The Inflation Reduction Act provided the IRS with billions of dollars of additional funding to reduce the so-called “tax gap” between what taxpayers owe and what they actually pay. The tax agency has already launched numerous initiatives aimed at this goal, including several business-related compliance campaigns. Let’s take a closer look at three of the most significant recent targets.
Abusive pass-through practices
The IRS has accelerated its enforcement efforts against partnerships and other pass-through entities, which it claims have been overlooked for more than a decade. According to the IRS, while tax filings for pass-through entities have jumped by 70% since 2010, audit rates for them fell from 3.8% in 2010 to 0.1% in 2019.
To remedy this, the tax agency is creating a new office that will focus exclusively on partnerships, S corporations, and trusts and estates. That’s in addition to a special work group focused on pass-throughs, including complex partnerships, in its Large Business and International Division.
The IRS also launched a new regulatory initiative to prevent basis-shifting, which it calls “a major tax loophole exploited by large, complex partnerships.” Basis-shifting occurs when a single business with many related-party entities enters a series of transactions to maximize deductions and minimize taxes. For example, a partnership might transfer tax basis from property that doesn’t generate tax deductions (stock or land) to property that does (equipment).
The end game, the IRS says, is to take abusive deductions or reduce gains when the asset is sold, effectively making taxable income vanish. The IRS claims these “shell games” cost the federal government billions of dollars annually. To combat the losses, it plans on issuing regulations that:
- Eliminate the inappropriate tax benefits created from basis-shifting between related parties, and
- Prohibit partnership basis-shifting among members of a consolidated group.
Proposed regulations released in June 2024 would require the reporting of certain basis-shifting transactions. The IRS has also issued a Revenue Ruling that provides that certain related-party partnership transactions involving basis-shifting lack economic substance — a sign it intends to challenge the transactions.
Improper Employee Retention Tax Credit claims
The IRS crackdown on ineligible Employee Retention Tax Credit (ERTC) claims came to light in July 2023, when the tax agency announced that it was shifting its ERTC review focus to compliance concerns. It began intensified audits and criminal investigations of both promoters and businesses that filed or were filing suspect claims.
Two months later, the IRS instituted a moratorium on processing claims submitted after September 14, 2023. The moves came in response to what the tax agency described as a flood of illegitimate claims largely driven by fraudulent promoters.
The moratorium gave the IRS time to review more than 1 million ERTC claims totaling more than $86 billion. The review found that 10% to 20% of claims have clear signs of being erroneous and another 60% to 70% of claims reveal an unacceptable level of risk. Tens of thousands of the former group have been or will be denied, and the IRS will perform additional analysis of the latter group.
The IRS continued to process claims made before September 14, 2023, during its review period. As of late June, it had processed 28,000 claims worth $2.2 billion and rejected more than 14,000 claims worth more than $1 billion. Review of claims filed for 2020 uncovered more than 22,000 improper claims, resulting in $572 million in assessments against taxpayers. These figures could be even higher when the IRS turns its attention to the 2021 tax year because the maximum per-employee credit amount was $7,000 per quarter that year. It was $5,000 for the 2020 tax year.
With more than 1.4 million ERTC claims still unprocessed, concerned businesses may want to take advantage of the IRS’s Withdrawal Program. The program is available to eligible employers that filed a ERTC claim but haven’t yet received, cashed or deposited a refund. The IRS will treat withdrawn claims as if they were never filed, so taxpayers aren’t at risk of liability for repayment, penalties or interest.
The IRS also may reopen its now-closed Voluntary Disclosure Program for employers that claimed and received the credit but weren’t entitled to it. A decision is expected this summer.
Personal use of corporate jets
In February 2024, the IRS unveiled a new audit initiative scrutinizing the personal use of corporate aircraft. The Tax Cuts and Jobs Act provides a generous bonus depreciation provision that prompted numerous businesses to buy corporate jets. These aircraft, however, are often used for both business and personal reasons, triggering some complicated tax implications.
Businesses generally can claim a deduction for expenses related to maintaining a corporate jet if it’s used for business purposes. Deductible expenses include depreciation, pilot wages, interest, insurance and hangar fees. The amount of the deduction for aircraft travel on a business’s tax return can reach into the tens of millions of dollars.
Corporate jets, however, are frequently used for both business and personal reasons by a company’s executives, shareholders and partners, as well as their family and friends. The personal use generally results in income inclusion for the individuals and can limit a business’s ability to deduct costs related to that travel.
Notably, personal use includes not only taking the jet for purely personal purposes (for example, to attend a concert in another city) but also bringing family members or other guests along on a trip that’s otherwise for a business purpose. That’s because the purpose of a trip is determined on a passenger-by-passenger basis.
The new audit initiative includes audits of aircraft usage by large corporations and partnerships (and also high-income taxpayers). The exams will focus on whether jet usage is properly allocated between business and personal reasons. While the initial plans called for dozens of audits, the IRS indicated that the number could increase based on the results and as it continues to add new examiners.
Protect yourself
An aggressive and well-funded IRS makes tax compliance more important than ever. We can help businesses minimize their tax bills while staying on the right side of the law.
Categories: Emerging Regulations, Tax
