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What are the audit risks with the new tax laws?
In the last couple of years, the IRS has reported a decrease in the country’s overall percentage of audited income tax returns. One of the reasons for this decrease is the budget cuts that mean the IRS has fewer budgets to effectively audit tax returns.
There has been a steeper decline for high-earning individuals as far as audit rates are concerned when compared to other people. However, there is still a higher audit rate for these individuals than the average population in the United States.
Even with the apparent decline in IRS audits, this does not mean you should be less careful with your taxes, especially if you belong to the high-income bracket. The Tax Cuts and Jobs Act (TCJA) that was passed in 2017 resulted in considerable tax cuts for many citizens with high gross incomes.
However, the act brought opportunities for write-offs to raise more than a few eyebrows within the IRS. While the revenue service may spend a couple of years following these write-offs, it will most assuredly catch up with them.
Declined Audit Rates
Out of the 160 tax returns that people filed in 2017, the IRS audited one. It recorded the sixth straight year in the decline of total audits. Besides, it was the lowest audit rate in 15 years.
The audit rate for people who earned $1million and above annually was higher than that of people in the general population category. In 2017, this rate was slightly above 4%, representing the lowest rate since the advent of the ’00 years. Interestingly, in 2015, this rate was at 10%.
The Transactional Records Access Clearinghouse located at Syracuse University surveyed in 2018; it reported a sharp reduction in the number of audits for people with more than $1million in annual incomes.
Additionally, the same report observed that the workforce at the IRS declined by 20%. It stood at 79,000 in 2018 as compared to100, 000 in 2010. Similarly, the employment of revenue agents who conduct tax audits at the IRS went down by around 35% during the same period.
Changes Caused by Tax Cuts and Jobs Act
When the TCJA was enforced in December 2017, it brought many considerable alterations to individual income taxes. One of the most noticeable changes was the modification of income tax brackets, which lowered tax rates.
While the lowest tax bracket caters annual incomes of up to $9,525, it still stands at 10%. However, the following are several changes that the TCJA introduced, and which could pose risks of 100% compliance.
- Moving the highest bracket to $500,000 and above
- Reduction of the tax rate of the most upper bracket to 37%
- Increasing standard deduction & family tax credits
- Elimination of personal exemptions
Under the TCJA, specific forms of income from investment and businesses are liable to different tax treatments. It could effectively give taxpayers a myriad of opportunities to save on their tax obligations.
However, the new changes could present the IRS with new opportunities for tax audits. For instance, this law permits a further deduction of business income from limited liability companies, S corporations, and other pass-through business entities.
Besides, the TCJA amends §1031of the Internal Revenue Code to get rid of the exemption of numerous “like-kind exchanges” from the capital gains tax. This section now only covers exchanges surrounding real property.
Audit Risks for the IRS
The Internal Revenue Service employs a couple of methods to zero in on taxpayers to audit. One of the ways involves deploying computer algorithms to find discrepancies between information filed by a taxpayer and what the agency already has in its systems.
The IRS also uses random selection. With these selection methods, high-net-income individuals face a higher likelihood of audit than their counterparts in other income brackets. A large number of deductions and self-employment are other factors involved.
It is prudent to point out the audit risks that the IRS faces with these new tax laws. For starters, there is a lack of clarity in the tax audit of certain limitations, such as pass-through entities and income thresholds.
These grey areas have prompted individuals and business entities to hire tax professionals to develop and devise strategies to maximize their benefits. Similarly, there arose opportunities for alterations of accounting methods.
Examples of new opportunities are the use of cash techniques of accounting and a reduction in inventory tracking. These were made available for taxpayers who attain the gross receipts test of $25 million.
While most changes were introduced in 2018 for the first time, the IRS may need years to follow through these. Estate tax returns, unlike individual returns, are audited routinely.
The IRS faces real challenges in ensuring full compliance of specific provisions under the TCJA. The agency may not access some reporting information from third-parties. Without this information, the agency faces more challenges of enforcing some of the new provisions.
If third parties do not report all tax information, the federal revenue agency will only rely on audits that are resource-intensive to enforce certain provisions. It is especially challenging given the reduced number of enforcement staff at the agency and declining audit rates.
Thanks to the magnitude of the changes brought about by TCJA. The IRS was not able to update its digital systems before the beginning of the 2019 tax season. It meant that the agency failed to include particular tax returns data in a format that they could quickly analyze and interpret for compliance planning.
Conclusion
Perhaps the most important practice that all tax returns professionals in the United States should adopt is to be as inclusive as possible when filing individual and business entity tax returns. When you provide the IRS with all the information they need, you get rid of the federal authority’s compliance issues.
Do you have questions related to tax in the United States? The tax advisory team at the Enterprise Consultants Group is here to provide answers. Feel free to reach us today on (800) 575-9284 or write to us online. We are glad to offer solutions appertaining to all your concerns.