So, now that Christmas is over and Santa Claus has made all of his visits you may be wondering if the government shutdown will affect the IRS.
Well, as you know the government is officially on shutdown–or actually on a partial shutdown. There are a number of functions which are relatively unaffected, such as the court system, for one reason or another, but most departments have contingency plans. Most IRS employees are considered nonessential and are going on furlough. That may be good news for someone anticipating an audit, but not if you have a question for the IRS.
How serious the shutdown is for the IRS will depend on the length of time it continues. Much more than a week and plans will change. Here are some of the functions still staffed under the short-term contingency plan:
Completion and testing of the upcoming Filing Year programs
Electronic returns processed systemically up to the point of refunds
Processing paper tax returns through batching
Processing disaster relief transcripts
Continuing IRS’s computer and accounting operations to prevent data loss
Protection of statute expiration, bankruptcy, liens and seizure cases
Upcoming tax year forms design and printing
Maintain criminal law enforcement and undercover operations
Some examples of functions that are non-excepted activities and will be on hold:
Service center processing after the point of batching (e.g., data transcription, error resolution)
Processing non-disaster relief transcripts, income verification express service/return and income verification services
Processing amended tax returns
Most Headquarters and administrative functions not related to the safety of life and protection of property
All audit functions, examination of returns, and processing of non-electronic tax returns that do not include remittances
Taxpayer services such as responding to taxpayer questions (call sites) (during Non-Filing Season)
Information systems functions (except as necessary to prevent loss of data in process and revenue collections)
Planning, research, and training and development activities
So as you can see, certain basic functions will continue. But if you’re looking for answers to questions, you’ll probably have to look elsewhere. If the furlough approaches the start of the filing season, which is just past the middle of January, it’s likely the IRS will have a problem adhering to the above schedule. Rest assured, it’s highly unlikely the filing deadlines will be extended.
In a somewhat recent court case on appeal —>United States v. Brabant-Scribner, No. 17-2825 (8th Cir. Aug. 17, 2018) the Eighth Circuit affirmed the decision of the district court allowing the sale of taxpayer’s home and affirmatively determining that an offer in compromise request filed by the taxpayer has no impact on the ability of the court to grant the request by the IRS to sell the home or on the IRS’ ability to sell the home once the court granted its approval. In reaching this conclusion the Eighth Circuit analyzed the exemptions to levy in Internal Revenue Code section 6334 and the relief those provisions do and do not provide.
The taxpayer, in this case, owes the IRS over $500,000. The opinion does not discuss the actions by the taxpayer to pay or resolve her liability prior to the action by the IRS to sell her house. I imagine that the IRS considered her a “won’t pay” taxpayer. Before seeking to sell her home, the IRS had seized and sold her boat and levied on her bank accounts.
The 1998 Restructuring and Reform Act added Internal Revenue Code section 6334(e)(1)(A) to require that prior to seizing a taxpayer’s principal residence the IRS must obtain the approval of a federal district court judge or magistrate in writing. Before the passage of this provision, the IRS could seize a taxpayer’s home with the same amount of prior approval needed to seize any other asset owned by the taxpayer. No approval was necessary to seize any asset of the taxpayer. Prior to 1998 collection due process did not exist. Prior to 1998 the 10 deadly sins did not exist one of which calls for the dismissal of an IRS employee who makes an inappropriate seizure. So, the landscape regarding seizures, and especially personal residence seizures, changed dramatically after 1998. However, the amount of litigation regarding seizure of personal residences is low and the Brabant-Scribner case offers a window on one aspect of this process.
As the IRS initiated the process of seizing her personal residence by obtaining the appropriate court approval, the taxpayer filed an offer in compromise. She filed an effective tax administration offer of $1,000 but the amount and sincerity of her offer do not really matter to the legal outcome of this case. The timing and the amount of the offer may have influenced the thinking of the judges and made them more inclined to dismiss her argument but her possibly bad faith effort to stop the approval and execution of the sale should not have affected the outcome here.
To convince the court to allow the sale of a personal residence, the IRS must show compliance with all legal and procedural requirements, show that the debt remains unpaid and show that “no reasonable alternative” for collection of the debt exists. The taxpayer argued that her offer was a reasonable alternative. However, the court spends three paragraphs explaining that an offer does not matter in this situation. The relevant language in the applicable regulation is “reasonable alternative for collection of the taxpayer’s debt.” The court explains that the word “for” holds the key to the outcome.
“For” refers to an alternative to the sale of the personal residence such as an installment agreement or the offer of funds from another source to satisfy the debt. An offer in compromise is not an alternative for collection but an alternative “to” collection.
Having determined that the words of the Treasury Regulation point toward a resolution other than an offer as providing the necessary alternative, the court looks at the remainder of the Treasury Regulation for further support of its conclusion. It points to the provision in Treasury Regulation 301.6334-1(d)(2) which provides that the taxpayer has a right to object after the IRS makes its initial showing and “will be granted a hearing to rebut the Government’s prima facie case if the taxpayer … rais[es] a genuine issue of material fact demonstrating … other assets from which the liability can be satisfied.” This regulation, like the one providing an alternative “for” collection, looks not to relief from payment of the liability but a source for making payment. It does not provide the offer in compromise as a basis for relief. Based on this the court concludes that “nothing requires the district court to ensure that the IRS has fully considered a taxpayer’s compromise offer before approving a levy on a taxpayer’s home.”
Since the IRS properly made its case for seizing and selling the home and the taxpayer did not rebut that case, the Eighth Circuit affirms the decision of the district court to approve the sale. The decision provides clear guidance for district courts faced with the request by the IRS to seize and sell a personal residence. Personal residence seizures by the IRS remain rare at this point. Taxpayers faced with such a seizure, almost always taxpayers the IRS characterizes as “won’t pay” taxpayers, will find it difficult to stop the seizure and sale based on this decision. I do not think this decision will motivate the IRS to increase the number of personal residence seizures but it will make it a little easier to accomplish when it decides to go this route.
With this year’s tax season coming to a close, I have to say that this is probably one of the most frequently asked questions that I will get.
So, the IRS has just come out with new data for a ten-year period. In the tables below, I’ve reproduced data for the most recent three years for selected categories. Following the table is my brief analysis of the raw data. But keep in mind that these are just broad numbers. Your chances of getting audited depends on many factors. Have only wage, interest, and capital gain income and take the standard deduction? Your chances are probably much less than indicated. Take a large charitable contribution deduction, have a Schedule C, or rental property, and your chances are likely to be higher. The same is true for business returns.
From 2013 to 2015 the number and percentage of returns audited has decreased, pretty much across the board. But looking deeper, audits declined from 2013 to 2014 and went up slightly in 2015. For individuals with income of less than $1 million, the percent audited decreased from 2014 to 2015, mostly at the lower end. Individuals with income of $1 million or more saw an increase from 2014 to 2015, but still below the percentage in 2013. If your income is less than $200,000, your audit chances are 3/4 of 1 percent; $200,000 to $1 million your chances go up to 2.6 percent; over $1 million they’re almost 10%. In general, field audits (which involve a visit from an agent) are down, correspondence audits are where the increase occurred.
The total number of partnership and S corporation audits increased substantially on a percentage basis (although the total number is relatively low). The percentage audited increased slightly from 2014 to 2015, but your chances of getting audited is still about 1/2 of 1 percent.
But keep in mind that your chances of getting audited could be significantly higher–or lower. For example, Middletown Partners is a two-person partnership generating about $375,000 per year in revenue. Jack-Hammer LLC is a construction company with 50 employees and $7 million in revenue with $1 million in assets. Other things being equal, Jack-Hammer’s chances of an audit are much higher. The same for individuals. Fred and Wilma had income of only $126,000, but they have rental losses, and deducted property contributions to charity of $12,000. Ralph and Alice work on Wall Street and have a combined W-2s of $1.2 million. But they rent an apartment, have no kids, and no outside investments. Fred and Wilma’s audit chances are probably higher than Ralph and Alice. While the numbers are interesting and give you an idea of your overall chances of getting audited in a particular category, the IRS is more likely to pick your return because of a particular triggering item. That could be charitable contributions materially in excess of the average for returns at your income level or claiming a substantial deduction for property contributions. Property contributions beyond a certain amount require an appraisal which are frequently challenged by the IRS. Checking the box for real estate professional and fully deducting rental losses is almost sure to generate an inquiry. But don’t worry….there are a host of others.
Keep in mind the IRS is also auditing “smarter”. They’re focusing on issues more likely to produce results for the government. And if that is not enough, the states are also getting “smarter” and using computers to analyze data. You could escape an IRS audit only to be trapped by your home state or a state in which you do business.
Of course, none of the numbers above matter if your return is picked. Playing the audit lottery has become more dangerous. If the IRS can assess the accuracy-related penalty, it generally will. That could add 20% to your tax assessment. Interest will increase the total and, while relatively low, it can add up quickly.
When pressed about releasing his individual tax returns during a past Republican debate, Donald Trump said he wouldn’t release them until the IRS finishes its audit. “You’re in the midst of negotiating and talking to the IRS,” Trump stated. “Your lawyers would never allow you to do that.”
Is there anything legally stopping Trump from publicly releasing his tax returns? Absolutely not.
Would any experienced tax professional representing Trump in an IRS audit advise him to publicly release his tax returns during the audit? Absolutely not.
So Why Not Just Disclose the Returns Under Examination? The tax professionals that Trump is working with most likely have their hands full responding to numerous informal and formal detailed inquiries by the IRS “Wealth Squad” audit team assigned to his case. Neither the IRS team nor Trump’s tax team likely want the additional scrutiny brought on by a public disclosure during the examination (the IRS’ name for Audit). However, depending on the status of the current examination, it would seem highly unlikely an open IRS examination involving multiple tax years and possibly numerous entities relating to any wealthy individual would be concluded before the general election in November.
The IRS Wealth Squad. The IRS maintains a specialized, experienced group of examiners solely focused on conducting audits of high-income/high-wealth taxpayers – the Global High Wealth Industry Group of the IRS Large Business and International division (commonly referred to as the IRS “Wealth Squad”).
In announcing the creation of the Wealth Squad, the IRS stated “For a variety of reasons – including valid business reasons – many high wealth individuals make use of sophisticated financial, business, and investment arrangements with complicated legal structures and tax consequences. Many of these arrangements are entirely above board. Others mask aggressive tax strategies.” Recently, the U.S. Court of Appeals for the Eleventh Circuit noted “It is no surprise that a knowledgeable tax attorney would use numerous legal entities to accomplish different objectives. This does not make them illegitimate. Unfortunately such ‘maneuvering’ is apparently encouraged by our present tax laws and codes.”
Although there are many sophisticated IRS representatives, few could realistically expect to individually unravel the intricacies of a well-designed business and estate plan possibly employing multiple domestic and foreign entities and investment arrangements. The Wealth Squad is designed to allow the IRS to better understand the sophisticated financial, business and investment arrangements of the taxpayer by engaging a team of specialists to take a unified, holistic look at the entire web of inter-related entities controlled by a high wealth individual to discover the entire economic picture of the enterprise and to assess the tax compliance of that overall enterprise.
In a Wealth Squad examination, the IRS deploys a team of highly capable, experienced examination specialists which include technical advisers to provide industry or issue specialized tax expertise, flow-through entity specialists, international examiners, economists to identify economic trends within returns, valuation experts and others. The Wealth Squad routinely draws on additional examination resources from throughout the IRS organization. The IRS recently even engaged a private law firm for assistance during a corporate examination.
The Wealth Squad pursues a comprehensive approach to auditing high-income taxpayers by expanding the examinations beyond the individual income tax return to include examinations of related and controlled entities. A typical Wealth Squad examination consists of a key case, generally the taxpayer’s Form 1040, and returns of related entities. These entities may include partnerships, trusts, S corporations, C corporations, private foundations, etc. Due to the complexity of most high-income taxpayers’ returns, it generally takes more time and resources than a traditional individual audit. Complex, detailed examinations of wealthy taxpayers are not easily concluded; neither the taxpayer nor the IRS examination teams have any desire to unnecessarily prolong the audit process. However, experienced IRS examination teams conducting Wealth Squad audits rarely conclude an examination until they are satisfied with the proposed resolution.
During such audits, examiners make detailed demands for information and supporting documentation that in turn generate detailed responses from the taxpayer’s representatives, which often generate additional detailed requests for information from the IRS. These examinations typically look at 2-3 years of returns for the individual and many, if not all, of the related entities. Sometimes, the audit can expand to the returns of other investors involved in the related entities as well. These examinations often take years to complete and as current tax returns are filed, the examiner often seeks to at least review reportable positions within the currently filed returns as part of the ongoing examination process.
Determining “Where and How” to Report a Transaction. Wealthy taxpayers often engage teams of sophisticated tax, business, and estate planning lawyers, tax professionals, and other advisers to oversee their business activities and to legitimately minimize their potential tax liabilities. For a wealthy individual with complex, diversified investments, the individual tax return, by itself, will typically only reflect net items flowing through from numerous other related entities.
Detailed IRS audits are actually anticipated by the teams of professionals typically representing wealthy individuals. In this regard, the tax advisors are often significantly involved in most every transaction from the initial consideration through to “where and how” the reportable items are set forth within the appropriate tax return for the individual and/or the related entities. Responsibility for proper reporting and disclosure is shared between the tax representatives and the individual taxpayer although, in complex returns, the individual is rarely directly involved in these discussions. Given the complexities of the Internal Revenue Code and other tax authorities, few non-tax experienced professionals would realistically be capable of discerning “where and how” to report transactions often associated with wealthy individuals and their related entities.
What’s in Trump’s Tax Returns? Teams of sophisticated tax advisers were likely engaged throughout Trump’s career to assure the absence of any “bombshell” within the returns. His returns might actually be somewhat unremarkable but for the fact they are the returns of Donald Trump. For wealthy individuals, individual tax returns sometimes only provide a brief financial overview linked to numerous other conclusions and entities. To fully understand the financial status of Trump, one would likely need to see returns for multiple years, the work-papers for the individual returns and the returns for numerous related entities, something that is unlikely to happen.
So, what is in Trump’s Returns? Likely information prepared by many very well-qualified tax professionals who were quite aware the general public might be looking at the returns at some future date. It’s unlikely an accurate overall financial picture will surface by simply reviewing his returns. He likely pays taxes at a lesser rate than many of us given the nature of his real estate and similar investments being subjected to lower tax rates than salaries earned by the rest of us. Certainly, his tax professionals have not advised him to overpay his taxes.
“No-Change” Audit Results of the Super-Rich. Overall, returns for wealthy taxpayers are audited by the IRS at a significantly higher rate than taxpayers at lower income levels. For FY2014, the IRS audited 16.22% (24.16% for FY 2013) of returns for individuals having $10,000,000 or more in adjusted gross income and 10.53% (15.98% for FY 2013) for individuals having $5 million to $10 million in adjusted gross income but only audited 0.86% of all returns filed by individuals (with the vast majority of individual returns being conducted remotely via correspondence between the IRS and the taxpayer). Why does the IRS audit a significantly higher percentage of wealthy vs. less-wealthy taxpayers? Quite simply. . .”because that’s where the money is,” not because of “politics or religion”.
Following these intensive, time-consuming processes, the Wealth Squad closed 41% of their FY 2014 examinations accepting the returns as filed (a ‘no-change” examination). The “no-change” rate was 37% for FY 2013. The “no-change” rate for other examination groups within the IRS Large Business and International division (groups generally auditing large corporate taxpayers) varied between 20% to 33% for FY 2014 and 20% to 38% for FY 2013.
Is Trump Worth More or Less Than He States? He is likely worth far more than us but may be worth far less than the approximately $10 billion he wants us to believe. However, alone, his tax returns are unlikely to provide an accurate picture beyond an estimate of $4.5billion.
STAY TUNED FOLKS!
So, what do you think about Trump’s claim of not being “allowed” to show his tax returns?