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Wednesday, June 11, 2014

Got Wealth? IRS’s New “Specialized Wealth Audit Techniques” Team (SWAT)


In 2009, the IRS authorized the formation of the Global High-Wealth Industry Group (“GHWI” is the preferred acronym) to audit high-wealth individuals more efficiently.

The purpose for forming this special industry group was to focus on the growing complexity of income and assets that are associated with the high-income taxpayer by looking at the complete financial picture of these individuals and the entities they control as an enterprise.

The administration believed it was time for the IRS to rethink the approach to audits associated with this taxpayer segment and take on a more holistic view of the examination process.

With this enterprise approach in mind, the GHWI Group was formed as part of the Large Business and International Division of the IRS, which is responsible for corporations and partnerships with greater than $10 million in assets.

The Senior Legal Counsel for the GHWI, James C Fee, Jr., recently spoke to a professional group in Philadelphia, saying, “Exams start with the taxpayer’s 1040 and then fan out to look at family member returns, as well as private foundations, retirement plans, and business entities.”

The IRS had employed individual agents to audit wealthy individual returns. There was no formal coordination of the individual 1040 audit and audits of the entities that the individual owned or controlled. Now, an auditor in GHWI can call in teams from other divisions of IRS to perform simultaneous audits of the individual’s entities.

Recently, I called the Acting Director of the GHWI, Cheryl Claybough, who spoke with me in general terms about the progress that has been made in the formation of this specialized division. During the “incubation period” the team assigned to the GHWI were “allowed to go about their business without the normal restrictions” placed on government auditors. As a result, they came up with “good audit techniques and practices that should be shared with the rest of IRS, particularly with respect to flow-through entities.” Since IRS is always constrained by budgetary concerns, they are “improving the use of technology to pull together a good picture of all entities involved with the high net worth individual.” They will be more issue-focused and strategic about which items or entities are audited because they don’t want to waste government resources. The GHWI will continue to work across divisions of the IRS including the Estate and Gift Tax Group and the Small Business & Self-Employed Division to improve audit efficiencies and results.

Who Is Chosen For Audit?

The IRS does not reveal the selection criteria. The cases selected over the past few years are good indicators of what piques the IRS’s interest: high-wealth individuals with domestic and offshore entities, corporations, multi-tiered partnerships, domestic and foreign trusts, foreign source income and other business interests like private equity and hedge funds. There is also a focus on wealth transfer transactions and contributions to private foundations.

According to the limited data available, about 8% of individuals with income of $1 million or more are likely to be audited. For those earning $10,000,000 and greater,the audit rate increases to over 25%. At this time, most of these are not GHWI audits. In the early stages of the GHWI, only 36 audits were completed by February 2012. Of these, one third resulted in no change for the taxpayer. This is a significantly higher no change rate than the general population of individual taxpayer audits. Nevertheless, for the GHWI audits that resulted in changes, the average examination resulted in additions to tax of almost $1,500,000. No one wants to write that check.

Currently, there are about 100 GHWI examinations underway resulting in about 500 total audits. In other words, for each individual called into this program, there are four additional audits of related parties or entities associated with that individual. If early results are any indication, a substantial portion of these audits are going to conclude with a no change report for the taxpayers.

Are You Ready For An Audit?
More importantly, if you are chosen, you are one of the fortunate to result in “No Change?” Since there is a current focus on increasing the number and effectiveness of GHWI audits, the high-wealth taxpayers should be aware of new rules, compliance updates, and ultimately, all filing requirements.

It is wise to be prepared and protect yourself to the fullest extent possible. An audit with the GHWI group begins with extensive pre-planning meetings between your accountant and them, which can be extremely disruptive. Here are four ways you can prepare yourself now:

  1. Keep good records – Not just numbers that balance. Make sure you identify the sources of receipts, the vendors for your business expenditures and the business or investment purpose for each payment.
  2. Keep business lines and entities separate – Don’t blend assets out of convenience. If it’s worth keeping them separate on paper, it is worth more to keep them separate in fact.
  3. Keep personal expenditures separate – Run even one personal item through your business account and you increase the risk of expanding an audit.
  4. Talk regularly with your tax advisers – if you have any significant changes in your business structure, changes in income, or, sales of assets with potential gains or losses, let your CPA know. Your accountant should be a steward for your tax reporting responsibilities, keeping you informed and advised.

No one wants to be audited and no one wants to write a check to the government for $1.5 million. Being diligent in reporting and aware of the changes in tax laws and other compliance rules can save you much time and expense in the future.

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