Expectation of Increasing IRS Audits in the Future
Our experience at BMSS over the last three to four years is that we have seen fewer examinations of taxpayers than we did in the years prior to that period. Of course, some of the decrease over the last 17 or 18 months can be attributed to COVID, but we were already seeing that trend pre-COVID. Now, however, we see indications that this trend is likely to reverse and we will begin to see more IRS audits in the future.
Indication of Increased Audits – Just the Numbers
Our experience regarding a recent decrease in IRS audits is supported by the Compliance Presence section of the IRS Data Book. The percentage of returns examined for the period starting with the 2010 tax year compared to the 2018 tax year exhibits a steady decline. In four major categories of income tax returns, the percentages of total returns selected for examination trended as follows:
|% of Returns Examined
|% of Returns Examined
|Type of Return|
The numbers reflect a 75% or greater decrease in the percentage of returns examined per category, with the percentage of partnership returns examined falling off the ledge. This result is easier to understand when the Data Book also exhibits that the partnership category has seen the largest increase in the number of returns filed over the 9-year period covered by the data.
Indication of Increased Audits – Particularly for Partnerships
Based on changing IRS forms and requirements for disclosure in partnership returns, the IRS seems to be gearing up for more partnership audits in the future. One example of these changing requirements is that 2020 partnership returns must now disclose tax capital accounts. This requirement is a change from prior years for which the partnership could choose to report capital accounts on one of three methods. Mandatory reporting of tax capital accounts will make it easier for the IRS to quickly determine if partners are deducting losses that they might not be entitled to and whether they may have received taxable distributions from partnerships.
The relatively new centralized partnership audit regime – under which the IRS generally assesses and collects any understatement of tax at the partnership level – also points to greater partnership audits, and the potential efficiency of those audits. Audits of partnerships not electing out of the centralized audit regime will allow the IRS to assess and collect tax at the partnership level instead of having to collect from each partner.
Indication of Increased Audits – Current Administration Budget Proposals
In response to the claims of this excessively high tax gap, the Biden administration has proposed significant funding to the IRS in its budget proposals. The Fiscal Year 2022 discretionary Budget proposal for the IRS provides $13.2 billion, an increase of $1.2 billion, or 10.4 percent, above the 2021 enacted level, to administer the nation’s tax system The longer-term budget proposals in the Administration’s legislative agenda would also allocate nearly $80 billion over the next 10 years to increase several central IRS functions. The Administration projects additional funding would generate about $700 billion in additional tax revenues over 10 years, yielding a return of nearly 10 to 1.
The primary emphasis of this funding proposal would be on increased IRS audits. The funding would also help implement proposed changes in yearly information reporting for financial transactions as well. Current examples include banks reporting yearly amounts of deposits and withdrawals from each customer account and businesses reporting transactions involving cryptocurrency that exceed $10,000.
One positive aspect of the proposed funding bill would increase the number of customer service representatives and allow better online access to taxpayers. Our clients have had increasingly frustrating experiences with the IRS since the onset of COVID with delayed return and payment processing. These delays, in turn, often lead to notices to taxpayers which are difficult to resolve with the current IRS staffing levels, significant remote workforce, and limited physical access to IRS offices.
The final details on the infrastructure bill are yet to be determined as the debate on spending continues between the two parties. Regardless of the final amount of IRS funding, we see IRS audits continuing to rise in the future.