The battle outside ragin’
Will soon shake your windows
And rattle your walls
For the times they are a-changin’
A change in presidential administrations brings with it the uncertainty of what the political, legal and tax landscape will look like in the future. Statements from the Commissioner of the Internal Revenue Service and the President of the United States are starting to provide clarity of what things will look like going forward. Here’s what we know and what you, as a taxpayer, should be thinking about as you adjust your financial planning.
Government Spending is at Record Levels
The national debt is now more than $28 trillion dollars. The global pandemic and three rounds of stimulus money have costs. Those costs are only getting bigger as President Biden signaled an aggressive spending plan on education, renewable energy incentives and tax cuts for lower income families. The cost of the previous and proposed spending must be justified and an explanation provided for how to pay for the additional benefits. President Biden offers up a tax reform plan that will end lower tax rates for capital gains and dividends and unabashedly targets “the highest income Americans” to raise $1.5 trillion dollars in the next 10 years. Enforcement provisions require further reporting by financial institutions of the flow of money and increased funding for the IRS to go after “large corporations, businesses, estates and higher-income individuals (i.e. more than $400,000 per year). Tax rates are set to increase as well with the top rate going to 39.6 percent which would be the new rate for capital gain income as well. Investment income is further targeted by ending the carried interest rules and ending the like-kind exchange rules for real estate investments more than $500,000. In short, a lot of traditional tax benefits could disappear if key elements of the plan are implemented in an effort to raise enough money to pay for other priorities.
The Tax Gap is Big and Getting Bigger
The tax gap is the difference between what the IRS knows, or thinks, is owed and what is actually paid. The number is made up of non-filing of tax returns, underreporting and underpayment of taxes owed. The IRS does a study of the tax gap periodically and the last study was reported in 2019 for the 2011 through 2013 tax years. The 2019 study indicates that the tax gap was $441 billion. However, IRS Commissioner Chuck Rettig believes it is much bigger and estimates that it either is, or will be, approximately $1 trillion without further changes to compliance and enforcement. The argument is that the numbers do not reflect significant items that would create a much bigger tax gap if measured today. Commissioner Rettig provides two significant changes causing the larger gap – cryptocurrency and foreign bank accounts. The first official guidance issued by the IRS on cryptocurrency didn’t occur until 2014 and a steady stream of enforcement efforts has occurred since. The IRS implemented an Offshore Voluntary Disclosure Program in 2009 and while it arguably peaked during the tax gap study (sometime in 2011) there were numerous other filings that occurred until the program ended in 2018. Whether or not these and other more recent information moves the $441 billion number to $1 trillion is arguable. What isn’t arguable is that there is a significant tax gap that the IRS believes would be remedied, at least partially, by increased enforcement. Which is why the IRS is asking for funding to increase enforcement efforts. President Biden has also called for increased funding for IRS enforcement. However, President Biden wants to ensure that those funds will be used to target the wealthiest taxpayers and businesses and flow through entities he believes aren’t paying their fair share of taxes owed.
The IRS Will Look Closer and Demand More Reporting
The Commissioner states that 60 percent of the tax gap comes from underreporting of income, including business income, on individual returns. The primary culprit, according to the Commissioner, is underreporting of income from sole proprietors, farmers and those earning rental, royalty, partnership, and S Corp. income. Therefore, you can expect that additional enforcement dollars will be spent auditing those businesses and making adjustments to account for that underreporting. Another target for IRS enforcement are high-wealth taxpayers. The Commissioner, and President Biden, both point to a study indicating that the top 1 percent of income earners hide “more than 20 percent of their income from the IRS.” The IRS believes it can collect another $175 billion annually if further enforcement funding is provided. The suggested enforcement plan would involve greater scrutiny of pass-through businesses, more comprehensive audits, more litigation of tax disputes, more whistleblower programs and regulations identifying noncompliant behavior. In short, the IRS plans to question more items on individual and business returns, and to compromise less and use the courts more.
Battle Lines are Drawn, the IRS Just Needs Funding
The Commissioner indicated that they are already taking measures to increase IRS staffing if Congress approves necessary funding. If the IRS receives the requested $1 billion, it would mean approximately 4,875 “front-line enforcement staff” as well as the supporting managers, appeals officers, tax payer advocate staffing, IRS attorneys and operations support. Even with this investment, the Commissioner indicates that it is just “the beginning” of efforts to replace the 17,000 enforcement employees lost over the last decade. These employees would be use for a variety of examination enhancements, specific initiatives (e.g. Global High Wealth, Fraud Enforcement, Promoter Investigations), collection enhancements and increased criminal investigations.
For now, all of these statements are just proposals and it will be some time before anything becomes a reality. However, what is clear is that things are changing and the President and the IRS are on the same page regarding the need for more tax enforcement. Some form of these changes will, eventually, be implemented and taxpayers would be wise to seek financial and tax planning advice now to prepare for potential changes. Previous and future planning appears to have a greater likelihood of being scrutinized by the IRS and it’s time to make sure you’ve assessed your risk and made any appropriate changes.