The IRS has made it clear publicly that it will increase efforts to identify tax fraud and underpayments by individuals and businesses with annual income of more than $400,000. But what it didn’t say, and that it isn’t going to reduce, are audits of people and businesses making less than that.
“It’s not that the IRS is going to stop auditing people at or under $400,000,” pointed out Nancy Ortmeyer Kuhn, a lawyer and shareholder at Shulman Rogers law firm. “It’s just that they’re not going to increase the audits. Since the audits for that category have been higher than other categories, many people and businesses are still going to be audited.”
In the wake of the passage of the debt ceiling legislation, Congress has authorized $60 billion for the IRS to spend on technology upgrades and to increase its auditing capabilities, which includes expanding its audit staff.
New technology improvements notwithstanding, “the IRS is very good at matching informational returns from banks and employers — all sorts of sources — that provide taxable income to taxpayers. Their computers just spew out information request letters to taxpayers and then the taxpayer has to respond. After that, the case will be assigned to an agent,” Kuhn said. “But with improved technology, I think those computer-generated letters are only going to increase. And in some ways, the automatic letters are easier for the agency because so much of the initial work is done automatically.”
We asked Kuhn, who spent her early career working for the U.S. Tax Court and then the IRS, to offer advice on what people should do to ensure they don’t run afoul of the federal tax code and draw an audit unnecessarily. She shared five tips.
Tax Tip 1: Look at your previous returns
For starters, Kuhn suggested reviewing tax returns filed for the past two to three years because, legally, the IRS can only audit back three years. Given that the IRS has provided a heads-up that it intends to increase audits, taxpayers have time to amend those older returns, she said.
“See if the positions taken on those tax returns are reasonable. If there are any risky positions that were taken, the taxpayer might want to think about amending their return,” she said.
Often the penalty fee will be greatly reduced or nonexistent if a taxpayer amends a return before the IRS flags a return and sends out an audit letter, Kuhn said.
“It’s time for taxpayers to seriously look at their filing history and review the last three years. Taxpayers should be realistic about what is accurate and what is fair, and what an IRS agent might find if they look at the tax return.”
Given that it will take the agency a bit of time to ramp up its new capabilities, some taxpayers might be comfortable only reviewing the past two years, she added.
Tax Tip 2: Vet your records and documentation
Kuhn also encouraged people to make sure they can document any actions taken on those previous three years of returns and to be more careful going forward. Because the IRS intends to improve its technology prowess, it might be able to more deeply review returns and supporting documentation, or gain insights about what to seek from taxpayers during audits, she said.
In her experience, Kuhn has often seen people lose tax cases because they cannot provide the receipts or documentation to support their returns or claims.
“It’s another thing that people can do, regardless of income level,” she said. “Because if you don’t have the documentation, the IRS is not going to take your word for it. That’s just not how it works.”
Tax Tip 3: Be wary of over- or under-valuating assets
As part of its audit ramp-up, the IRS plans to hire more specially trained auditors.
“The IRS has said it’s going to bring in experts that will be able to provide valuations at a sophisticated level, that will be credible in court, and so taxpayers really need to pay attention to valuations claimed on their tax returns,” Kuhn said.
That puts the onus on people and businesses to provide credible valuations from trusted third-party appraisers, particularly for real estate and any type of non-cash donations, she said. “If it’s too good to be true, then it probably is too good to be true, and they need to get a reasonable valuation.”
Funds moved offshore are also an issue the IRS could target. “I’m sure that the IRS will hire agents that will be very well-educated in international issues because there’s a lot of money that could be collected from transfer pricing and funds that are being shipped offshore,” Kuhn said.
She also noted that this is another opportunity for taxpayers to amend returns if their review of earlier filings raises questions.
“This is a huge area of enforcement for the IRS,” she said. “I think they’re going to be looking at it pretty closely.”
Tax Tip 4: Expect more scrutiny of estate and gift taxes
There was a period of time when any estate tax return over a certain threshold received an automatic audit. “I suspect that will happen again,” Kuhn said.
She also said that it seems likely that IRS agents will delve more into gift taxes. “I’ve seen quite a few taxpayers that don’t file gift tax returns when they should,” Kuhn said. “There are ways that gifts can be structured, whether right or wrong, so that it eludes the IRS’ notice.”
Tax Tip 5: For businesses, keep employment taxes in good stead
For businesses big and small, it’s critical to properly manage employment taxes, she said. It’s an area where IRS already uses matching technology and may choose to invest in new technology, Kuhn said.
“The employer submits all these forms showing how much has been withheld from employees’ paychecks,” she said. “If the employees’ tax returns don’t match that, then it’s an automatic computer matching issue.”
The IRS is also vigilant in making sure that businesses pay the taxes to the agency that each business has withheld from its employees’ wages. “The employment tax collection division is very aggressive in going after those individuals that have not paid over the employment taxes — very aggressive. And I don’t think that’s going to change,” Kuhn said.
IRS will lean into technology
She also expects that the agency will be aggressive in its deployment of newer technologies that can help auditors do their jobs both more efficiently and more effectively.
“My experience with employees at the IRS is they’re very smart,” Kuhn said. “As long as they have money to get the equipment and to hire the people that can do this work, the IRS will take full advantage of artificial intelligence and other tools that will make their jobs easier and more effective.”
She advised people to get advice early should they face an audit, so that they can respond quickly and avoid excessive penalties and interest whenever possible. “It’s almost always better to settle cases if you are able to do so.”
Musician turned tax lawyer
Nancy Ortmeyer Kuhn had every intention of becoming a professional musician.
“I started out in music, got a master’s degree, went to Europe on a Fulbright came back, tried to be a musician, and it just wasn’t quite what I was after,” Kuhn said.
Today, she’s a shareholder at the Shulman Rogers law firm, where she handles a varied practice that involves helping clients with tax cases, along with counseling nonprofits.
She discovered her interest in tax law while in law school, ultimately getting a master of laws in taxation. Kuhn began her career working at the U.S. Tax Court and from there went to the IRS, where she worked for nearly 10 years.
“I enjoy helping people. That’s one reason I went to law school, so I could help people. Tax law is an area where people really do need support — not only legal support but help calming things down so it doesn’t seem like it’s the end of the world.”
