Tax Season 2010

Net Worth Audits Are Back

Commissioner Shulman: IRS to focus on taxpayers with overseas assets, high-wealth individuals

By T. Steel Rose, CPA

Saying "the IRS must embrace enormous change," Commissioner of Internal Revenue Douglas Shulman told the AICPA National Conference on Federal Taxation in Washington, D.C., that almost 9 out of 10 individual taxpayers either use a tax preparer or third-party software to complete their federal tax returns.

Shulman described the globalization of tax administration as "a game-changing trend," noting that the Foreign Tax Credit dollars claimed against U.S. tax by individuals have more than doubled — from $6 billion dollars in 2001 to $15.4 billion in 2007.

"Now, for individuals with overseas income and assets, it's straightforward," Shulman said. "If you are a U.S. individual holding overseas assets, you must report and pay your taxes, or we will be increasingly focused on finding you."

After announcing a week earlier that more than 7,500 people came in under a special offshore voluntary compliance program, Shulman said: "It's too early to say how much money will come in from this effort. However, I can tell you that account sizes ranged from just over $10,000 to over $100 million. As importantly, these taxpayers are now back in the U.S. tax system and will be paying taxes on their offshore income in the years to come."

The IRS recently formed a Global High Wealth Industry Group (GHWIG) to centralize IRS compliance expertise involving high-wealth individuals and their related entities — which often have international components. Tax agencies around the world, including those in Japan, Germany, the UK, Canada and Australia, also have formed high-wealth groups.

"You cannot assess compliance among the nation's wealthiest individuals by looking only at their 1040s," Shulman said. "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," Shulman said.

He went on to say: "We've looked at what other countries have done. Some countries have defined high-wealth individuals based on assets, wealth or income amounts under their control, such as through privately held corporations, partnerships, trusts and family members."

The Organization for Economic Cooperation and Development (OECD) suggests that $30 million worth of assets defines high-wealth individuals for many countries. "At least initially, we will be looking at individuals with tens of millions of dollars of assets or income," Shulman said.

A unified look at the web of business entities controlled by a high-wealth individual will enable the IRS to better assess the risk such arrangements pose to tax compliance and the integrity of the tax system. "We have begun hiring some agents and specialists, such as flow-through specialists and international examiners, who will begin conducting examinations of high-wealth individuals and their related enterprises," Shulman said.

The new unit will add economists, appraisal experts and technical advisors. New risk assessment techniques will "identify high-income and high-wealth individuals and their related enterprises that should be reviewed holistically," Shulman said.

The GHWIG and international initiatives will involve every IRS Business Operating Division even though the program is housed in the Large and Mid-Size Business operation division. "We are talking about small businesses ... medium-size businesses ... large businesses ... private companies ... and very wealthy individuals who may have a myriad of holdings and sources of income beyond the obvious ones," Shulman said.

The commissioner wants to "ensure the success of the tax preparation community, which has become an integral part of our tax system. Tax preparers and the associated industry must be supported and at the same time, held accountable in the key role they play in preserving the integrity of the tax system," he said.

Referring to the IRS' decision to review how it will oversee the tax preparation community, Shulman said: "First, we want to ensure that taxpayers who use a return preparer receive competent, professional and ethical service. And we want to make sure return preparers are part of the IRS' overall goal of seeing that taxpayers file accurate returns and pay what they owe."

Competency was the key word — ensuring taxpayers receive competent service from preparers who demonstrate competency through testing and maintain competency with CPE. "Among the thoughtful suggestions on how this could be done were a lot of people saying there should be a testing requirement for preparers," Shulman said. "The IRS also learned that some of the possible outcomes of the effort could represent a big shift in the tax return preparer community. This significant change for us might need to phase-in over a number of years."

Shulman thanked the AICPA for its valuable input in the review: "We have received comments from you and others that those enrolled under Circular 230 are already held to a high standard of conduct and should not be subject to any new test requirements if we were to require testing of return preparers. Let me just say that I have heard your concerns, and have some sympathy for them."

Responding to a question from one of the 275 CPAs, Shluman said: "The OIC (Offers In Compromise) program is incredibly important, and they have declined. A lynchpin is to eliminate the 20% down payment for OIC [applications]."