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President Biden To The IRS: Resources Are On The Way

This article is more than 2 years old.

While the IRS postponed “Tax Day” from April 15 to May 17 this year, tax enforcement has received substantial attention in recent weeks culminating in President Biden’s proposal to boost the IRS’s budget (previewed here and here). The desire to make a massive investment in the IRS is attributable to three interrelated issues: concerns regarding how to pay for the Biden administration’s domestic priorities; substantial increases in estimates of the so-called tax gap, which reflects the difference between the amount of taxes that are owed and taxes that are collected; and the perennial hope that revenue shortfalls can be filled through increased enforcement. While it is tempting to view increased enforcement as a panacea to cure budget shortfalls, it is important to be clear-eyed about just how much additional revenue can really be raised and how quickly the floodgates will open.

Before the COVID-19 pandemic wreaked havoc on the economy, the federal government spent approximately $984 billion more than it collected in the fiscal year that ended September 30, 2019. While there was bi-partisan agreement regarding the need for substantial spending to mitigate the impact of the pandemic, that spending contributed to a $3.1 trillion deficit in fiscal 2020 and an anticipated deficit of $2.3 trillion for the current fiscal year.

On top of the Covid relief spending authorized by the American Rescue Plan Act of 2021, President Biden has proposed spending trillions of dollars on domestic priorities. While the White House wants to pay for the American Jobs Plan by increasing the corporate tax rate to 28% and partially offset the cost of the American Families Plan by increasing taxes on the wealthiest Americans, Congress will be looking for substantial additional revenues if it authorizes the additional spending sought by the Administration. Hence the increased focus on the tax gap. 

As I noted last Fall, in a September 2019 report, the IRS estimated that between 2011 and 2013, the annual revenue shortfall due to non-compliance was $441 billion. In testimony before the Senate Finance Committee earlier this month, IRS Commissioner Charles Rettig increased this estimate to as much as $1 trillion annually. Outside estimates suggest that the government might miss out on a total $7.5 trillion in tax revenues over the next decade.

There is an assumption that the tax gap can be substantially narrowed through increased funding. And for good reason. Over the past decade, the IRS has been the target of numerous budget cuts, resulting in the loss of 15% of its work force. Yet as I previously noted (here and here), the agency has been expected to do more with less, including implementing the Affordable Care Act and other legislative initiatives, as well as distributing hundreds of millions of stimulus checks over the course of the pandemic. 

Not surprisingly, even before the pandemic, budget cuts and the resulting loss of personnel resulted in personal income tax returns being audited at the lowest rate in 40 years. Perhaps more important in terms of the tax gap, according to one analysis, the IRS is now auditing the top 1% of taxpayers at the same rate as individuals who claim the Earned Income Tax Credit available to low income earners. Assumedly, this is largely because audits of the wealthy require in depth investigations into complex transactions, while the IRS can assess whether the EITC was properly claimed through correspondence audits utilizing automated letters. 

But to paraphrase Willie Sutton, auditing high income earners is where the money is. According to a recent paper published by the National Bureau of Economic Research, the top 1% of earners fail to report more than 20% of their income. The NBER found that a third of this unreported income could be attributed to what it dubbed as “sophisticated evasion.”  While the devil is in the details and reasonable minds can disagree as to whether certain aspects of underreporting reflect intentional tax evasion or lawful tax avoidance techniques that the IRS dislikes, the absence of skilled, experienced auditors having access to resources such as enhanced technology has undermined the IRS’s efforts to realize incremental tax revenues from the richest Americans. This lack of resources is especially problematic given the sophisticated lawyers, accountants and other advisors available to wealthy taxpayers. 

Increasing the IRS’s enforcement budget is generally viewed as a viable method of raising revenue, with the Congressional Budget Office recently estimating that giving the IRS an additional $20 billion for examinations and collections would generate an incremental $61 billion in revenues over ten years. While some of this additional revenue would result from hiring more agents to conduct audits and criminal investigations, there are other means of realizing additional tax revenues. 

For example, the Treasury Inspector General for Tax Administration (“TIGTA”) recently found that the IRS was only able to collect 39% of the $4 billion in delinquent balances owed by taxpayers with an average adjusted gross income of $1.6 million. Hiring additional revenue officers would assumedly enhance the government’s ability to chase these funds. 

Additionally, former IRS Commissioner Charles Rossotti and others recently unveiled a plan to create a new third-party verification system for business income, similar to W-2 verification for individual wage income. Under the proposed plan, the IRS would implement a “1099New reporting requirement” for high income taxpayers who would be required to list the account numbers of all their financial institution accounts on their tax returns. The financial institutions listed would be required to send the taxpayer and the IRS a “new 1099 summary report” of total deposits received and total withdrawals made for each of the taxpayer’s accounts. The taxpayer would then be required to explain or reconcile any differences between the total amounts on the new 1099 summary report and the amounts listed on the taxpayer’s return. 

Of course, not all shortfalls in tax collection are the result of intentional (criminal) tax evasion or even complex (but lawful) tax avoidance. In her 2020 Report to Congress, the National Taxpayer Advocate (again) described how underfunding the IRS creates significant challenges for honest, well-meaning taxpayers seeking to comply with their tax obligations. The IRS has formulated a massive plan to modernize the agency’s technology and additional resources will enable the agency to implement this plan. According to a study published last November by former IRS Commissioner Charles Rossotti, former Treasury Secretary Laurence Summers and Professor Natasha Sarin of University of Pennsylvania Law School, investing $100 billion in enhanced technology and personnel over the next decade could help the IRS collect up to $1.4 trillion in unpaid tax revenue.

The tax gap is inherently difficult to estimate and may be overstated as a result of the failure to distinguish between intentional noncompliance and reducing one’s tax burden through lawful (albeit aggressive) means. While additional funding should increase revenues, it is far from clear how much incremental revenue will be generated, let alone how quickly the additional cash flow will hit the Treasury. It takes time to train civil (revenue) and criminal (special) agents and will take even more time for the new agents to develop the experience necessary to conduct complex examinations and investigations. While increased funding for the IRS will not immediately yield an avalanche of new audits and criminal investigations, high income taxpayers should anticipate increased scrutiny in the years to come and should take advantage of this hiatus to bring themselves into compliance.

Mary Vitale, an associate at the firm, assisted in the preparation of this blog.

To read more from Jeremy H. Temkin, please visit www.maglaw.com.