Armed with a budget increase of $80 billion and anticipating hiring another 87,000 revenue agents over the next few years, the IRS is poised to increase enforcement efforts and enhance taxpayer data safety. As we had discussed in last year’s annual tax letter, wealthier taxpayers can certainly continue to expect increased audit activity, especially with respect to large partnerships and other pass-through entities. Other areas where increased IRS activity is projected include tax return scanning technology, taxpayer identity protection, data security, issue enforcement and tax-scam protection.
Similar to the barcodes scanned in most retail establishments for purchasing purposes, the IRS is considering implementing a similar technology in processing income tax returns. In an effort to overcome the enormous backlog of unprocessed paper returns (8.7 million as of August 2022), the National Taxpayer Advocate (NTA) is pushing the IRS to adopt barcode scanning of paper-filed returns. The NTA is also encouraging the IRS to work with tax software providers to develop and voluntarily implement a 2-D barcode on returns prepared with its products. In addition, the IRS is being asked to upgrade internal systems in order to accommodate barcode scanning, optical character recognition and machine-readable text. Currently, the IRS is piloting different technologies but will not commit to specifics or timing. The IRS continues to make more forms available for electronic filing and encourages taxpayers to e-file their returns instead of paper filing.
Taxpayers wanting to proactively protect themselves and their Social Security numbers (SSNs) from identity theft can apply for an identity protection (IP) PIN. This is a six-digit number designed to prevent a person from using an SSN or individual taxpayer identification number (ITIN) that does not belong to them. The IP PIN is an identifying number known only to the specific taxpayer and the IRS. Taxpayers who are known victims of identity theft are automatically assigned an IP PIN.
IP PINs are valid for one year and are automatically generated each subsequent year. Once obtained, it must be used when filing Form 1040 (as well as Forms 1040-NR, 1040-PR and 1040-SS) during the tax year (including prior-year returns). If lost, the IRS has a system in place to recover or reassign the IP PIN. Spouses and dependents can also obtain an IP PIN.
Requesting an IP PIN by validating a taxpayer’s identity can be done in three ways:
Another IRS focus area is protecting taxpayer data. Tax-related identity theft has become a multimillion-dollar enterprise with national and international reach. Criminals steal taxpayer names, addresses and Social Security numbers using a variety of scams (described below) as well as through business and organizational data breaches. This information is then used, in part, to file false tax returns in order to claim refunds from the IRS.
To offset this theft, the IRS works with state tax agencies and the private-sector tax industry to create data safety parameters. Over time, changes such as strengthened password protocols on tax products, driver’s license requirements to file certain state returns and redaction of personal information from tax transcripts have been implemented in an effort to protect taxpayer information. On their end, taxpayers can help themselves by increasing their own security measures around their personal identifying information. Using virus protection on all electronic devices, strong passwords and multifactor authentication on all accounts as well as safe file back-up programs are steps that can be taken to secure personal data.
The Large Business and International (LB&I) division of the IRS is responsible for tax administration activities for domestic and foreign business with a U.S. tax reporting requirement. The LB&I works with corporate (including S corporations) and partnership entities with assets equal to or greater than $10 million. With over 70 different enforcement campaigns aimed at various subcategories of taxpayers, resources continue to be poured into LB&I in order to collect the greatest amount of tax revenues. Additionally, the IRS is targeting partnerships in an effort to close the perceived tax gap (lost government revenue attributed to the difference between taxes owed and paid to the IRS).
A new campaign, begun in February 2022, targets partnership losses in excess of a partner’s basis. Generally, each partner in a partnership has a basis in their interest representing their distributive share. Basis can go up or down based on several factors, including contributions, distributions, increase or decrease in shared liabilities and allocation of income or loss items. Calculating basis and determining whether allocated losses need to be suspended can be complicated. The IRS is hoping this new campaign will help identify taxpayers that had deducted losses that should have otherwise been suspended.
Another LB&I campaign deals with the sale of a partnership interest. In keeping with IRS concerns of correctly computing basis, this campaign addresses those taxpayers that do not report correct gain or loss on the sale or exchange of a partnership interest. Areas of focus include whether the partnership interest was owned for more than one year and if the partnership had depreciable assets, inventory or unrealized receivables at the time of sale.
Not to be outdone, S corporation distributions and losses in excess of basis have their own LB&I campaigns. In the former, S corporation shareholders have to analyze whether a received distribution is taxable, plus the S corporation has to recognize gain on the distribution to its shareholders of appreciated property. Similar to partnerships, the latter campaign consists of analyzing S corporation shareholder basis and whether losses in excess of that basis were utilized in error instead of being suspended.
Pass-through members should also be aware that the IRS is taking a second look at the qualified business income (QBI) deduction under section 199A. The IRS has expressed concern that some of the QBI calculations include tax attributes that should be excluded from the deduction.
Virtual currency is another area in which the IRS is ramping up enforcement. In 2021 and 2022, the IRS aggressively used John Doe summonses to force virtual currency exchanges to turn over the names of U.S taxpayers who may have failed to disclose income. See our article, “The ever-changing world of digital asset taxation,” for additional information on this. The IRS is also expected to promulgate new regulations under IRC section 6045 which would require virtual currency exchanges to proactively report transactions in a similar manner to traditional securities brokerages.
Additional campaigns include:
In general, the IRS contacts taxpayers using U.S. mail and not via email, text message, telephone or social media. The agency typically initiates contact through a mailed notice letter outlining a specific issue needing to be addressed. At times, this letter may be followed up with a telephone call. On the other hand, scammers do use all of the aforementioned communications in an effort to con taxpayers and tax professionals. Tax scammers impersonate IRS employees and steal taxpayer identities, refunds and other personal data. Since the IRS does not use threatening collection techniques, taxpayers that receive urgent pre-recorded voice messages, demands for immediate payment, threats of arrest, requests for credit and debit card numbers or require payment without an appeal opportunity should report the activity to the proper authorities.
Unfortunately, a vast myriad of tax scams are being conducted at any given time. A handful of these are described below. Additional information on tax scams can be found at irs.gov.
These scams are not limited to individuals. Recently, many scammers have begun to target businesses as well. These scams include email phishing to access sensitive client data, or even using the business’s EIN to prepare fraudulent documents to claim a refund or issue false information returns.
For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.