With billions of dollars in additional funding from the Inflation Reduction Act, the IRS is ramping up its efforts to reduce the “tax gap”—the difference between taxes owed and taxes paid. The agency has launched several significant business-related compliance campaigns as part of this initiative. Below, we take a closer look at three key areas of focus.
Target 1: Abusive Pass-Through Practices
The IRS has significantly stepped up enforcement against partnerships and other pass-through entities, which have been under-audited for over a decade. Despite a 70% increase in tax filings for pass-through entities since 2010, audit rates fell dramatically from 3.8% in 2010 to just 0.1% in 2019.
To address this, the IRS is establishing a new office dedicated to partnerships, S corporations, and estates & trusts. Additionally, a special work group in its Large Business and International Division will focus on complex pass-through entities.
One of the agency’s major initiatives involves curbing basis-shifting, a practice it describes as “a major tax loophole exploited by large, complex partnerships.” Basis-shifting occurs when a business transfers the tax basis from non-deductible assets (like stock or land) to deductible ones (such as equipment) through a series of related-party transactions. The goal is to inflate deductions or reduce gains when the asset is sold, thereby reducing taxable income.
To combat this, the IRS plans to issue regulations aimed at:
- Eliminating inappropriate tax benefits from basis-shifting between related parties.
- Prohibiting basis-shifting among members of a consolidated group.
Proposed regulations released in June 2024 will require certain basis-shifting transactions to be reported. The IRS has also issued a Revenue Ruling indicating that certain related-party partnership transactions involving basis-shifting lack economic substance, signaling its intent to challenge these transactions.
Target 2: Improper Employee Retention Tax Credit (ERTC) Claims
In July 2023, the IRS intensified its crackdown on improper Employee Retention Tax Credit (ERTC) claims, shifting its focus to compliance. The agency began audits and criminal investigations targeting both promoters and businesses involved in filing ineligible claims.
By September 2023, the IRS imposed a moratorium on processing new ERTC claims to address what it described as a surge of fraudulent claims. This pause allowed the agency to review over 1 million ERTC claims totaling more than $86 billion. The IRS found that 10% to 20% of claims were clearly erroneous, with another 60% to 70% posing significant risk. Tens of thousands of erroneous claims have been or will be, denied, with further analysis pending on the high-risk claims.
During the review period, the IRS continued processing claims submitted before September 14, 2023. By late June, the agency had processed 28,000 claims worth $2.2 billion and rejected over 14,000 claims valued at more than $1 billion. For the 2020 tax year alone, over 22,000 improper claims were uncovered, resulting in $572 million in assessments against taxpayers. The numbers could be even higher for the 2021 tax year, when the maximum per-employee credit was $7,000 per quarter, compared to $5,000 in 2020.
With more than 1.4 million ERTC claims still unprocessed, businesses may want to consider the IRS’s Withdrawal Program. This program allows eligible employers to withdraw their ERTC claims before receiving, cashing, or depositing a refund, thereby avoiding liability for repayment, penalties, or interest.
The IRS may also reopen its Voluntary Disclosure Program, which allows employers who received the ERTC but were not entitled to it to voluntarily disclose and correct the error without severe penalties. A decision on this is expected in the coming months.
Target 3: Personal Use of Corporate Jets
In February 2024, the IRS launched an audit initiative focusing on the personal use of corporate aircraft. The Tax Cuts and Jobs Act’s bonus depreciation provision led many businesses to purchase corporate jets, but these assets are often used for both business and personal purposes, which creates complex tax implications.
Businesses can generally deduct expenses related to maintaining a corporate jet if it’s used for business purposes. These deductible expenses include depreciation, pilot wages, interest, insurance, and hangar fees. However, when jets are used for personal reasons—by executives, shareholders, partners, or their families and friends—these costs can limit a business’s ability to deduct them and may result in income inclusion for the individuals.
The IRS’s new audit initiative will scrutinize the allocation of corporate jet usage between business and personal purposes, particularly among large corporations, partnerships, and high-income taxpayers. The initial plan involves dozens of audits, but the IRS may expand this number as more examiners are added.
Protect Your Business
With the IRS becoming increasingly aggressive in its enforcement efforts, staying compliant is more critical than ever. We can help you navigate these complex tax issues, minimize your tax liability, and ensure your business remains on the right side of the law.
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