Wow! IRS Comm'r Rettig Estimates Annual Tax Gap at $1 Trillion!

Today (April 13, 2021) the Senate Finance Committee held a hearing on The 2021 Filing Season and 21st Century IRS.  The sole witness was IRS Commissioner Charles Rettig. 

There are three takeaways I want to share:

1. The IRS is Overburdened! I encourage you to at least skim Commissioner Rettig's written testimony. He lays out numerous challenges that that IRS has faced for years and even more due to COVID-19 tax law changes. Consider the three rounds of Economic Impact Payments they had to issue while sheltering in place (each round went to about 160 million individuals), new tax forms for employers to get new refundable payroll tax credits, the need to issue guidance quickly because most changes were almost immediately effective, and the American Rescue Plan enacted March 11 included two changes to 2020 forms millions of which had already been filed!

The IRS is overburdened with a declining workforce due to lots of retirements and problems of funding cuts and dealing with decades old technology.  And the reality is that we all need more from them. We need more audits and we need more guidance. 

Congress needs to increase funding for the IRS - this will be significant revenue raiser (more on that in my #3 below).

2. The IRS and Some Lawmakers Want to Regulate Return Preparers - This is not new as the IRS implemented a system in 2010 that was then found beyond statutory authority. President Trump's budgets included the need to regulate return preparers. This topic seems to have bipartisan support. In response to a question from SFC member Senator Cardin, Commissioner Rettig said "we absolutely need the ability to regulate paid tax preparers" particularly those serving underserved taxpayers. He noted that paid preparers tend to make more mistakes with the EITC than occurs on self-prepared returns! He also noted that most preparers are "amazing" but there are some that the IRS needs to after in a more efficient manner that could occur with regulation. I assume he means through testing and annual continuing education in order to be allowed to obtain a PTIN.

3. Commissioner Rettig Estimates that Annual Tax Gap is About $1 Trillion Per Year! IRS data on its tax gap website is based on 2011 and way out of date. It estimates the net annual tax gap at about $381 billion. That is a lot of money (more than we brought in even from the pre-TCJA corporate income tax). When SFC Chairman Senator Wyden asked Comm'r Rettig what his personal opinion was on the actual size of the tax gap, the reply "it would not be outlandish that the annual tax gap could approach or possibly exceed $1 trillion per year".  WOW!!!

I say "wow" (and we all should) because our annual tax revenues collected are about $3.1 trillion. President Biden's American Jobs Plan is estimated to cost $2.7 trillion over 8 years (see Committee for a Responsible Federal Budget estimate). And many question how we'll pay for that plan. Let's collect even half of what is owed as represented by the tax gap and we can also pay down the federal debt! [hear Comm'r Rettig's tax gap estimate at about 43 minutes into the hearing video]

There are many things that can be done to reduce the tax gap. Here are a few of them:

• Hire more revenue agents at the IRS.
• Provide adequate training to those hired (like it was back in the 1980s when I worked there - months of training in the classroom and in the field provided by a well-prepared education office).
• Expand information reporting and lower the filing thresholds. And, make it easy to file these forms using online portals. Also, provide an incentive for non-business payors (such as households) to file these forms.
• Allow voluntary withholding on non-employee compensation and mandate it for non-filers.
• Work with states to include tax education in high school so more people understand their taxes and the obligation to pay them.
• Let's get 21st century technology and practices into the IRS! Too many aspects of the entire compliance process are still using 20th century technologies and thinking. This is something we all need to focus on, not just the IRS. I said this at a 2013 hearing of the Senate Small Business Committee - Filing should be as simple as ordering from Amazon!

What do you think?

Ideas for Retirement Savings Reform

Most people won't look like this in retirement.

On 1/28/16, the Senate Finance Committee held a hearing on - Helping Americans Prepare for Retirement: Increasing Access, Participation and Coverage in Retirement Savings Plans.  This isn't the first time for this topic.  There were a few hearings on this in 2014. I'm not sure if anything is driving the renewed attention to this topic now.  While tax reform is challenging in an election year, this important topic seems good for any year.  There is a need for reform of the tax rules for retirement plans to make them more equitable and simple to help more people save for retirement.

Here are a few suggestions I have for reform in this area.  They focus on equity.  I submitted these to the Senate Finance Committee in April 2015 when they were seeking ideas for tax reform via their working group project.  I'll likely submit them again and add more on simplification. One overall reform I recommend is to change the focus of retirement plans from the employer to the employee, making them truly portable from job to job and if in employee or contractor status or both.

Bring greater equity to retirement savings rules and better enable young people to save for retirement. Possible approaches include:

·         A simple system to enable all workers (employees and self-employed individuals) to have a retirement savings account. This should occur for both part-time and full-time workers and even if an employer does not help with administration or contributions.

·         Retirement savings contributions should be coordinated with payroll tax deductions. A system to enable self-employed individuals to also make contributions along with self-employment tax payments should be considered.

·         Find ways to help individuals improve their financial literacy.

·         Portability. Be sure the system allows for contributions to be made to one account even if a worker changes employers or also has income from self-employment.

Example of a new approach: The first time an individual receives a W-2 or pays self-employment tax (whichever happens first), the government could set aside a set dollar amount in a retirement account for that person. This would constitute the start of their retirement account that would be used for all future contributions; there would be only one account. When the individual works for an employer who also wants to contribute to employee retirement accounts, such funds are placed in the individual's existing account. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, an amount would be contributed to their retirement account. Individuals could be allowed to transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government could be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know their account balance and other details. Rules would continue to exist, but in more simplified form, governing how much could be contributed annually, how much employers could also contribute, the age when distributions may begin, hardship withdrawals, etc.

Benefits of this type of approach:

·         All individuals who work would have a retirement account. This single account would be used whether they are an employee or sole proprietor or both.

·         The initial contribution from the government ensures that all workers start a retirement account.

·         The initial contribution from the government may also encourage individuals to be tax compliant from the start of the time they begin earning money.

·         The system ties to payroll tax withholding and so should not be burdensome to any size employer since they already are required to comply with payroll tax rules.

·         For low-income workers, the annual contribution could be made via part of the earned income tax credit (EITC) the worker receives.

What do you think? What would help all individuals better save for retirement?

Senate Finance Committee's New Approach to Tax Reform

The Senate Finance Committee recently announced that it will be holding weekly meetings to discuss various topics.  There will be "tax policy option papers" posted to their website that list a variety of reforms and their source.  This seems more for discussion purposes because they also note that just because a suggestion is included in an option paper doesn't mean it is endorsed the the Chair or Ranking Member.

The first paper posted is on Simplification for Families and Businesses.  Simplification is a good topic to start with. That is likely the most serious problem with our tax system.  The complexity stems, though, from both the rules themselves and transactions that can be complex (both for families and businesses). The simplification topics also include ones focused on administration of the tax laws. They note the following key problems areas regarding administration:

Some specific concerns about tax administration today include the following:

• Overall complexity
• Identity theft
• Tax gap
• Problems with the filing schedule
• Regulating paid return preparers 

Here are a few interesting reforms (I think) from the list and my commentary:

• Repeal AMT - yeah! This is not only simplification but brings some logic to the system. Why should there by two taxes - your actual one and your perceived minimum one?
• Repeal phase-outs for itemized deductions and personal exemptions - yeah! These phase-outs disguise a higher tax rate and make it difficult for affected individuals to know their marginal tax rate.
• Change due dates to enable taxpayers and IRS to get certain information earlier - yeah! It is difficult to file a return with missing K-1s. Also, former Commissioner Shulman's idea to have the IRS take the information returns and prepopulate returns for taxpayers so they know before they file (rather than a few years later) what 1099s and W-2s they have. Click here to see the AICPA proposal on this.
• If the IRS is not successful in its appeal in the Loving case on the paid return preperer system, provide a statutory solution - yeah!  I think there is value in having Circular 230 cover more than attorneys, CPAs and Enrolled Agents. Attorneys and CPAs are already subject to regulation by their licensing bodies.  Why have a system where about 50% of the preparers are not subject to rules of conduct regarding due diligence, return preparation standards, and more. While the preparers are subject to penalties, why not lay out some rules of conduct for them to help them avoid the penalties.
• Revoke or deny passports for individuals who are seriously delinquent - interesting.  If you want someone to do something, consider a carrot or a stick.  If the stick of penalties isn't working, why not deny them something they want. Of course, not everyone wants a passport.

Here are a few I think should be on the committee's list:

• Simplify depreciation rules.  Today, the rules on depreciation are scattered over at least 4 Code sections (167, 168, 179, 280F) and over 60 pages, not counting regulations. Depreciation should not be this difficult.  It is because of special rules, often designed to address some perceived abuse (such as the mid-quarter convention and the limitation on depreciation of passenger cars).  [I have a paper with some ideas on this topic.]
• Remove special rules where divorced parents can decide which parent claims a child as a dependent. Just leave it as going to the parent who has the child residing them with the majority of the time. If the parents want a different financial result, work it out through child support and alimony. The tax law is not intended to solve problems, but to raise revenue for government operations.
• Repeal the kiddie tax.  This is intended to address the situation where parents or someone else gives income-producing assets to a child who is in a lower tax bracket. Well, if it is a valid transfer of assets, let the child pay based on their rate bracket.  Also, if tax reform does result in broadening the base and lowering tax rates, this is not as significant of an issue.
• Repeal the uniform capitalization rules (Section 263A).  Doing so will enable manufacturers and retailers to use their book method for identifying inventoriable costs and save compliance costs due to not requiring a separate set of inventory records and calculations.

I have a few more, but would like to see what you have.  What would you do to simplify the income tax?