How to Help Wealthy Clients Avoid Audits as IRS Cracks Down

These businesses pass their tax liability through to the individual owners of the business and onto their personal tax returns. With added IRS scrutiny directed toward pass-throughs, it's important that these entities have an accurate set of books and that all revenues and expenses are properly documented.

Over the years, pass-throughs have been cited as contributors to a shortfall in tax collections reflected in the new IRS emphasis on higher-income taxpayers.

Cryptocurrencies

Cryptocurrencies have been an area of enforcement emphasis for the IRS, with taxpayers required to indicate if they have transacted in digital assets on their tax return since 2020. It's important that your clients who trade in cryptocurrencies, nonfungible tokens (NFTs) and other digital assets fully document all aspects of their activity.

Beyond this, there are rules surrounding the use of cryptocurrencies to pay for transactions. Clients may still have a tax liability for capital gains on these assets even though they did not sell them for cash.

As recordkeeping on digital exchanges can vary widely in quality and accuracy, it is incumbent upon clients to keep accurate records to avoid misreporting crypto activity.

Employee Stock Options

Many higher-income clients may receive stock options or other stock-based compensation. In many cases, your client may exercise an option to buy shares and sell them shortly thereafter. While this quick turnaround will often result in little to no gain, the sale must still be reported to the IRS.

Many employees fail to report the exercise price as the cost basis for this sale, so all the IRS sees is a sale and a gain for the full amount of the proceeds. While this is fixable, the IRS might initially look at these sales as short-term capital gains and expect tax payments to match.

It is important to emphasize that your clients keep good records for these transactions and report them properly to the IRS.

Art and Collectibles

Many higher-earning taxpayers own art or other collectibles such as gold coins, sports memorabilia and comic books. For such investors, the long-term capital gains tax rate is a flat 28% rather than varying by income for gains on investments such as stocks and bonds.

This also includes taxes on ETFs that invest in gold, silver and other precious metals. Investors in collectibles can deduct any losses, as well as professional expenses such as restoration costs, fees to auction off their collectibles and appraisal fees.

Those deemed to be collectors as opposed to investors cannot deduct these expenses and will only pay taxes on any gains on selling the artwork or collectible. The difference between an investor and a collector lies with what they do with the art or collectible while they own it.

An investor will typically wait for the collectible to appreciate in value and then sell it. A collector will typically display the piece for their enjoyment.

This area will likely draw scrutiny under the new IRS initiatives. Be sure your clients are aware of the documentation they need to have.  

Conclusion

Higher-earning clients may find themselves the focus of increased IRS enforcement of high-income taxpayers and those who use pass-through entities in their business or investing. There are additional types of investments beyond those discussed above that could invite added IRS attention.

Whether you work with clients directly on their recordkeeping or tax compliance, you will want to discuss these increased IRS enforcement efforts with them. Urge them to work closely with their tax professionals to ensure they have all required documentation of income and expenses to avoid problems with the IRS going forward.

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