ATHLETES, ARTISTS, AND AUDITS: IRS RENEWS FOCUS ON HIGH-WEALTH INDIVIDUALS AND ASSOCIATED ENTITIES

  • United States
  • 06/23/2020
  • Morgan Lewis

The IRS has announced its intention to audit wealthy taxpayers and their associated business entities starting in mid-July. This LawFlash alerts sports owners, athletes, entertainers, and others in these industries to the impending issues and their unique exposure to becoming targets of these audits.

The US Internal Revenue Service (IRS) Global High Wealth Program announced via webcast on June 18 that it is preparing to review hundreds of high-income individuals’ tax returns between July 15–September 30. Each review is expected to include both individual tax returns as well as the returns of related business entities, with a focus on “pass-through” entities and partnerships.

These reviews pose particular exposure for sports owners, athletes, entertainers, and others in these industries, who often have high incomes and other business interests conducted through pass-through entities.

TRIGGERING EVENTS
The IRS’s review comes at a confluence of several important trends:

The coronavirus (COVID-19) pandemic has caused governments to not only spend extraordinary amounts to combat the health and economic effects of the pandemic but also to have lost billions of dollars in tax revenues worldwide. One report estimated that, as of mid-April, the state of New York alone was facing a shortfall of more than $10 billion in tax revenue.[1] The United States is no exception, and the federal government (along with state and local agencies) will soon be turning their attention to maximizing their ability to collect more tax revenue to shore up their coffers.
The IRS has recently faced increased criticism due to a perceived failure to audit high-income individuals.[2]
Recent amendments to the tax code—including the Bipartisan Budget Act of 2015 (BBA), which supplanted the regime for auditing partnerships, and the Tax Cuts and Jobs Act of 2017 (TCJA), which dramatically altered key rules for US taxation of income earned domestically and abroad—created complexities and planning opportunities that the IRS has only begun to investigate.
Adding to the above factors, taxpayers in the sports and entertainment industries have long been a focus of IRS attention, and recent years have been no exception.[3] Thus, as it often is in sports and entertainment, the stage is set for a showdown.

CONSIDERATIONS & INSIGHTS
Athlete and Entertainer Income Sources Make Them Likely Targets

Unlike the typical salaried employee, athletes, entertainers, and other performers often earn income outside of a fixed salary subject to wage withholding. For example, athletes may receive payments for endorsements of products or services, and for professional appearances. This income is generally not subject to withholding and potentially exposes individuals to IRS challenge as to how the income was reported and how much tax was due. Further, athletes may earn income through holding companies established for liability and financial security reasons.

This type of structure—high-income individuals, related business entities, and reporting positions subject to challenge—is arguably exactly what the Global High Wealth Program is targeting in its looming review. Further, as reported in our recent LawFlash, opportunistic investors are increasingly eyeing prized sports assets and investments in the sports industry. This type of increased activity in the sports investment community is also likely to focus the Global High Wealth Program toward sports and entertainment figures as an area of audit opportunity.

Changes in Tax Law Add Fuel to the (Audit) Fire

Recent material changes in tax law—via the TCJA and BBA—have left many holding-company and pass-through structures open to uncertainties, as interpretation of the new laws is subject to new regulations, interpretations, and other guidance, as well as being largely untested in the courts.

The Global High Wealth Program is likely to review high-income individuals’ tax positions in light of these uncertainties to obtain a roadmap of how such individuals (and related entities) might be both complying with—and taking advantage of—the TCJA. Moreover, the economic ramifications of COVID-19 have already caused massive declines in tax revenue. As such, the Global High Wealth Program necessarily will be incentivized to identify audit targets that may help ameliorate any shortfalls.

GLOBAL HIGH WEALTH PROGRAM
The Global High Wealth Program was formed in 2015 to take a holistic approach in addressing tax compliance among high-wealth taxpayers. Its purpose was to look at the complete financial picture of high-wealth individuals and the enterprises they control—a departure from prior examinations that focused on just one tax return alone.

Review Process

A Global High Wealth Program examination consists of a “key” case, generally the individual income tax return of the primary high-wealth individual at issue, and related income tax returns of business entities in which the individual has a controlling interest and significant compliance risk exists. A “controlling interest” may include significant ownership of or significant influence over an entity or multiple entities.

The enterprise case may include interests in partnerships, trusts, subchapter S corporations, C corporations, private foundations, gifts, and other entity types. Personnel in the Global High Wealth Program work with personnel from other IRS business operating divisions to address noncompliance across the entire enterprise.

HOW WE CAN HELP
While it is not a foregone conclusion that sports and entertainment figures will be audited due to the Global High Wealth Program’s recent announcement, the risk is real and deserves attention—especially now. Recent legislation such as the BBA and TCJA has increased uncertainty, and COVID-19 and criticism of the IRS due to perceived failures to audit high-income individuals has increased pressure to pursue targets.

In this environment, sports owners, athletes, entertainers, and other high-income taxpayers in these industries are well advised not to “drop the ball” in seeking advice for what may come. Our talented team of tax specialists stands ready to assist individuals and entities to prepare for, manage, and maximize outcomes of Global High Wealth Program audits, or any other tax issues they face.