Since the passage of the first Internal Revenue Code, it has seemed as if the lion’s share of personal income taxes have been paid by higher income taxpayers. If high tax rates were not enough, Congress came up with a series of things to add to the burden. In recent times, it enacted the dreaded alternative minimum tax. Then George H. W. Bush broke his “read my lips” promise, and signed legislation that phased out itemized deductions and deductions for exemptions as income levels rise. Now, as the George W. Bush tax cuts are scheduled to expire after 2010, and the Obama administration and its Democratic Congress is talking about raising the rates on ordinary income, dividends and capital gains to their old levels or above, we also have the specter of a surtax on income over $1 million for married couples, and $500,000 for individuals, to help pay for the health care plan. Can matters get worse? Well, if you read the newspapers lately, it sure sounds like it: the IRS has recently announced that it is about to create an enforcement “unit” which targets “the very wealthy.” What’s a successful taxpayer to do when faced with all of this?
There is no need for “wealthy taxpayers” to fear that unmarked cars carrying Agents from the new “Global High Wealth Industry Group” are suddenly going to be parking in their neighborhood and spying on them. The IRS reorganizes its resources periodically, and this is the first time it has begun to view “wealthy people” as if they were worthy of special consideration. Once this group gets its sea legs, one should realize that it is probably not going to affect very many people, even if one satisfies the as yet undefined standard of “wealthy.” In this regard, every taxpayer at this level should consider whether she is in a group that has been targeted for special attention.
The IRS announcements indicate that there are a number of places where they believe there is significant non-compliance. The first involves international transactions, and particularly taxpayers who hold money in bank accounts or other investments outside the United States. There is nothing illegal about doing that. If a taxpayer can demonstrate that whatever money went overseas has been taxed in the United States, or that those accounts are properly being reported on the required forms, and that all income is being recognized on U.S. tax returns, any audit should be short and more inconvenient than threatening.
The next group that needs to be concerned includes anyone who has invested in what is known as a “listed transaction” or a “transaction of interest.” Most of these are tax shelters. During the 1970’s and early 1980’s, some were sold to the higher end of what were middle class people, but since the late 1990’s they seem to have been marketed to high income individuals who can benefit most from them. The IRS has been increasingly focused on such transactions, and the scrutiny is likely to continue.
A third group involves taxpayers who have transactions with the entities they own. At first blush, this sounds as if the IRS always looked at one to the exclusion of the other, but that is a false impression. In this writer’s experience representing taxpayers over many years, an audit of an individual always included at least a survey of the returns of any closely held entities she owned, and a survey of an entity like a corporation or partnership invariably included a survey of the returns of the major officers and owners. Transactions between people and their entities always received scrutiny in these audits, but perhaps the IRS is simply going to look at them more closely.
A final group of situations which the IRS has mentioned as candidates for examination includes individuals who receive gifts or property from estates. This is a change to be concerned about, because the IRS has generally conducted separate examinations of income tax returns on the one hand, and gift and estate tax returns on the other. The IRS claims it is now going to “coordinate” those examinations. Whether the agency’s culture will allow this to take place smoothly remains to be seen.
So what should a taxpayer do if she fears that she will be in the roundup of “usual suspects”? The first move is to sit down as soon as possible to review her personal or business affairs with her tax advisor. With the October 15th filing deadline now passed, this is a perfect time to talk to a tax preparer or a tax lawyer and review exactly what her situation is, not only for the sake of 2009, but planning forward for 2010, and to address all the draconian measures that may be appearing in the Internal Revenue Code anyway. That person should also be able to tell her whether she has the kind of circumstances that are identified above as being on the IRS Radar Screen. Be sure to cover all aspects of planning, including estate and gift planning and employee benefits, as part of this process. The other action to be taken is to make sure all transactions are as well documented as they can be. For instance, if she received a gift from Aunt Bernadette this year, make sure that there are documents to show that it was in fact a gift. If there is a loan between a shareholder and a corporation, or a business pays travel and entertainment expenses for an owner, those are almost guaranteed audit items. Likewise, all documents reflecting foreign transactions should be preserved. And, as always, if approached by someone offering a transaction with tax benefits that seem “too good to be true,” make sure it is reviewed by a truly independent and knowledgeable tax professional before taking the plunge. That person’s charges will be “cheap at twice the price” if the advice keeps her out of a bad situation.
It remains to be seen exactly how much upheaval will result from this new “Global High Wealth Industry Group.” Surely every wealthy individual is the potential subject of an examination, and should begin a review of her situation right now rather than wait until someone mysteriously appears at her door or sends a letter announcing that an audit has begun.