On May 20, 2021, the U.S. Department of the Treasury released The American Families Plan Tax Compliance Agenda, describing two key tax compliance proposals from the Biden administration. These tax compliance proposals are intended to close the "tax gap" and provide critical funding for the recently proposed American Families Plan (discussed by us here). These tax compliance proposals are in addition to the tax law changes proposed in the American Jobs Plan announced by President Biden on March 31, 2021 (discussed by us here).
The "tax gap"-the difference between taxes owed to the government and actually paid-is estimated to be about $7 trillion over the next decade (roughly 15% of taxes owed), according to Treasury analysis. The tax compliance proposals are intended to significantly shrink this tax gap, raising $700 billion in revenue over the next decade and $1.6 trillion in the second decade.
The tax compliance proposals raise a number of issues for taxpayers to consider and plan for in anticipation of future IRS audits.
Restoring IRS Resources
As the Biden administration has previously indicated, the first key tax compliance proposal calls for nearly $80 billion in additional resources to the Internal Revenue Service (IRS) over the next decade. These resources will fund IRS priorities, including hiring, training, and technology improvements.
With these resources, the IRS intends to revitalize its examination of "large corporations, partnerships, and global high-wealth and high-income individuals," according to the Treasury. The IRS also intends to overhaul its outdated information-technology system, which dates back to the 1960s.
Baker Botts Note: We expect the IRS to materially increase its audit rate of large corporations, partnerships, and high net-worth individuals. The IRS will likely target these taxpayers through IRS campaigns and a new approach to auditing partnerships. Many taxpayers will be audited for the first time, or for the first time in many years, and are well-advised to prepare in advance for such audits. Familiarity with the audit process, including information document request (IDR) timelines and privilege issues, will be of critical importance as these audits unfold. Taxpayers should set their strategic approach to audits at the beginning for the best outcomes.
Increased Information Reporting
The second key tax compliance proposal calls for expanded information reporting by financial institutions on "account flows." Financial institutions would be required to report gross inflows and outflows on all business and personal accounts, including bank, loan, and investment accounts. Such reporting requirements would go well beyond existing reporting requirements that target specific types of income, such as interest and dividends.
This increased information reporting is intended to improve the tax compliance of passthrough entities, like partnerships, S corporations, and proprietorships. The Treasury estimates that, while roughly 99% of taxes due on wages are paid to the IRS, compliance on less visible sources of income is estimated to be just 45%.
In addition, the Treasury is aware of the challenges of tracking cash and virtual currency, which can easily escape existing third-party reporting. Under the proposed reporting regime, new Form 1099 reports would also be required from payment services providers to prevent taxpayers from obscuring their incomes by shifting out of traditional financial institutions to other kinds of platforms. Similarly, businesses that receive cryptoassets with a fair market value of more than $10,000 would be required to report such transactions to the IRS, which aligns with existing reporting obligations on Form 8300 for cash transactions.
Baker Botts Note: While the Treasury notes "practical barriers" that keep taxpayers from switching to cash-such as "security risks and the difficulty of spending large amounts of cash for certain transactions"-these barriers are less obvious with respect to cryptocurrency, which can be more secure than cash and easier to spend in large quantities. As a result, the proposed reporting regime may encourage greater use of cryptocurrency.
>Baker Botts Note: While increased information reporting should theoretically help the IRS better target non-compliant wealthy taxpayers without harming compliant taxpayers, new sophisticated technology, such as machine learning, would be needed to make use of the massive amounts of data created by the type of reporting being proposed. The IRS has had difficulty in the past updating its information-technology systems, suggesting the IRS may struggle with implementation of these technologies.
Baker Botts Note: Businesses and individuals with atypical cash flows may trigger additional IRS scrutiny, and commonplace business customs could trigger audits and challenges. For instance, if a lower-tier entity distributes funds to an upper-tier entity without passing the funds through one or more mid-tier entities, there may be matching issues caused by differences in K-1s and third-party financial reporting. Similarly, commonly controlled businesses with shared bank accounts that are in the name of a single entity may trigger new challenges by the IRS. Taxpayers should scrutinize their business practices to ensure formalities are being followed and they are in the best position possible in a future IRS examination.
Other Compliance Proposals
The Tax Compliance Agenda also describes other tax compliance proposals, including regulating paid tax preparers, improving taxpayer information accuracy, and imposing liability on shareholders for unpaid corporate taxes in specified tax shelter cases.
We will continue to monitor developments and will provide further updates as more details are released. In the meantime, Baker Botts would be pleased to assist you in your analysis of these proposals.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.