The Internal Revenue Service recently announced its plans for the visible increased audits on wealthier taxpayers, large corporations and large complex partnerships for the 2026 tax year.
Audit rates will increase by more than 50% for those with positive total income above $10 million (from a coverage rate of 11% in 2019 to 16.5% in tax year 2026). This news is sure to cause anxiety among some high net worth earners.
But an IRS audit is more of a documentation-intensive exercise; it is not necessarily an accusatory event. They just want to see your customers' homework to show how they got their answers.
Dot i's, Cross t's
Taxpayers must be able to explain and justify their tax positions and investments to the IRS. Proper documentation is crucial and I advise clients to make it a priority. I tell them to keep track of what they do and when they do it. That way, they have their homework in place and ready to show the IRS if needed. They should start a file or folder that includes all forms and documents that explain their financial actions.
The documentation should answer these questions:
- What did you do?
- How did you do it?
- Why did you do it? And;
- What documents do you have that support what you did?
Some of the wealthiest people are inherently risk takers. By translating this into tax planning, they aim to take a calculated risk and say, “Do I have a position here? Can I document this position that gives me the opportunity to make an argument to the IRS as to why this position works? Do I have enough documentation to support it?”
The next time a client hears the word “audit,” they should consider it a tool that IRS employees use to check their homework. Make sure they do theirs.
Practices that may trigger an audit
While there are many honest reasons that someone might drop or forget some earned income, those cases are rarely limited to criminal or wrongful intent. But illegal practices, such as fabricating documents, taking deductions that are not allowed or creating various types of expenses that did not occur, can cause problems.
Here are six items that may attract the attention of the IRS:
Matthew Chancey (matthewchancey.com) is a Certified Financial Planner and author of Tax Alpha Solutions: Effective Tax Management Strategies for High-Net-Worth Investors.