The IRS is Targeting High-Income Taxpayers for Civil Audits and Criminal Prosecutions

August 23, 2007

For more information, contact Bob Webb.

On September 12, 2002, the IRS announced its new audit priorities.  The IRS will focus its Civil Revenue Agents and its Criminal Division Special Agents on identifying non-compliance issues for high income taxpayers.  In short, the probability of being audited by the IRS will increase over the next few years for high income taxpayers.  The IRS is auditing and investigating more high income taxpayers to identify "deliberate tax cheating." 

The new IRS audit priorities will focus on six key areas of non-compliance:

• Offshore Credit Card Users

•  High Risk, High Income Taxpayers

•  Abusive Schemes and Promoter Investigations 

•  High Income Non-Filers 

•  Unreported Income

• The National Research Program and the IRS' Compliance Study Involving 50,000 Tax Returns

Offshore Credit Card Project

It is not illegal to use offshore bank accounts or offshore credit cards.  However, the IRS believes that U.S. taxpayers are using offshore accounts and offshore credit cards to avoid paying U.S. income taxes.  The IRS estimates that there may be one to two million taxpayers concealing taxable income through the use of offshore entities, costing honest taxpayers billions of dollars each year.  Offshore credit cards provide easy access to offshore funds that are in offshore bank accounts.  Often, the offshore accounts are located in tax haven countries that allow income to be hidden from U.S. taxing authorities.  The U.S. tax law requires all U.S. citizens to pay tax on all of their worldwide income (including interest earned in offshore bank accounts).

The IRS has taken the following steps to identify and prosecute tax-avoidance schemes involving credit cards issued from offshore banks.

• In late 2000, the Department of Justice (acting for the IRS) convinced a federal judge to order American Express and MasterCard to provide information for 1998 and 1999 revealing U.S. taxpayers who hold credit cards issued by banks from tax haven countries such as the Cayman Islands, Bahamas, and Antigua.

• In March 2002, the Department of Justice convinced a federal judge to authorize Visa International to reveal U.S. taxpayers using credit cards issued by banks in over 30 tax haven countries for transactions that occurred in 1999 and 2001.

The IRS recently announced that MasterCard has produced documents  reflecting 230,000 accounts.  Once the IRS identifies the U.S. taxpayer who owns the offshore credit card, a civil audit and/or a criminal investigation may begin.  Many taxpayers who have offshore accounts fail to check the box on their IRS 1040 which specifically asks if the taxpayer has an offshore account.  The failure to disclose an offshore account could be viewed by the IRS as a felony tax crime.

High-Risk High-Income Taxpayers

Many high-income taxpayers are involved in partnerships, trusts and corporations that are "pass through" entities.  These pass through entities create compliance problems for the IRS's matching programs.  In other words, it is difficult for the IRS to trace income generated by an offshore or a domestic partnership (or other pass through entities) to the actual taxpayer who must report the income.  The IRS started matching K-1 forms from the pass through entities to the individual tax returns.  However, this technique does not verify the amount of income reported by the pass through entity itself.  Taxpayers who receive substantial losses from pass through entities such as partnerships and trusts will receive close scrutiny from the IRS under its new audit priorities.

Deliberate Tax Avoidance Schemes

The IRS is attacking (i) abusive schemes; (ii) high-income non-filers; and (iii) unreported income.  Many schemes are being promoted by so-called professionals that claim to reduce a person's tax liability by inflating expenses, creating false deductions, or creating unallowable credits.  These schemes are all targeted under the IRS's new audit guidelines.

The IRS is also targeting high-income individuals who simply fail to file federal income tax returns.  These high-income non-filers will be identified and possibly prosecuted by the IRS under its new IRS audit priorities.

Unreported income creates the largest audit problem for the IRS.  However, the IRS has developed a new tool to detect unreported income. The IRS has developed a new Unreported Income Discriminate Index Formula ("UIDIF") analysis.  The new UIDIF score will rate the probability that income has been omitted from an individual tax return.  This new UIDIF screening tool will result in more high-income tax returns being audited by the IRS.

The National Research Program

The National Research Program ("NRP") examinations will begin in the Fall of 2002.  The NRP examinations will measure reporting compliance and identify compliance issues for the IRS.  The NRP examinations will review a small, statistically valid sample of individual returns for the tax year 2001 (less than 50,000 returns out of 132,000,000 individual returns filed).  However, if you are one of the unlucky 50,000 individuals who are audited, you can expect a detailed and thorough review of your tax return.


If there are issues that you believe may be present with your current or past federal income tax returns, you should consider voluntarily disclosing these issues to the IRS before they discover the problems through an IRS audit.  However, before you contact the IRS, you should talk with an experienced tax lawyer who is familiar with the IRS policy on voluntary disclosure.