While the IRS audit coverage has declined for most people, primarily due to budget cutbacks, the IRS will soon be back with a vengeance ‒ targeting high-income individuals. The overall individual audit rate is only about one in 250 returns, but the odds increase as your income goes up (especially if you have business income). High-income taxpayers are being specifically targeted by a new IRA audit initiative, which will be broad and comprehensive in scope. An audit will typically involve three tax years, include related entities, and may take years to resolve.

The IRS classifies taxpayers by their “total positive income,” which is the sum of all positive income items reported, not including deductions. The IRS classifies income based on the following income brackets:

  • $500,000 to $1,000,000
  • $1,000,000 to $5,000,000
  • $5,000,000 to $10,000,000
  • $10,000,000 or more

In the summer of 2020 IRS announced that the agency will launch a campaign to audit several hundred high-income households that have a related partnership, S corporation, trust, or private charitable foundation.  It will look at all the entities an individual owns or controls – not just their Form 1040. These audits are complex and require knowledge of several areas of tax law.  That’s why it is important to have competent tax professionals at your side as early in the game as possible.

IRS will assign these audits to a specialized, highly trained group of auditors known as the Global High Wealth Industry Group whose sole focus is to examine the returns of high-income, high-wealth taxpayers. The “wealth squad” is specially trained to examine complex domestic and offshore financial activities, including sophisticated structures and arrangements whether in the form of partnerships, corporations, foundations or trusts.

Regardless of whether a person falls in the high-profile category, there are certain recommended steps to prepare for an IRS audit. Documentation wins tax cases. The first thing an auditor will ask for is a copy of all of your bank records to look for unreported income. You should keep a paper copy of all bank and brokerage statements because banks don’t keep on-line versions forever. Be sure to keep copies of all records relating to your tax returns for at least three years. Such records include:

  • “Information returns” such as W-2s, 1099s, K-1s, and the like;
  • Bank records;
  • Records documenting your basis in partnerships and S corporations;
  • Receipts for deductions;
  • Closing statements for purchases and sales of realty;
  • Significant contracts and agreements;
  • Details on business auto/truck mileage, travel, lodging, and meals.

If you fit the “high-income” profile and you receive an IRS audit notice, you should not represent yourself.  If you are selected for audit, they will normally make first contact with you through the mail. They will not make an initial contact by telephone or email.  If someone visits you from the IRS, they should have government issued identification known as a “pocket commission,” which they must show you upon request.

If you are approached by an IRS employee, you should politely decline to answer questions, take their name and telephone number, and tell them that your attorney will be in touch with them shortly. It is much easier to stop something bad from happening than to repair the damage once it’s done.