IRS announces new initiative aimed at high-income non-filers

ARTICLE | March 07, 2024

Authored by RSM US LLP

Executive summary

IRS announces new initiative directed at high-income earners who have not filed prior year tax returns. IRS has identified 125,000 instances of non-compliance. There is estimated $100 billion of financial activity from these instances based on information from third parties. The IRS has started sending compliance letters to high-income taxpayers.

IRS launches new initiative directed at high-income taxpayers, including millionaires, who have failed to file tax returns. The IRS estimates there are 125,000 instances of non-filing equating to $100 billion of financial activity.

The IRS is utilizing funding from the Inflation Reduction Act (IRA) to continue their efforts to improve tax compliance and ensure fairness. The newest IRS initiative will focus on high-income taxpayers who have not filed federal income tax returns. The IRS will mail out compliance letters in more than 125,000 cases where taxpayers have not filed tax returns for years between 2017 - 2021. 25,000 letters will be mailed to non-filing taxpayers with more than $1 million in income, and 100,000 letters will be mailed to non-filing taxpayers with incomes between $400,000 and $1 million. The IRS is utilizing third-party information, such as Forms W-2s and 1099s, to identify which non-filing high-earning taxpayers will be receiving these compliance letters, formerly known as the CP-59 Notice. About 20,000 to 40,000 letters will go out each week beginning with the non-filers in the highest-income categories.

The IRS previously announced various initiatives using funding from the IRA to ensure complex partnerships, large corporations, and high-income individuals pay the taxes they owe, including this most recent announcement to target high-income non-filers. Another previously announced initiative is targeting individual taxpayers who had more than $1 million in income reported on their filed tax returns but had an outstanding tax liability in excess of $250,000. That initiative has collected nearly $500 million in tax revenue. Another initiative is the use of artificial intelligence to select the largest partnerships containing highest risk issues for examination. As of December, the IRS has opened examinations for 76 of the largest partnerships (on average over $10 billion in assets) in the U.S., including entities in industries such as hedge funds, real estate investment partnerships, publicly traded partnerships, and large law firms. These initiatives are part of the larger effort by the IRS to ensure fairness in the tax system.

Although the third-party information reporting financial activity of more than $100 billion for non-filers serves as the basis for this newest initiative, the amount of potential revenue to be gained is uncertain given potential credits and deductions that taxpayers may have. However, a conservative estimate by the IRS is that this initiative could generate hundreds of millions of dollars of unpaid taxes. Alternatively, some of these non-filing taxpayers may actually be owed a refund if they are still within the three-year window of opportunity to claim a tax refund.

High-income taxpayers who have not filed prior tax returns should consult with a trusted tax professional to assist with compliance by filing the late tax returns and paying the delinquent tax, including penalties and interest. The failure-to-file penalty is 5% of the amount owed every month, up to 25% of the tax liability.

In the event that a taxpayer receives a compliance letter, action should be taken quickly to avoid additional follow up notices, higher penalties, as well as increasingly stronger enforcement measures. Further, if the taxpayer fails to respond to compliance letters, the IRS can instead file what is known as a Substitute for Return (SFR). An SFR calculates the tax based on wages and other income reported to the IRS by third parties such as employers, financial institutions, and others. The SFR factors in the tax, penalties, and interest owed by the taxpayer, but does not factor in things like credits, deductions, or exemptions since the IRS would not know each taxpayer’s personal situation. Therefore, it is still better for the taxpayer to file their own tax return to be able to claim deductions, credits, and exemptions. In this SFR scenario, the IRS will issue a Notice of Deficiency CP3219N (a 90-day letter) proposing a tax assessment after which the taxpayer will have 90 days to file the late tax return or file a petition in Tax Court. If the taxpayer does neither, the IRS will proceed with the proposed assessment.

The SFR for these taxpayers will likely cause a tax bill and, if unpaid, will start the collection process. Collections can include actions such as a levy on wages or a bank account or the filing of a federal tax lien. If the taxpayer does not file for multiple years, they could be subject to additional enforcement, including additional penalties or even criminal prosecution. It is highly recommended that non-filers consult with a qualified tax professional to file late tax returns and pay outstanding tax liabilities to ensure they are in compliance moving forward.