IRS Enforcement Plan—All the Scrutiny $45.6 Billion Can Buy

The IRS’ strategic operating plan, announced April 6, includes a new enforcement strategy backed by $45.6 billion in earmarked funding. The plan makes no secret of its intended targets: large corporations, large partnerships, and high-net-worth families.

It notes that the corporate audit rate fell to 1.7% in 2019 from 10.5% in 2011. The audit rate for high-net-worth families is even smaller (0.7% in 2019) and for large partnerships is almost vanishingly small (0.05% in 2019). Increasing audit rates for those groups is an explicit goal.

The funding’s effects won’t be apparent for at least two years—the IRS has hinted that audit activity may decline in the short run, as agents are trained and new systems are placed into service. This may tempt taxpayers in high-scrutiny categories to postpone any preparations for IRS audit activity, but this would be short-sighted.

Everyone expects the IRS to go on a hiring spree. Indeed, there are already signs of stepped-up hiring for enforcement roles. But there’s much more to the new enforcement strategy than increased staffing.

There are two clear themes in the plan’s enforcement strategy: centralization and data analytics. Specifically, Initiative 3.1 provides that the IRS “will develop a centralized, integrated approach to assess risk to inform the selection of cases and appropriate treatments.” This “centralized planning function will use risk analytics to prioritize and assign cases.”

If all goes to plan, by fiscal year 2026, taxpayers will be selected for audit “by centralized compliance planning function using new analytics systems and refined risk-based case selection and routing.”

Expect the Unexpected

Centralization and data analytics are logically intertwined. To be effective, data analysis must have access to a large data set. As a practical matter, that volume of data could only be managed centrally to assure that the data set is accurate, unbiased, and comprehensive. Data analytics expertise also is likely to be centralized within the agency. Therefore, any meaningful data analysis would require centralized coordination.

The results would then be directed to the field. It would be impractical and unwieldly to have field agents conducting their own searches independently. Uniform tax administration is served by a centralized approach and ensures that similar taxpayers receive similar outcomes.

Centralization has side effects, however, that will make resolving tax issues harder for many taxpayers. A top-down approach to enforcement means field agents will have less discretion about how to conduct an audit. Information document requests will be dictated centrally, and agents will have less flexibility in tailoring those requests to the situation of individual taxpayers. Decisions on whether to disallow a position will be made globally based on policy decisions made in Washington, forcing taxpayers increasingly to challenge adjustments in the IRS Independent Office of Appeals or in court.

For all the discussion about analytics, the IRS has been tight-lipped about the precise nature of the technology it will deploy. Even without reverse-engineering algorithms, taxpayers can predict certain likely areas of IRS scrutiny. Because data analytics is statistics-based, it’s fair to assume that statistical outliers will be subject to more scrutiny.

For example, if a corporation claims research credits significantly higher than the norm for similarly situated corporations, the algorithm will likely flag that as an anomaly. Therefore, a taxpayer who recently has increased research and development activity to gain a competitive advantage over its competitors, resulting in a concomitant increase in research credits, could reasonably expect additional scrutiny based on that fact alone.

At the same time, taxpayers should expect the unexpected. The IRS has access to a treasure trove of data beyond income tax returns. Financial statements, information returns, and information obtained from international tax authorities are all fair game. Inadvertent discrepancies between reporting positions taken in the US versus other countries will be less likely to escape detection, making consistency increasingly important for multinational corporations.

The plan indicates a strategy for increasing scrutiny of excise and employment taxes. In particular, excise tax disputes tend to involve large sums and can be intensely fact specific. They also frequently involve industry-wide issues, so the IRS uses a coordinated approach to such cases. Taxpayers subject to significant excise taxes, particularly in the energy and transportation sectors, should likewise develop an industry-wide approach to anticipating and responding to IRS activity.

Next Steps

What should taxpayers in the high-scrutiny categories do now? The first step is to acknowledge that higher scrutiny is coming. That includes preparing C-suite executives and other decisionmakers for increased risk and making the case for growing in-house capacity.

Taxpayers also must remember the first principle of tax controversy: Substantiation is key. Many winnable tax disputes are lost because taxpayers fail to substantiate their positions. Maintaining an audit-ready file of transactions with potential tax implications both reduces the burden on taxpayers during an audit and increases chances of success in a dispute.

Awareness of the IRS’ new strategy suggests that taxpayers should be on alert for changes in the business that may trigger a statistical alert. Anything that creates a significant change in a taxpayer’s usual profile or that sets a taxpayer apart from its peers could be flagged as an anomaly by an IRS algorithm, and taxpayers must prepare for additional scrutiny.

The IRS may not meet all the benchmarks set forth in the strategic operating plan. Not all the new proposed enforcement strategies may come to pass. It’s undeniable, however, that the IRS has $45.6 billion in earmarked funds to spend.

Equally undeniable is the political support for using that money to target large businesses, large partnerships, and high-net-worth-families. Those taxpayers must appreciate that increased IRS scrutiny is certain, and that early preparation is the best defense.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Robert J. Kovacev is a tax lawyer at Miller & Chevalier Chartered in Washington, D.C., and a former senior litigator at the US Department of Justice, Tax Division.

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