About a decade ago, the Internal Revenue Service launched an initiative targeting “high net worth families.” This project was designed to look well beyond just the individual 1040s of the nation’s very wealthy to their related entities including private foundations. It “lasted a little while and then fizzled out a few years later,” according to law professor Phil Hackney who was in the IRS Chief Counsel’s Office at the time. This push apparently ended “… without much to show for itself.”
But Professor Hackney and others – including the IRS itself – now tell us that the agency had planned to, even before COVID-19, pretty much shut operations down for a few months, to “take another cut at this issue.”
Probes of Foundations: Reasons
This effort “appears to be in reaction to various factors” including criticism from a number of quarters to disclosures that the agency had been focusing much of its audit activity in the past several years on lower-income taxpayers instead of aiming its sights on the much more productive target of the financial elite.
In early March 2020, Treasury Secretary Steven Mnuchin appeared before the House Ways and Means Committee. He responded to questioning by Rep. Judy Chu (D-CA) on this problem: “I have specifically directed the IRS commissioner to come up with a plan to increase the amount of funding so that we can audit more high-income earners, so that is specifically in our plan.”
There had been prodding as well from a Treasury Department inspector general’s report “recommending that the IRS increase its focus on certain high-income taxpayers.” This new project also “complements other initiatives at the IRS focused on high-income individuals, and those aimed at better understanding taxpayer behavior to improve future audit practice.”
The COVID-19 quarantine shut down much of the Internal Revenue Service’s operations until July 15th. But some activity continued virtually, producing evidence that the Internal Revenue Service “… is making good on that promise” by Secretary Mnuchin. At an NYU Tax Controversy Forum on June 18, 2020, Douglas O’Donnell, the Commissioner of the IRS Large Business and International (”LB&I”) Division, told conference attendees that it will open “several hundred new audits involving high-income individuals” beginning at that mid-July reopening date.
These audits will focus on the wealthy “who have a connection with at least one pass-through entity such as a partnership or S-Corporation, or a connection with a private foundation.” The examinations will be conducted primarily by the IRS’ Global High Wealth Industry Group – known more colloquially as the “Wealth Squad” – that is contained within the LB&I Division. The target enterprises for this group “are generally controlled by individuals with assets or earnings in the ten of millions of dollars.”
Nevertheless, this project will span several IRS divisions including the Tax-Exempt and Government Entities (TE/GE) Division that has responsibility for oversight of private foundations. Director Tamera Ripperda has announced that over “1,000 cases of private foundations that are connected to high income or high net worth individuals” have been identified and audit case files have been opened.
The Foundations Angle
So far, there seems to be “limited guidance” on the scope and extent of the examination of the private foundations connected with the targeted high-wealth individuals and families. But it’s been reported that the Internal Revenue Service is “particularly interested in auditing whether those private foundations have engaged in prohibited “self-dealing,” such as making loans to a disqualified person.”
Of course, the definition of “self-dealing” within the Internal Revenue Code includes acts far broader than insider loans. It can include as well transactions between a private foundation and a disqualified person involving – just to name some: (1) the sale, exchange, or leasing of property, (2) providing goods, services, or facilities, (3) paying compensation or reimbursing expenses, or (4) transferring foundation income or assets to, or for the use of benefit of, a qualified person.” There is also “indirect self-dealing” which includes transactions between organizations controlled by a private foundation.
And those who will receive audit letters in connection with this initiative should recognize that the private foundation element will only be a part of a more comprehensive examination of the entire financial picture including other pass-through entities or issues.