Closing the Tax Gap: How the IRS is Cracking Down on Tax Evasion

Flush with a cash infusion from the Inflation Reduction Act of 2022, the IRS is using its new funds to provide better service to taxpayers, implement new technology, and intensify its enforcement efforts. As part of its enforcement efforts, the Service is closely scrutinizing partnerships, corporations, and high-wealth individuals to enhance tax compliance and crack down on tax fraud, discrepancies, and failure to pay.

Background

Years of underfunding, during which its budget was cut by 20% and its staff by 38%, left the IRS in an unenviable position by 2020. While pandemic lockdowns further decreased the number of available staff, the Service was simultaneously tasked with administering COVID-related programs such as stimulus checks and emergency rental assistance.

In addition to backlogged returns and longer service times, the lack of funds resulted in a tax gap (the amount of tax due but uncollected) of nearly $400 billion each year.

In 2022, the Inflation Reduction Act (IRA) allocated $80 billion over 10 years for the IRS to improve taxpayer services, upgrade technology, and expand its enforcement. That $80 billion was reduced significantly last May, when it was cut by $21.4 billion as part of the debt ceiling deal. Despite the cut, the approximately $60 billion left still leaves the agency with a substantially higher budget than it has had in the recent past.

Since then, the IRS has begun trying to close the tax gap, ramping up its enforcement efforts and targeting partnerships, corporations, and wealthy individuals. In September 2023, the Service announced that it had begun contacting about 1,600 new taxpayers in this category that owe hundreds of millions of dollars in taxes. As of October 2023, it had collected $122 million dollars, and as of January 2024, it had collected more than $482 million.

Partnerships

The IRS is significantly enhancing its enforcement efforts to address tax noncompliance among partnerships, particularly large and complex entities. Two key areas of focus are the Large Partnership Compliance Program and High-Value Partnerships.

Large Partnership Compliance Program
The IRS is expanding its Large Partnership Compliance (LPC) program, initially launched in 2021. This program places some of the largest and most complex partnership returns under audit. These entities include hedge funds, real estate investment partnerships, and publicly traded partnerships, typically with assets over $10 billion. The expansion of this program will leverage Artificial Intelligence (AI) to identify potential compliance risks, enabling more effective scrutiny of partnership tax issues.

High-Value Partnerships
The IRS is also directing its attention toward partnerships with significant assets and balance sheet discrepancies. The Service has observed growing discrepancies between end-of-year balances and the following year’s beginning balances in partnership returns. These discrepancies often involve millions of dollars and lack the required explanatory statements. To address this, the IRS is sending compliance alerts to around 500 large partnerships with assets over $10 million.

Corporations

The IRS is intensifying its efforts to ensure that large corporations, especially those with complex structures and high income, comply with tax laws. It is IRS is implementing a series of initiatives to scrutinize and audit large corporations more effectively. These include the following:

Large Foreign-owned Corporations Transfer Pricing Initiative
One key area of focus is large foreign-owned corporations, specifically their U.S. subsidiaries. The IRS has observed that these subsidiaries often report losses or very low profits year after year due to improper use of transfer pricing. This tactic is used to minimize reported U.S. profits and, consequently, tax liabilities. To address this, the IRS is sending compliance alerts to about 150 subsidiaries of large foreign companies to remind them of their U.S. tax obligations and encourage self-correction of any non-compliant practices.

Expansion of the Large Corporate Compliance Program
Another significant initiative is the expansion of the Large Corporate Compliance (LCC) program within the IRS’s Large Business & International Division (LB&I). The LCC includes the largest and most complex corporate taxpayers with average assets of more than $24 billion and average taxable income of approximately $526 million per year. The LLC uses data analytics to identify large corporate taxpayers that may be non-compliant. The IRS plans to initiate additional audits of the largest corporate taxpayers, leveraging artificial intelligence and expert insights, with a particular focus on complex issues such as cross-border transactions.

Abuse of Repealed Corporate Tax Breaks
After the 2017 repeal of a tax code provision allowing deductions for domestic production, the IRS noted a surge in refund claims, which collectively amounted to over $6 billion. The Service has launched a campaign to scrutinize these claims and has already seen successes, including a significant win in the Tenth Circuit Court of Appeals, supporting the IRS’s position in denying a refund claim based on a $1.8 billion deduction.

Wealthy Individuals

Last April, the IRS noted that taxpayers who earned over $1 million or more we subject to a .7% audit rate in 2019, down from 7.2% in 2011, and vowed to increase enforcement for high-income and high-wealth individuals. It is now focusing on taxpayers with total positive income above $1 million and more than $250,000 in recognized tax debt.

Tonneson + Co Can Help

Whether corporation, partnership, or individual, wealthy taxpayers can anticipate closer scrutiny from the IRS over the coming years. More than ever, it pays to work with tax professionals with experience in your industry and an up-to-the-minute understanding of ever-changing tax regulations. Tonneson + Co can help. Contact us today.