President Biden has proposed significant tax compliance measures as an alternative way to fund his ambitious American Families Plan. Recently, he offered Republicans compliance measures as an alternative to individual tax increases, but Republicans still consider new compliance measures a type of tax increase. Still, the Treasury Department is pressing ahead, releasing detailed information on Biden’s compliance agenda, with the most far-reaching proposal being the requirement that banks report to the IRS taxpayer’s deposits and withdrawals like wage reporting. Treasury estimates the entire plan would raise $700 billion over 10 years. Below is a description of the proposals.
IRS Resources: Provide the IRS with $80 billion in additional resources to address sophisticated tax evasion. The agency would then be in a position to make investments with large, fixed costs—like modernizing information technology, improving data analytic approaches, and hiring and training agents dedicated to complex enforcement activities. Treasury wants to focus on examinations of high-income and global high-net-worth individuals and complex structures, like partnerships, multi-tier pass-through entities, and multinational corporations. The report notes that audit rates for individuals with over $1 million in annual income have fallen over 60% from 2010 to 2018.
Bank Account Reporting: Impose new third-party reporting by requiring financial institutions to report total bank account outflows and inflows on Form 1099-INT, the form taxpayers already receive from financial institutions when they earn more than $10 in interest from a bank, brokerage, or other financial institution. Bank reporting would become effective for the tax year 2023. Specifically, the annual return would report gross inflows and outflows on all business and personal accounts from financial institutions, including bank, loan, and investment accounts but carve out exceptions for accounts below a de minimis gross flow threshold. The report states that the minimum threshold will be determined by the IRS later. Treasury estimates that this reporting will close the tax gap in reporting Schedule C proprietorship income, Schedule E rent and pass-through income, and small corporation income as well as the portion of the employment tax gap associated with business incomes.
Other accounts would be covered as well, for example, payment settlement entities would be required to report gross receipts and gross purchases, an expansion from the current law reporting of credit card transactions above a certain level. The reporting regime also would cover foreign financial institutions and crypto-asset exchanges and custodians. Treasury notes that virtual currencies have grown to $2 trillion in market capitalization and pose a significant detection problem by facilitating illegal activity including tax evasion.
Technology Funding for IRS: Overhaul outdated technology to help the IRS identify tax evasion. The IRS still relies on Individual and Business File Systems that date back to the 1960s—the oldest in the federal government. Modernization funding would allow the IRS to develop machine learning to better identify suspect tax filings by comparing returns to similarly situated taxpayers and historical filings. Modernized IT would also improve taxpayer service, Treasury explains.
Regulating Paid Tax Preparers: Several years ago, the IRS issued regulations making unlicensed tax preparers subject to practice rules, in the same way, enrolled agents, CPAs, and attorneys are. The IRS set up the credential of “registered tax return preparers” and required anyone preparing a tax return for compensation to register with the IRS, pass an exam, get a background check, and take continuing education courses. However, the regulations were struck down in the courts as not authorized by statute. The Administration’s proposal asks Congress to authorize the IRS to regulate all paid tax preparers. It also would increase penalties for those who commit or abet evasion and impose additional sanctions for so-called “ghost preparers” who fail to identify themselves on the tax returns that they prepare.
Plan Addresses Tax Gap
These tax compliance initiatives are designed to close the “tax gap”—the difference between taxes owed to the government and the taxes paid. According to a Treasury analysis, the tax gap totaled nearly $600 billion in 2019 and will rise to about $7 trillion over the next decade if left unaddressed—roughly equal to 15% of taxes owed. Treasury also contends that the tax gap is asymmetrical in that 99% of the taxes due on wages are reported while noncompliance is concentrated at the top of income distribution involving nonwage income. A recent study found that the top 1 percent failed to report 20% of their income and failed to pay nearly $175 billion in taxes owed annually.
What it Means for You
The most burdensome proposal is bank account reporting. It would require a huge amount of information going to the IRS and it is unclear exactly what the IRS would do with it. As Steven M. Rosenthal of the Tax Policy Center explains, the proposal could “…bury the agency in a sea of unproductive information.” He gives the example of a bank that reports an account with a total of $1 million in deposits, $800,000 in withdrawals, and $5,000 in interest. “The IRS, in theory, could use this information to help construct a financial profile for the account holder, which the IRS would compare to the tax returns filed by the holder. In practice, the IRS’ task would be daunting…”
The IRS having access to a taxpayer’s aggregate bank deposits and withdrawals would give it a picture of self-employed income and business receipts that now are almost impossible for the agency to track. As a result, the new reports could lead to a significant increase in audits and tax adjustments, even when deposits and withdrawals do not represent unreported income.
In testimony before a Senate Finance subcommittee, the American Bankers Association argued against the new reporting regime, stating, “…recent proposals to create new reporting requirements for financial institutions would impose cost and complexity that are not justified by the potential, and highly uncertain, benefits. Furthermore, we believe additional reporting requirements guided by subjective criteria have privacy and fairness implications and the potential to put financial institutions in an untenable position with their account holders.”
The political outlook for the legislation is mixed. Republican Senate negotiators have floated an infrastructure proposal that would not include any tax increases or compliance measures. Biden and the Republicans are far apart on funding issues for all of Biden’s initiatives. Still, compliance programs are more palatable to both parties than outright tax increases, so some elements of the Biden compliance agenda have a fair chance of passage, especially if he can garner full Democratic support. The bank account reporting requirement is something to watch.