The Wealth Squad

Despite its name, the Wealth Squad is not the latest Hollywood blockbuster about altruistic billionaires out to change the world.

Instead, it’s the nickname for the crack team of audit specialists formed by the IRS in 2009 to catch high-net-worth (“HNW”) tax dodgers.

Officially named the IRS Large Business and International (LB&I) Division, the Wealth Squad suffered initial setbacks in its quest to recover unpaid taxes by HNW individuals from reduced budget and staff. However, with renewed resolve, it recently announced it was going to resume its efforts to crack down on ultra-wealthy tax cheats.

On June 18, Wealth Squad director Douglas O’Donnell announced that on July 15, the IRS will open several hundred new audits involving HNW individuals.

The audits will focus on ultra-wealthy individuals with connections to at least one pass-through entity such as a partnership, LLC, or S-Corp. The IRS also announced that it was also targeting the ultra-wealthy connected to private foundations with a particular interest in “self-dealing” transactions including prohibited loans to a disqualified person.

Why now?

Because according to a recent report, the Treasury Inspector General for Tax Administration (TIGTA) estimated that 34% of high-income non-filers owed an estimated $45.7 billion in taxes for the 2014 through 2016 tax years.

According to a study conducted by the IRS’ Andrew Johns and the University of Michigan’s Joel Slemrod, the top 0.5 percent of income earners account for $50 billion each year in unpaid taxes.

There’s a good reason for the Wealth Squad to go after HNW individuals but should high-income earners like physicians who have pass-through investments be concerned?

As the old saying goes, pigs get fat and hogs get slaughtered. In other words, you should only be concerned if you’ve got something to hide.

The IRS is not looking to punish HNW individuals who take advantage of legitimate tax benefits in the tax code like business and real estate deductions, depreciation, and deferrals; they’re looking for the ones who step over the line and by either abusing these tax benefits or avoid paying taxes altogether. They’re targeting cheaters, not entrepreneurs.

Many passive investors like high-income physicians legally take advantage of the many tax benefits of investing in passive income funds. There’s no doubt the IRS will come across many individuals who invest in private investment funds and private debt and equity.

There’s one audit technique that the IRS is known for using to pick out the cheats among similar pools of taxpayers – and that is to compare and contrast those taxpayers in the same pool (i.e., those who are in similar financial situations or who invest in similar assets).

The IRS will not only look for but will expect many HNW individuals with pass-thru investments to take advantage of the many tax benefits of investing in productive assets such as business and real estate deductions and depreciation.

These tax items along with income are typically reported on K-1’s provided to the taxpayer by the various private investment funds at year-end.

The IRS isn’t looking to nail those investors who legitimately pay reduced taxes by leveraging deductions and depreciation reported on K-1’s, it’s looking to nail those investors who DON’T report passive income by intentionally omitting income reported on K-1’s.

Do you know how the IRS will know if an investor is hiding income by not reporting K-1’s?

Because the company that issued the investor the K-1 will send copies of them to the IRS. Using sophisticated software tracking tools, the IRS will be able to match up company-issued K-1’s with taxpayers who don’t report them.

The Wealth Squad will be out in full force on July 15th and taxpayers who hide income by omitting K-1’s or the taxpayers who use elaborate entity structures in obscure foreign jurisdictions or ones known to attract tax cheats should be very worried.

On the flip side, there’s no need for honest high-income earners like physicians who have passive income investments to panic.

If you have competent tax advisors or if you prepare your own taxes and you report in good faith all items of income and deductions as reported by the various funds in which you invest, you have nothing to worry about.