The Internal Revenue Service (IRS) has recently announced a significant increase in the number of audits it plans to conduct in the coming years. This development is part of a broader initiative aimed at improving tax compliance and closing the tax gap, which is the difference between taxes owed and taxes paid on time. As a taxpayer, understanding who the IRS plans to target with these audits is important. Here’s what you need to know.
The Inflation Reduction Act
The Inflation Reduction Act (IRA), which was signed into law in 2022 by President Biden, granted the IRS $80 billion in new funding. The goal of the funding is to bolster an agency known for lengthy processing delays, a drop-off in audit rates, and major customer service shortcomings.
Over the next three tax years, the IRS plans a sharp increase in audits, but the agency insists these audits won’t affect taxpayers who earn less than $400,000 annually.
Focus on High-Income Earners
The IRS plans to focus on individuals earning $400,000 or more annually. This demographic has historically been associated with more complex tax returns, which can include multiple income streams, investments, and deductions. The IRS’s goal in focusing on high-income earners is to ensure that these taxpayers are accurately reporting their income and paying the correct amount of taxes.
Large Corporations
The IRS plans to triple the audit rates on large corporations with assets totaling more than $250 million. By tax year 2026, audit rates for these companies will rise to 22.6%, up from 8.8% in 2019. Additionally, large partnerships with assets totaling more than $10 million will be subject to significant audit rate increases, rising to 1% in tax year 2026 from 0.1% in 2019.
Small Businesses Potentially Under the Microscope
Despite initially assuring small business owners that the increase in audits won’t affect small businesses, some evidence is signifying otherwise. The Government Accountability Office, a nonpartisan agency, reported that more than 90% of audits are on families and small businesses below the $400,000 income threshold. In March, when Treasury Secretary Janet Yellen was asked by the House Ways and Means Committee about the number of new audits funded by the Inflation Reduction Act, she confirmed that the proportion of new audits targeting those families and small businesses would remain at the historical level of 90%.
Cryptocurrency Transactions
With the rise of digital currencies, the IRS is increasing its efforts to audit taxpayers involved in cryptocurrency transactions. This includes gains from the sale of cryptocurrencies, mining activities, and even receiving cryptocurrencies as payment for goods or services. If investors do not comply with reporting requirements, the IRS could impose accuracy penalties. Therefore, investors should maintain detailed records of all cryptocurrency transactions.
Offshore Accounts
Taxpayers with offshore accounts and foreign assets are also on the IRS’s radar. The Agency has long focused on foreign income and assets due to the potential for significant tax evasion. The Foreign Account Tax Compliance Act (FATCA) requires U.S. taxpayers with foreign financial assets exceeding certain thresholds to report these assets to the IRS. Failure to comply with these reporting requirements can result in substantial penalties. The boost in funding will allow the IRS to continue an aggressive pursuit of individuals and businesses attempting to hide income and assets overseas.
Preparing for a Possible Audit
Given the IRS’s focus on these areas, taxpayers need to ensure their tax returns are accurate and comply with all applicable laws. Keeping thorough records and documentation can help in the event of an audit. Consulting with qualified tax professionals can also provide guidance and help mitigate the risk of errors on your tax return.
