New IRS Audit Campaigns Announced

IRS Commissioner Charles Rettig testified before the Senate Finance Committee on June 30, 2020. He addressed various topics, including IRS audit priorities, Taxpayer First Act and budget proposals.

Regarding audit priorities, the IRS is still focused on abusive tax shelters, especially conservation easements and micro-captives. They will continue to enforce compliance of virtual currency and investigate high income taxpayers. The focus on high income taxpayers will be both non-filers and questionable transactions for filers.

Due to COVID-19, Rettig has pushed timelines for reporting to Congress on the Taxpayer First Report. This will now be delivered in December as opposed to July. The increased budget is going to be heavily focused on IT implementations and updates to digital communications.

What are IRS audit campaigns?
The IRS conducts audit campaigns through two different divisions within the IRS. The Large Business and International (LB&I) Division of the Internal Revenue Service serves corporations, subchapter S corporations and partnerships with assets greater than $10 million. The Small Business Self Employed (SB/SE) Division serves individuals and businesses with assets below $10 million.

Both divisions recently announced new campaigns in which additional attention and resources are devoted to exposing potential tax abuse areas. They will develop criteria for creating tools that select returns for examination based on the likelihood they will pay more tax.

Why are the IRS campaigns developed?
These campaigns were developed in response to declining funding for the IRS as well as a decrease in IRS examination personnel. The IRS’s move toward issue-based examinations and a campaign process also provides the division with better information when deciding which tax issues need to be allocated additional resources.

Like previously announced campaigns, businesses with activity in the campaign areas will typically have a higher likelihood that the IRS will examine their tax returns.

What are the new campaigns?
Below are some of the new campaigns:

• Claims for Domestic Production Activity Deductions (DPADs) under former IRC Section 199 deduction
• Captive Insurance companies under 831(b)
• Syndicated conservation easement transactions and similar charitable contribution schemes
• Contributions of intellectual property to related entities for royalties
• High Income Non-Filer
• S-corporation and partnership basis and at-risk limitations (losses in excess of basis)
• S-corporation compensation and shareholder loans
• S-Corporation Built in Gains Tax
• Research and Development Credits
• Manufacturing branch rules related to foreign base company sales income
• Interest and home office expenses of foreign corporations filing Form 1120F (U.S. Income Tax Return of a Foreign Corporation)
• Individuals employed by foreign government and international organizations
• IRC 183 Activity Not Engaged for Profit
• Virtual Currency
• Tax Cuts and Job Acts (TCJA) Campaign

If a tax return is selected for examination but does not fall under one of these campaigns, it is likely that it was selected under a regular DIF score classification. Meaning, the numbers on the return fall out of the “normal” range and Large Unusual Questionable (LUQs) items exist. The revenue agent is always going to audit income and losses on the return. Net operating losses, flow-through losses from related entities, and capital gain losses are always examined.

Both Divisions have recently started to hire Revenue Agents due to heavy attrition within the IRS. There has been an increase in “training” examinations in which new agents examine basic returns in order to learn the IRS exam process. These exams tend to be very focused and follow the Internal Revenue Manual procedures precisely.

Individuals or businesses with activity that falls under one of the areas listed above may be subject to IRS scrutiny. Now would be a good time to review your processes to ensure compliance before the IRS comes to call.