How would additional billions of IRS funding affect taxpayers, audits?

The Inflation Reduction Act covers a lot of ground. The Democratic-backed legislation includes provisions to reduce prescription drug costs for consumers, encourage greater energy efficiency, impose a minimum tax on certain corporations and more.

There’s also $79.6 billion in increased multi-year funding for the Internal Revenue Service, largely to help the agency crack down on tax cheats. And it could rekindle awareness and debate about the tax gap.

What is the tax gap?

The gap is the amount of taxes that are legally due but not collected from the public and businesses, largely due to tax evasion. This shortfall is on top of the country’s huge federal deficits. Closing the gap is a way to increase revenue without increasing tax rates.

It’s hard to say how big the discrepancy is, because the IRS itself hasn’t made an estimate for nearly a decade. The average gap from the latest IRS study, for tax years 2011 through 2013, showed an estimated shortfall of $441 billion per year. That amount fell to $381 billion after taking into account additional tax revenue generated by late payments and IRS enforcement actions, including audits.

In other words, the IRS collects about 84 cents for every tax dollar owed, or 86 cents, including late payments and enforcement actions.

The current dollar gap is likely much higher now due to inflation, a growing economy, the emergence of hard-to-trace cryptocurrencies, and other factors. Some estimates put it closer to $1 trillion per year.

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How important is compliance?

The IRS audits relatively few Americans each year, less than 1%, so it’s important that the public voluntarily pays all or most of what they owe to adequately fund the government.

“Small dips in compliance cost the nation billions of dollars in lost revenue and shift the tax burden from those who don’t pay their taxes to those who pay their fair share on time, every year,” the agency said in a statement. publication on its website.

However, the same IRS post doesn’t seem to view this as a particularly serious problem.

“In general, tax gap estimates dating back decades consistently show that the United States enjoys a relatively high and stable rate of voluntary tax compliance,” the IRS said.

Note: some people probably pay less tax because they don’t understand all the labyrinthine rules, rather than out of a deliberate desire to cheat.

“Non-compliance due to unintentional errors on the part of taxpayers is included in the tax gap but is not considered tax evasion,” Tax Foundation analyst Alex Muresianu wrote in a 2021 report. .

Either way, the US doesn’t appear to be a tax haven like Italy, but instead ranks closer to highly compliant countries like Canada, Switzerland, Luxembourg and New Zealand, according to a study quoted by Muresianu which followed the tax gap. as a percentage of gross domestic product.

How could the IRS use this funding?

Audits and other enforcement efforts would get the lion’s share of new legislation funding, $45.6 billion of the additional $79.6 billion through 2031, but other areas would also see gains.

About $25.3 billion would go to operational support (information technology, security, rent, etc.) and $4.8 billion to upgrades to the IRS’ business systems, which oversee the administration of services to taxpayers, operations, cybersecurity, etc.

There’s also a modest $3.2 billion to shore up the IRS’ deplorable taxpayer services. IRS representatives answered 59% of the phone calls they received in 2019, but that figure fell to 18% this year, the Congressional Research Service noted. Unprocessed tax returns are also a problem.

In other words, funding would increase to 69% for application, 53% for operational support, 153% for modernizing business services, but only 9% for customer service.

Muresianu said that increase may not be enough to help the IRS better interact with the public, especially if audits increase. “Taxpayer services should go hand in hand with law enforcement,” he said in an interview.

Tom Wheelwright, a chartered accountant and financial author at Chandler, said even tax professionals often have to wait hours to contact an IRS representative by phone, compared to minutes in recent years. He would like to see less money for law enforcement and more for customer service and upgrading the IRS’ outdated technology systems.

“Why don’t they fix the customer service issue before they tackle more customers?” He asked.

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Should you care more about audits?

The answers to whether all this means more audits for average taxpayers are down to party lines. Some Republicans predict the increased funding will turn the IRS into an aggressive, audit-heavy agency. Democrats see the increased funding as an opportunity to give the IRS the proper resources to enforce the tax code while improving customer service and bringing the agency’s IT systems into the 21st century.

Enforcement activities would likely target wealthy taxpayers.

“They would really look at large corporations and individuals earning $400,000 or more a year,” said Lisa Featherngill, national director of wealth planning at Comerica Bank. “They would also be looking for undeclared income,” such as those from cryptocurrency trading profits.

Wheelwright warns small business owners to beware. He already describes the IRS as a “bully” in some cases by sometimes denying legitimate business deductions, forcing objecting taxpayers to take their grievances to court. Hiring more auditors could make the agency more aggressive. He suggests that business owners keep all receipts, keep good records, and otherwise “cross out all the t’s and cross out all the i’s.”

But Wheelwright doesn’t think employees who earn salaries subject to tax withholdings and third-party reporting should worry about increased audits if they earn less than $400,000 a year.

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Are there any other costs for taxpayers?

Yet the mere public perception of a more vigilant IRS could have a chilling effect. “More people would follow the rules,” predicted Muresianu.

Featherngill suggests taxpayers may want to think twice about making aggressive use of deductions or other tax-saving opportunities. “For the past few years, the public has known that the IRS lacked resources, especially for audits,” she said.

Wheelwright puts it more bluntly: “Because people weren’t audited, some got lazy,” he said.

Even though most Americans do not face significantly higher audit risk, they could still face higher costs. Taxpayers might choose to pay professional tax preparers more to avoid mistakes, or they might give up legitimate benefits for fear of making a mistake, Muresianu said. Some may feel compelled to spend more time and effort compiling their own statements.

Wheelwright said small business owners, in particular, should make sure they have good help with tax preparation. And they should probably plan to pay more for it at a time when many aging CPAs and other finance professionals are retiring anyway.

Contact the reporter at [email protected]

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