IRS is Eyeing Wealthy Taxpayers

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IRS is planning to target “Wealthy Taxpayers.” There is a new push from the Biden administration to close the revenue gap, and the president calls it tax fairness. President Biden is giving IRS $70 billion over 10 years and IRS estimates the new funding will bring in an additional $700 billion in tax dollars for the same period to help bridge the budget gap.

The proposal in a nutshell is to give IRS a lot of money for enforcement efforts so that it could audit more wealthy individuals (>$400K). IRS would use this money to hire and train revenue agents to specialize in complex audits. IRS states that the audit rates wouldn’t increase for the taxpayers with income under $400K i.e., the push for the increased IRS scrutiny and audits is for the taxpayers with income more than $400K.

Here are the main things IRS would be looking out for

1. Income Level:IRS statistics show that people with incomes of $200K or higher had an audit rate of 1.25% (more than twice of average audit rate) and people with incomes of $1 million or higher had an audit rate of 3.2% i.e. The higher the income, higher the probability of being audited.
2. Not reporting ALL income:IRS gets copies of all 1099s and W-2s you receive, so make sure you report all income on your return. A mismatch sends up a red flag and causes the IRS to review a return.
3. Rental Losses:IRS actively scrutinizes rental real estate losses that are claimed for active participation, especially those written off by taxpayers who have W-2 income and/or other non-real estate businesses income.
4. Hobby Losses:You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income only. The law bans writing off losses from a hobby. For you to claim a loss, your activity must be entered into and conducted as the business with the reasonable expectation of making a profit.
5. Cash Intensive Business:Business owners in cash-intensive businesses e.g. taxis, car washes, bars, hair salons, retail stores, restaurants are a tempting target for IRS auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income, so IRS agents are trained to determine the average cash collected by each business by region.

I would like to emphasize that everyone’s situation is different so it’s important to fully consider your specific situation before claiming a particular expense. The list does not guarantee that a person will (not) be audited, and most agencies and tax courts typically look at the totality of the circumstances to determine if a tax return should be audited, but the list is very helpful in understanding the thought process.