During the latter part of 2009, the IRS announced a number of new compliance initiatives that, when fully implemented, have the potential to dramatically alter how the IRS deals with certain groups of taxpayers. The programs are important not only in how they will directly affect the targeted taxpayer groups but also in the insight they offer on the priorities of current IRS leadership for 2010 and beyond.
These compliance programs come on the heels of the IRS’s well-publicized voluntary disclosure program aimed at cracking down on offshore abuses. Under this program, approximately 14,700 taxpayers came forward to report their offshore accounts to the IRS. While compliance initiatives such as the voluntary disclosure program for offshore accounts are no doubt important and make splashy headlines, the new and less-publicized programs discussed here could affect certain taxpayers just as drastically.
IRS Launches High-Wealth Task Force and Prepares Audits
On Oct. 26, 2009, IRS Commissioner Douglas Shulman announced the creation of a new specialized industry group to target high-wealth individuals. Surprisingly, this Global High Wealth Industry Group will be housed within the Large and Mid-Size Business (LMSB) Division, and the IRS is planning a number of examinations to test the program. According to Shulman, many other countries already employ specialized task forces to pursue their wealthiest taxpayers. The idea is to centralize IRS compliance efforts for high-wealth individuals because the IRS has to look at sophisticated financial, business, and investment arrangements with complicated legal structures and tax consequences. The task force will take a unified approach to its audits by focusing on the entire web of business entities controlled by a wealthy individual, including issues involving offshore structures, income sources and tax residency.
The IRS has ostensibly been targeting high-income taxpayers all along, but Shulman seemed to indicate in his comments that current IRS efforts typically involve identifying single returns for audit based on the usual scoring systems for audit selection. The new program would instead look at everything that may be connected to a single taxpayer, including trusts, private foundations, partnerships, equity-sharing arrangements, royalty and licensing agreements, and privately held and related entities where the taxpayer may have actual or beneficial ownership. The IRS has already hired flowthrough specialists and international examiners for the team and is considering adding economists, appraisal experts and industry specialists.
The IRS has not yet settled on a formal definition of high-wealth individuals, but Shulman specifically noted that other countries have often drawn the line at $30 million. He said the IRS will initially focus on individuals with “tens of millions of dollars” in assets or income.
Intensive Employment Tax Audits
The IRS has also announced that it will conduct intensive employment tax audits under its National Research Program (NRP). This is a multiyear program with random audits scheduled to begin in February 2010. The IRS has said it will audit approximately 6,000 U.S. companies under this program (Gardner, “NRP Employment Tax Audit Program to Examine 6,000 U.S. Companies,” BNA Daily Tax Report G-1 (Sept. 23, 2009)). The NRP is a study and data collection project that helps the IRS update its noncompliance estimates and retool its computer-driven audit selection programs. Typical audits do not yield as valuable compliance data as random audits because the IRS, in typical audits, is intentionally targeting the taxpayers they believe have noncompliance problems. NRP audits are random to allow the IRS to statistically measure the total amount of noncompliance in a specific area. The IRS then uses this data to update its computers and estimates of the tax gap—the difference between total taxes owed and the amount actually paid by taxpayers.
The NRP audits are also more intense and less targeted than a typical audit, though the IRS maintains that they are much less intrusive than the unpopular Taxpayer Compliance Measurement Program audits they replaced. The NRP audits allow the IRS to identify where the compliance problems lie in a specific population and to better target noncompliant tax returns for audit in the future.
The goal of the employment tax audit program is to gather information in five categories: worker classification, fringe benefits, nonfilers, reimbursed expenses, and officer compensation. Various government agencies have recommended that the NRP be implemented for employment taxes to study and access the impact of worker misclassification on the employment tax gap, which has become a high priority of the government.
The administration has been quiet thus far on the issue of worker classification, but President Barack Obama was a supporter of reform efforts while in the Senate. If Congress enacts a health care reform bill with a “pay-or-play” provision for employers, it could put even more pressure on the worker classification rules.
Putting Pressure on Corporate Governance
The IRS also appears to be stepping up the dialogue with corporate boards of directors in order to influence their behavior. In a speech given to the National Association of Corporate Directors on Oct. 19, 2009, Commissioner Shulman warned that the IRS is interested in monitoring their assessment and oversight of corporate tax risks.
Shulman told board members that they need to be aware of aggressive tax positions that use elaborately structured transactions or arrangements to push tax planning beyond acceptable bounds. He assured the audience that the IRS would not second-guess legitimate and thoughtful business decision making by corporate leaders and acknowledged that there will be legitimate disagreements about identifying and quantifying the risk of various tax positions. But he maintained that boards should have a mechanism in place to oversee tax risk as part of the governance process. He specifically suggested that they set a threshold confidence level for taking a tax position and discourage or eliminate “opinion shopping” by tax departments by allowing an independent tax firm to have direct dialogue with the board of directors and review major tax positions. He also stated that boards needed to address transfer pricing and the relative profit allocated to low-tax jurisdictions to make sure they reflect real economic contributions.
Over the past few months, the IRS has provided certain insights into some of the new initiatives that it will focus on during 2010 and beyond. In connection with these initiatives, the IRS has been hiring and training many new agents. Armed with this knowledge, taxpayers in the affected groups should not be surprised if the IRS contacts them about these issues.
Walter Goldberg is with Grant Thornton LLP in Washington, D.C.
This article originally appeared in the February 2010 issue of The Tax Adviser, the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price. Call 800-513-3037 or e-mail firstname.lastname@example.org for a subscription to the magazine or to become a member of the Tax Section.