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International Tax - October 2011

 

IRS Begins Audits of High Net Worth Global Families

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As reported in recent Wall Street Journal articles, the IRS has initiated its business plan of auditing individual taxpayers that have a net worth greater than $10 million.In selecting returns to audit, the IRS is focusing its efforts on taxpayers that have global economic activity.This article provides certain information to effected global taxpayers and their advisors about this enhanced IRS focus and what steps should be taken in light of the elevated audit risk.

New IRS Audit Group

To address the examination of taxpayers with global activity, the IRS has created a new unit called the Global High Wealth Industry Group (“Group”).The audits initiated by the Group will go beyond examining the income reported on the taxpayer’s U.S. income tax return (Form 1040).The examination will set out to gain a complete understanding of the taxpayer’s global activity. The Group will be comprised of highly trained examiners who will be well versed in domestic and international tax matters. Potentially, a team of IRS auditors, who have expertise in different fields, will be assigned to a single taxpayer’s audit.

Information Requested by the IRS

Prior to commencing an examination, the IRS issues to the taxpayer an Information Document Request (IDR).Based on the vast array of activity that can be conducted outside the U.S., the IDRs are rather extensive in scope.

Asample of the initial information and documents requested by the IRS includes:

  • Foreign bank accounts, financial accounts and retirement accounts
  • Foreign business and partnership interests along with organizational charts and audit reports
  • Listing of property (real, tangible, intangible) held outside the U.S.
  • Matters dealing with foreign gifts, trusts, estates and inheritances
  • Personal financial statements, including net worth and cash flow computations
  • Domestic and international estate planning documents
  • Related party transactions with family members and businesses
  • Lending and borrowing transactions

Steps to Take Now

Taxpayers that fall within the IRS target group need to focus on their global accounting and record keeping capabilities.Failure to produce supporting documentation about foreign financial activity during the course of an IRS examination can ultimately lead to IRS audit adjustments with the imposition of additional income tax, interest and potentially penalties.

Taxpayers who have previously received only limited information about their foreign holdings should contact their foreign based service providers to assess what historical information is available.Ideally, a service provider has the ability to provide information going back at least three to four years to help support income and deductions.

Foreign based banking and brokerage documents often are presented in formats that require further analysis in order to extract the relevant information needed for U.S. income tax reporting. Thus, a foreign service provider may need to provide supplemental information that will enable the taxpayer to support the amounts reported on the U.S. tax return.

Beginning in 2013, the IRS is requiring certain foreign financial institutions to report information that is more consistent with domestic IRS tax reporting.Accordingly, the IRS will be receiving information directly from foreign banks and financial institutions and will be looking to use this information to help discover unreported income by U.S. taxpayers.

Taxpayers will need to consider changing service providers who are not able to provide the necessary accounting and documentation.

 
 
 
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