IRS Utilizing New Technology to Detect Under-Reporting in S Corps

The IRS has shown heightened fervor in detecting and combating under-reporting and compliance issues over the past few years. As such it has taken significant steps to increase the efficacy of its efforts. By taking advantage of new machine learning and big data technology, the IRS has become notably more efficient in detecting and auditing S Corporations that report lower than expected compensation for its officers. These new technologies allow the IRS to perform its work much more effectively – naturally leading to a rise in investigations.

As of 2022, the IRS has operated two programs through its Compliance Initiative Project (CIP) that specifically target non-payment or underpayment of compensation paid to S Corporations to shareholders who are also employees. The IRS has the ability to utilize these programs to detect under-reporting businesses at an astonishing rate. Alongside the new funding received with the Inflation Reduction Act, which includes over $45 billion to be used for tax enforcement, the organization is ramping up to what will potentially be a significant increase in reasonable compensation challenges. 

The Compliance Initiative Project (CIP)

CIPs are authorized activities that exist outside of the IRS’s planned strategy to correct various noncompliance issues. As opposed to a traditional form 1120-S audit, CIPs identify potential areas of noncompliance in an attempt to correct that specific issue. Starting in 2020, the IRS began a new CIP aimed at enforcing compliance of S Corporations that have not appeared to adequately compensate shareholders in their W2 wage. Within this CIP, the IRS primarily uses two tech-based resources to raise red flags on potential compliance issues:

  • Issue Recommender: This 2018 pilot program uses various algorithms to highlight anomalies among tax returns from similar S Corporations.
  • Discriminant Function System (DIF): This system utilizes a series of models that are run against a tax return measuring and grading the risk of noncompliance. Once complete, the DIF assigns a score to the tax return based on the potential for tax changes on the return.

In the past, getting audited was oftentimes a random, happenstance occurrence. Today, the IRS is using technology to comb through every tax return at faster rates to identify red flags that may have otherwise gone unnoticed in the past.  

Staying Prepared

If you own an S Corporation, your chances of getting flagged by the IRS may have significantly increased. Along with having clear documentation to support your W2 reasonable compensation figure, it’s smart to have legal help in your corner. contact The Law Offices of Tyler Q. Dahl today and let’s make sure you’re protected if the IRS comes calling.

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