“Out of Sight”: Heightened IRS Scrutiny and Business Appraisals

The Business Observer, which covers entrepreneurs, small businesses, companies and executives from Tampa to Naples, recently published a story highlighting the IRS’s regional efforts to beef up its enforcement activities. While the article focuses on fraud and tax evasion, enhanced enforcement is one result of recent legislation that created tens of billions of dollars in new funding for the IRS. Beside criminal activity, what else will the taxing authorities focus on?

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Dry Powder for Taxing Authorities

In 2022 Congress passed the Inflation Reduction Act. The Act included a provision to increase IRS funding by approximately $80 billion over 10 years, a 50 percent increase over previous funding.  Following the bill’s passage, the Tax Foundation, a Washington, D.C. think tank, analyzed how the IRS planned to utilize the increased funding, including for taxpayer services, business system modernization, operations, and enforcement. Figure 1 summarizes the findings:

“Enforcement” jumps off the page as the largest amount of funding for the IRS over the next decade. But what does that mean? The IRS released a Strategic Operating Plan update that reiterated its previous five objectives and updates on its progress through 2024. One of the objectives includes: “Focus expanded enforcement on taxpayers with complex tax filings and high-dollar noncompliance to address the tax gap.”

The 2024 update goes into more detail on the direction of the IRS’s gaze at wealthier taxpayers. This includes [per the release]:

  • Plan to triple audit rates on large corporations with assets over $250 million to 22.6 percent in tax year 2026, up from 8.8 percent in tax year 2019.
  • Increase audit rates by nearly tenfold on large, complex partnerships with assets over $10 million, from 0.1 percent in 2019 to 1 percent in tax year 2026.
  • Increase audit rates by more than half on wealthy individual taxpayers with total positive income over $10 million, with audit rates going from an 11 percent coverage rate in 2019 to 16.5 percent in tax year 2026.

The IRS continues to insist that it will not increase audit rates for small businesses and taxpayers making under $400,000; those rates are at historically low levels. This was reiterated by former Federal Reserve Chair and current head of the U.S. Treasury Department Janet Yellen.

Business Appraisal and Avoiding the IRS’s Gaze

How do these change affect business appraisers? As highlighted in our summary of Hoensheid v. Commissioner , having a business appraisal (and appraiser) that meets IRS scrutiny is the difference between a clean tax return and a potential surprise hefty tax bill. If your tax return involves a private business valuation, having a trusted valuation advisor on your estate planning team is more important than ever. So what should estate planners and business owners keep in mind regarding appraisals?

  • Focus on quality and standards. Not all valuations are created equal. While an appraiser’s credentials are important—ASA, ABV, CVA, or even a CFA—they are not enough.  A good appraisal report should be comprehensive, well-reasoned, and defensible in legal or financial disputes. The IRS, Department of Labor, and other agencies or review bodies have specific requirements for meeting the standard of an acceptable valuation. A quality report will meet these standards and provide a reasonable estimate of value for the valuation in question. Valuation is both science and art, and a valuation report should both cover the blocking and tackling on the numbers as well as tell a story. Future cash flows, risk measurements, and expected growth are subjective and rely on reasonable assumptions that can be both explained and defended.
  • Keep your advisors on call. An advisor and client collaborating on an estate plan will likely need experts of various disciplines to get results that go beyond legal compliance. Before signing documents, having both trusted tax experts who can synthesize tax ramifications as well as valuation professionals who can explain valuation methodology and pressure points can make the difference between an okay strategy and an excellent one.

Audit rates for taxpayers overall have declined over the last decade, but a beefed up IRS is signaling that additional scrutiny is on the horizon for wealthier taxpayers. Having the right financial team in your corner is critical to your peace of mind. HBK’s tax and accounting team in collaboration with our valuation professionals will help you sleep better at night. Give one of our professionals a call at 941-909-7194, or email me at afrank@hbkvg.com to discuss your tax, valuation, or other financial needs.

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