What Increasing IRS Enforcement Hiring Means for Tax Season
In FY2011, the Internal Revenue Service (IRS) spent $5.5 billion in enforcement-related activities. Since FY2011, this has declined in every year through FY2019, when the IRS spent $4.6 billion on such activities. In FY2020, the IRS budget for enforcement activities began to rise and was $4.8 billion. Because of the pandemic, this increase was not very visible to the public.
To close the real or imagined “tax gap,” the Build Back Better Act (H.R. 5376) as passed by the U.S. House of Representatives included about $45 billion (over 10 years) to be allocated specifically to increased tax enforcement activities by the Internal Revenue Service (IRS). The Biden administration estimated that the additional funding could raise at least $140 billion in new tax revenue. This estimate included money directly raised by enhanced tax audits as well as from additional reporting requirements. As was widely reported, there was considerable debate over whether this predicted revenue was achievable, how big the “tax gap” (difference between taxes owed and taxes collected) actually is, how increasing IRS budget would help close it, and whether the IRS can be trusted to use these vastly increased funds (about double its current budget) fairly.
Now that Build Back Better is, at best, on life support, many taxpayers (and practitioners) may be lulled into a false sense of security about the direction of IRS enforcement activities. Even without Build Back Better, and perhaps not obvious yet given the pandemic related challenges the IRS has experienced, IRS enforcement has and will continue to increase. The IRS Data Book for 2021 has not been released yet but the IRS enforcement budget should rise by about $200 million in FY2021 and by at least that much in FY2022 based on the Administration’s budget proposal.
To illustrate this, in 2020 IRS had 8,346 Revenue Agents (down from 13,879 in 2010). In March 2021, the IRS posted a job announcement to hire 1,084 Revenue Agents in the Small Business/ Self-Employed (SB/SE) division, which audits small businesses (with assets less than $10 million) and self-employed taxpayers. Significant hiring is also expected by the IRS’s Large Business & International (LB&I) division. LB&I audits corporations, subchapter S corporations and partnerships with assets greater than $10 million.
Further, on January 21, 2022, the IRS Office of Chief Counsel announced plans to hire up to 200 additional attorneys to help the agency combat syndicated conservation easements, abusive micro-captive insurance arrangements and other tax schemes. These attorneys will work in a variety of areas, including serving on trial teams and working in the IRS National Office to develop regulatory solutions to real or perceived abusive schemes.
Any tax controversy starts with the examination of the taxpayer’s tax return. With respect to high-profile, atypical, or significant items on a return, tax preparer and client should analyze (and document) the relevant law and operative facts appropriately. It is more efficient and less distracting to do contemporaneously rather than retrospectively when an audit has begun.
When evaluating a planning strategy where a tax “introducer” or promoter involved, be hyper-vigilant. The suitability of these types of tax positions are going to be extremely dependent on taxpayer’s actual, granular facts, not the broad-brushed facts that may be presented by a promoter. The new IRS Office of Promoter Investigations (“OPI”), which was established in April 2021, will be increasingly using data analytics and other techniques to identify abusive tax planning transactions.
Depending on one’s perspective, a beefed-up IRS enforcement budget could be cumbersome (e.g., more audits, dealing with inexperienced auditors) or broadly beneficial (if it promotes tax fairness and speeds the IRS up).
Practitioners should make sure that the workpapers are complete and thorough based on the nature of the item. Taxpayers should make sure they understand how large items on a tax return are being reported (or not reported).
Determining what is “right” under applicable tax law often requires significant review and balancing of competing legal and factual factors. In determining whether to take an “aggressive” (but justified) position on a tax return, careful consideration should be given to the tax benefit versus the cost (and stress) of an audit as well as the penalties and interest if the taxpayer’s position is not sustained.
Where appropriate, taxpayers should get a second opinion on “novel” positions on their tax returns in order to be fully informed about how a significant tax return item should be reported. Obviously, in situations involving a promoter, this independent review should tax place well before a tax saving transaction is undertaken.