IRS funding and a potential rise in malpractice claims

In 2022, Congress enacted the Inflation Reduction Act, P.L. 117-169, which added $80 billion to the IRS’s budget over the next decade. While some funds have been rescinded and others reallocated from enforcement to operations, the IRS still has more appropriated resources than it has had in decades.

In the Inflation Reduction Act Strategic Operating Plan FY2023–2031 (SOP), IRS Commissioner Danny Werfel indicated that the Service’s transformation objectives include:

1. Renewed enforcement focus on taxpayers believed to be major contributors to the tax gap; 
2. Modernization of operations using cutting-edge technology and data; and 
3. Investment in people to reverse the effects of chronic underfunding.

Almost $46 billion has been allocated to enforcement efforts. The SOP states that enforcement will focus on:

• Large corporations;
• Large partnerships; and
• High-income/high-wealth individuals, including those making greater than $400,000 annually (focus taxpayers).

This may be a welcome relief to CPA firms who don’t serve these taxpayers, but things aren’t always as they appear. Modernizing operations through improved technology and data analysis will likely allow the IRS to identify more errors more efficiently, and this will likely affect all taxpayers. Clients faced with unanticipated tax bills may assert that their CPA firm is responsible for the penalties and interest owed because, had the CPA prepared the tax return correctly or if the client had been properly advised, there would not have been a liability.

HOW WILL THE IRS ACCOMPLISH ITS STATED GOALS?

For each objective, the SOP demonstrates two themes:

• More and better trained employees to help taxpayers meet their tax obligations; and
• The use of data analytics and artificial intelligence (AI) to transform the IRS’s approach to compliance and enforcement.

Let’s examine how each theme may affect a CPA’s risk.

More and better trained employees

To combat a nearly 20% decrease in workforce between 2010 and 2022, the IRS plans to increase hiring and retention and upskill its workforce to provide the capabilities required by today’s data-driven environment. This is anticipated to result in higher error detection.

Data analytics and AI

Today’s IRS systems are antiquated and not integrated or optimized for processing and analysis of large-scale data.

Newer, more integrated systems will allow IRS auditors to use case-building insights, driven by data, to provide a holistic understanding of interconnected tax entities and/or financial transactions — something not currently possible.

With improved technological capabilities, better prepared auditors may begin examinations and criminal investigations with a clearer, more focused, picture of all of the potential errors on tax returns rather than conducting a fishing expedition to try to find them.

Not just focus taxpayers

The IRS matching program currently performs well, and future iterations will likely perform better with additional funding and emphasis on systems improvements. Although Treasury has stated that funding should not be used to increase the share of audits for taxpayers earning less than $400,000 (nonfocus taxpayers), CPAs should not expect that nonfocus taxpayers will get a free pass from the IRS when the improved systems identify noncompliance. Nonfocus taxpayers may not get audited, but they may receive a notice.

HOW MAY INCREASED IRS FUNDING RESULT IN MORE PROFESSIONAL LIABILITY CLAIMS?

The IRS expects increased funding to produce an improved workforce and connected systems. Connected systems will have the ability to quickly receive, synthesize, and analyze information, including from other foreign, federal, and state governmental agencies. This information will be used to identify taxpayer noncompliance more efficiently. 

Data will allow multiple returns related to a single taxpayer to be identified and, possibly, audited. Audits of a high-income/high-wealth individual taxpayer may be expanded to include business, trust, gift, and estate tax returns. For partnerships, especially tiered partnerships, better data may provide the IRS greater visibility, which may result in more audit adjustments. All taxpayers are likely to experience greater scrutiny of international activity. 

All of this may allow the IRS to choose the enforcement actions predicted to be most effective in ensuring tax compliance, likely increasing tax liabilities for focus and nonfocus taxpayers alike. Clients faced with unanticipated tax bills may look to recoup their “losses” by blaming their CPA firm.

WHAT CAN CPAs DO?

Since the IRS is building its offense with its investments in staffing and data analytics, CPAs should ready an effective defense.

Do it right the first time

Easy to say, harder to do. 

How will you prepare for the IRS’s improved matching programs? Will you pull client transcripts to ensure that your client has provided every tax document they should, or is this outside the scope of your responsibilities under the AICPA Statements on Standards for Tax Services Section 2.3, Reliance on Information From Others? Will you obtain a client representation letter that confirms the client’s acceptance of the consequences for not providing complete and accurate information, or is this impractical? There might not be a definite answer. You have to do what’s right for your firm. 

Staying on top of new legislation and guidance issued by the IRS and other tax authorities is imperative, but guidance doesn’t anticipate every client situation. What’s a CPA to do when guidance is limited and/or nonauthoritative? 

The answer? Do your best … and remember that documentation and communication are key. First, document the issue. Include facts and assumptions, research performed, copies of research materials relied upon, filing options, and potential benefits and risks of each option. Then communicate this to the client. Require the client to decide, in writing, how to treat the item. If later guidance contradicts the position taken, you can use the contemporaneous documentation to support the position taken at the time. 

Finally, don’t dabble. When you are unfamiliar with an area, whether it be a new tax law or something you haven’t encountered before, consult with the people who know the area.

Prepare for more IRS activity

The IRS anticipates more audits of focus taxpayers, and CPAs should prepare now by ensuring that workpapers for tax returns prepared today are complete and will withstand IRS scrutiny should an audit occur. 

Assisting a client with an IRS exam is not the same as, and is not part of, preparing the client’s tax return — it’s a new engagement. Obtain an engagement letter if asked to represent the client in an examination. 

With historically low audit rates, many CPAs have limited experience with IRS audits. Professional liability claims may also arise from representing the client before the IRS. Educate yourself now, before a client receives an audit notice, about how audits are handled.

BUT THIS IS A FEW YEARS AWAY . . . RIGHT? 

Wrong. 

Many initiatives are already in process, and many CPAs have experienced these changes, whether they realize it or not.

According to the SOP, in fiscal year 2023 the first wave of focus taxpayer specialists was hired and onboarded. Robotic process automation was implemented to automate high-volume, manual processes, creating more time for identifying discrepancies. According to the 2024 IRA Strategic Operating Plan Annual Update, focus taxpayers who have not filed tax returns or paid debts received enforcement letters, resulting in $520 million in recoveries through January 2024. 

For fiscal year 2024 the IRS plans to select taxpayer compliance cases using a new centralized compliance planning function that leverages new analytics systems. More specialists will be hired to focus on high-risk areas of noncompliance (digital assets, listed transactions, and certain international issues). 

The SOP is a 10-year plan, and changes will continue to ramp up. Will you be prepared?

Empire State audits

56%: The increase in the number of tax audits in New York from 2021 to 2022 despite a 5% decline in the number of auditors.

Source: Business Insider, April 16, 2024.

Deborah K. Rood, CPA, is a risk control consulting director at CNA. For more information about this article, contact specialtyriskcontrol@cna.com. 

Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. Aon Insurance Services, the National Program Administrator for the AICPA Professional Liability Program, is available at 800-221-3023 or visit cpai.com.

This article provides information, rather than advice or opinion. It is accurate to the best of the author’s knowledge as of the article date. This article should not be viewed as a substitute for recommendations of a retained professional. Such consultation is recommended in applying this material in any particular factual situations. 

Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. The relevant insurance policy provides actual terms, coverages, amounts, conditions, and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice.