Volume 4, No. 1

One out of 11 millionaires faced an audit in 2007, the IRS recently reported. The IRS touted a significant uptick in audits of very wealthy individuals in its FY 2007 roundup of enforcement activities posted on its Web site. For the first time since 1998, total audit coverage was higher than one percent of all individual returns. At the same time, audits of S corps and partnerships increased but audits of large corporations fell from the prior year.

• Take-Away Point. The increase in audits of wealthy individuals in 2007 came after a critical report by the Treasury Inspector General for Tax Administration (TIGTA) (While Examinations of High-Income Taxpayers Have Increased; The Impact on Compliance May Be Limited, 2006-30-105) in 2006. TIGTA discovered that increased audit coverage was "due largely to an increase in correspondence examinations, which limit the tax issues the IRS can address in comparison with face-to-face examinations." The trend identified by TIGTA appears to be continuing. One million of the 1.38 million individual returns selected for audit in 2007 were correspondence audits.



• Comment: The IRS is under great pressure from Congress to show results in closing the $300 billion tax gap, the difference between what taxpayers owe and what they pay. The agency reported that enforcement and examination revenue totaled more than $55 billion in 2007, up from roughly $45 billion in 2006.

All Audits
Audits of all individuals across all income levels increased in 2007. The IRS reported that the total number of individual returns audited in 2007 was 1.38 million compared to 1.29 million in 2006, an increase of seven percent.

Overall audit coverage continued to climb since 1998. It was 1.03 percent in 2007 compared to 0.98 percent in 2006.

High-Income Individuals
The IRS considers high-income individuals to be those who file a Form 1040 with Total Positive Income (TPI) of $100,000 or more. Generally, TPI is calculated by using only positive income values from specific income fields on the tax return and treats losses as zero.

• Example: Abby files a return showing wages of $90,000, interest of $12,000, and a $25,000 loss from an interest in a partnership. Abby's return would have a TPI totaling $102,000 and be considered a high-income tax return by the IRS.

Millionaires. Audits of individuals with incomes of $1 million or more increased 84 percent from 2006 to 2007. More than 30,000 millionaires were audited in 2007 compared to 17,000 in 2006.

• Comment: More than one-half of the audits of millionaires were correspondence audits.

Other high-income individuals. The IRS also audited more individuals with incomes above $200,000 in 2007 than in 2006. Audits of individuals with incomes over $200,000 reached 113,105 returns, reflecting an increase of nearly 30 percent from 2006. The higher audit numbers were also reflected in audits of individuals with incomes of $100,000 or more. The IRS audited 293,188 of these returns in 2007, up nearly 14 percent from 2006.

Businesses
On the business side, the IRS took special interest in two popular business entities: S corps and partnerships. Audits of both entities were up in 2007 compared to 2006. Audits of S corp returns (taxpayers filing Form 1120-S) and partnership returns (taxpayers filing Form 1065) increased by roughly 25 percent. The coverage rate for S corps and partnerships was approximately 0.45 percent in 2007.

While audit statistics for S corps and partnerships were up, the number of large corporation returns (corporations with assets of $10 million or higher) examined fell in 2007. The IRS examined 9,644 large corporation returns in 2007 down from 10,591 in 2006. The coverage rate fell slightly from 18.6 percent in 2006 to 16.8 percent in 2007.