IRS Using Inflation Reduction Act to Launch Further Initiatives and Penalties to go after High-Income Taxpayers

More than $482 million recovered from 1,600 millionaires who have not paid tax debts and even more taxpayers will be subject to further scrutiny.

Under the Inflation Reduction Act the IRS is receiving $80 billion in new funding over nine years. The $80 billion price tag is more than six times the current annual IRS budget of $12.6 billion. The money will be distributed to IRS over nine years and comes with few strings attached. Before the Inflation Reduction Act, the IRS had limited budgets and staffing resources to be able to carry out this task. With new funding available due to the Inflation Reduction Act, the IRS now has the capability to launch a large compliance effort.

IRS Claims Of Collection Enforcement And Examinations

The IRS previously announced continued progress to expand enforcement efforts and increase scrutiny related to high-income individuals, large corporations, complex partnerships who do not pay overdue tax bills as a result of the additional funding it is receiving under the Inflation Reduction Act.

In its enforcement efforts and increasing scrutiny, the IRS is focusing on people using partnerships to avoid paying self-employment taxes. The IRS is also continuing to pursue millionaires that have not paid hundreds of millions of dollars in tax debt, with an additional $360 million collected on top of the $122 million reported in late October 2023. The IRS has now collected $482 million in ongoing efforts to recoup taxes owed by 1,600 millionaires with work continuing in this area.

The various and specific ways the IRS is pursuing higher scrutiny and expanding their enforcement efforts include, prioritization of high-income collection cases, pursuing multi-million-dollar partnership balance sheet discrepancies, ramp of audits of 76 largest partnerships leveraging artificial intelligence, compliance alerts for large foreign-owned corporations who use transfer pricing rules year after year to report losses and avoid reporting an appropriate amount of U.S. profits, expansion of large corporate compliance program, and IRS has been increasing compliance to ensure that Self-Employment Contributions Act (SECA) taxes are being properly reported and paid by wealthy individual partners who provide services and have inappropriately claimed to qualify as “limited partners” in state law limited partnerships (such as investment partnerships) not subject to SECA tax.

IRS Commissioner Danny Werfel noted Inflation Reduction Act resources allows the IRS “to increase scrutiny on high-income taxpayers as we work to reverse the historic low audit rates and limited focus that the wealthiest individuals and organizations faced in the years that predated the Inflation Reduction Act. We are adding staff and technology to ensure that the taxpayers with the highest income, including partnerships, large corporations and millionaires and billionaires, pay what is legally owed under federal law. At the same time, we are focused on improving our taxpayer service for hard-working taxpayers, offering them more in-person and online resources as part of our effort to deliver another successful tax season in 2024. The additional resources the IRS has received is making a difference for taxpayers, and we plan to build on these improvements in the months ahead.]

IRS begins new compliance efforts and penalties on high-income taxpayers who failed to file tax returns

Following its commitment to enhancing tax compliance enforcement activity, on February 29, 2024, the IRS announced that IRS compliance notices CP59 are going to be mailed out to more than 125,000 taxpayers where tax returns haven’t been filed since 2017. The mailings include more than 25,000 to those with more than $1 million in income, and over 100,000 to people with incomes between $400,000 and $1 million between tax years 2017 and 2021. In these cases, the IRS has received third-party information—such as W-2s and 1099s—indicating these people received income in these ranges but failed to file a tax return. The IRS is sending out CP59 notices starting with the highest-income taxpayers, with thousands of additional notices to be followed weekly.

Under this new compliance effort, if a taxpayer does not file there is a  failure-to-file penalty, which is an additional 5% of the amount owed every month – up to 25% of the tax bill.  If a person continually fails to file, the IRS may create a substitute tax return for the taxpayer. This substitute tax return is calculated based on wages and other income reported to the IRS by employers, financial institutions, and others. These substitute tax return factors in the tax, penalty and interest owed by the taxpayer. Furthermore, if a taxpayer does not file their taxes they could possibly miss out on a refund, a right to claim specific tax credits, or if a taxpayer is self-employed, they will not receive credit towards Social Security retirement or disability benefits.

What the IRS does if you do not file a tax return …

People who don’t respond to the non-filer letter will receive additional notices and other enforcement actions. Ultimately, this can lead to a variety of IRS compliance activity, including collection and audit action as well as potential criminal prosecution. As part of this, the IRS can also take steps to file what’s known as a Substitute for Return (“SFR”).

If a person repeatedly fails to respond and does not file, the IRS may create a substitute tax return for the taxpayer. The IRS calculates this substitute tax return based on wages and other income reported to the agency by employers, financial institutions and others. The return factors in the tax, penalty and interest owed by the taxpayer.

When the IRS creates a SFR, almost always that liability on the SFR is higher than if an actual return is filed by the taxpayer.  That is because an SFR does not take into account deductions and basis that you would otherwise be entitled to report.

In this scenario, the IRS will send a Notice Of Deficiency (Form CP3219N or sometimes referred to as a “90-day letter”) proposing a tax assessment. The taxpayer will have 90 days to file the past due tax return or file a petition in Tax Court. If the person does neither, the IRS will proceed with the proposed assessment.

If the IRS files a substitute return, it is still in the person’s best interest to file their own tax return to take advantage of any exemptions, credits and deductions they are entitled to receive. The IRS will generally adjust the account to reflect the correct figures.

The tax return the IRS prepares for these taxpayers will likely lead to a tax bill, which, if unpaid, will trigger the collection process. This can include such actions as a levy on wages or a bank account or the filing of a notice of federal tax lien. If a taxpayer repeatedly does not file, they could be subject to additional enforcement measures, such as additional penalties and/or criminal prosecution.

Importance To Preserve Records

Keep in mind that the IRS has up to three years to select a tax return for audit. For California taxpayers, the Franchise Tax Board has up to four years to select a California State Income Tax Return for audit. In some cases these 3 and 4 year periods are extended to six years. When a taxpayer is selected for audit, the taxpayer has the burden of proof to show that expenses claimed are properly deductible. Having the evidence handy and organized makes meeting this burden of proof much easier.

Essential Records to Have for a Tax Audit

If you are getting ready for a tax audit, one of the most important things to do is gather and organize your tax records and receipts. There’s a good chance that you have a large amount of documents and receipts in your possession. No matter how organized you are, it can be a daunting task to collect the right pieces and make sure that you have them organized and handy for the audit conference.

We have seen many tax audits that hinge on whether or not the taxpayer can provide proper documentation for their previous tax filings. A tax lawyer in Orange County or elsewhere can make sure that the documentation is complete and proper.  By submitting this to your tax attorney in advance of the audit, your tax attorney can review your documentation and determine if there are any gaps that need to be addressed before starting the dialogue with the IRS agent.

So what are the most essential tax records to have ahead of your audit? Here are a few must-have items:

• Any W-2 forms from the previous year. This can include documents from full-time and part-time work, large casino and lottery winnings and more.
• Form 1098 records from your bank or lender on mortgage interest paid from the previous year.
• Records of any miscellaneous money you earned and reported to the IRS including work done as an independent contractor or freelancer, interest from savings accounts and stock dividends.
• Written letters from charities confirming your monetary donations from the previous year.
• Receipts for business expenses you claimed.
• Mileage Logs for business use of vehicle.
• Entertainment and Travel Logs for business

Appealing Results Of An IRS Tax Audit

Now if your IRS tax audit is not resolved, the results may be challenged. After the Revenue Agent has concluded the tax examination, the agent will issue a copy of the examination report explaining the agent’s proposed changes along with notice of your appeals rights. Pay attention to the type of letter that is included as it will dictate the appeals process available to you.

The “30-day letter”

The “30-day letter” gives you the right to challenge the proposed adjustment in the IRS Office Of Appeals. To do this, you need to file a Tax Protest within 30 days of the date of the notice. The Appeals Office is the only level of appeal within the IRS and is separate from and independent of the IRS office taking the action you disagree with. Conferences with Appeals Office personnel are held in an informal manner by correspondence, by telephone, or at a personal conference.

The “Notice Of Deficiency”

If the IRS does not adopt your position, it will send a notice proposing a tax adjustment (known as a statutory notice of deficiency). The statutory notice of deficiency gives you the right to challenge the proposed adjustment in the United States Tax Court before paying it. To do this, you need to file a petition within 90 days of the date of the notice (150 days if the notice is addressed to you outside the United States). If you filed your petition on time, the court will eventually schedule your case for trial at the designation place of trial you set forth in your petition. Prior to trial you should have the opportunity to seek a settlement with IRS Area Counsel and in certain cases, such settlement negotiations could be delegated to the IRS Office Of Appeals. If there is still disagreement and the case does go to trial, you will have the opportunity to present your case before a Tax Court judge. The judge after hearing your case and reviewing the record and any post-trial briefs will render a decision in the form of an Opinion. It could take as much as two years after trial before an Opinion issued. If the Opinion is not appealed to a Circuit Court Of Appeals, then the proposed deficiency under the Opinion is final and your account will be sent to IRS Collections.

IRS Area Counsel are experienced trial attorneys working for the IRS whose job is to litigate cases in the U.S. Tax Court and look out for the best interests of the Federal government. So to level the playing field, it would be prudent for a taxpayer to hire qualified tax counsel as soon as possible to seek a mutually acceptable resolution without the need for trial, and if that does not happen, to already have the legal expertise in place to vigorously defend you at trial.

What Should You Do?

You know that at the Law Offices Of Jeffrey B. Kahn, P.C. we are always thinking of ways that our clients can save on taxes.  People receiving CP59 notices should take immediate action to avoid additional follow-up notices, higher penalties, and potentially stronger enforcement measures. If you are selected for an audit, or CP59 notice stand up to the IRS by getting representation. Tax problems are usually a serious matter and must be handled appropriately so it’s important to that you’ve hired the best lawyer for your particular situation. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the San Francisco Bay Area (including San Jose and Walnut Creek) and elsewhere in California are highly skilled in handling tax matters and can effectively represent at all levels with the IRS and State Tax Agencies including criminal tax investigations and attempted prosecutions, undisclosed foreign bank accounts and other foreign assets, and unreported foreign income. Also if you are involved in cannabis, check out what a cannabis tax attorney can do for you and if you are involved in crypto-currency, check out what a Bitcoin tax attorney can do for you.