor on Capital Gains and Losses
High-income filers should work with their investment advisors to ensure that capital gains and losses are reported accurately and that transactions avoid wash sales. Discuss your overall tax strategy with your advisor at year’s end to optimize gains and losses while avoiding potential pitfalls.
Obtain Professional Appraisals for High-Value Donations
Charitable contributions of high-value items, such as art or property, should be supported by professional appraisals. The IRS often challenges donations where the valuation appears inflated, so it’s critical to have substantiated values from qualified appraisers and keep all associated documentation.
Work Closely with Legal Advisors on Trusts and Estate Plans
For trusts and estate planning, work closely with a legal advisor to ensure compliance with IRS regulations on gift and estate taxes. High-net-worth individuals using trusts to manage or transfer wealth should ensure these structures are appropriately separated from personal assets and that all documents are in place for every transaction.
Consider Proactive Audit Defense Preparation
Proactive audit defense can be a smart move for high-income filers, especially those with complex returns. An audit defense strategy typically involves reviewing your return with a tax attorney or audit professional to identify any weak points or areas of concern before they attract IRS attention.
Conclusion
For high-income individuals, the IRS’s increased scrutiny means it’s more important than ever to prioritize compliance and ensure all income, deductions, and investments are accurately reported. A proactive approach, thorough documentation, and a strong partnership with tax and legal advisors are crucial for navigating today’s tax landscape with confidence. By understanding the IRS’s areas of focus and implementing best practices, high-income taxpayers can avoid potential audit risks and maintain compliance with evolving tax laws.
Navigating the IRS’s New Focus on High-Income Filers © 2024 by Durfee Law Group is licensed under CC BY 4.0 
Navigating the IRS’s New Focus on High-Income Filers