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Tuesday, April 13, 2021

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

IRS Commissioner Charles Rettig

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 IRS data on its tax gap website is based on 2011 and way out of date.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?

Tuesday, March 30, 2021

Temporary tax law changes should be EASY!


We are in tough times! The pandemic is in it's second year and the March 13, 2020 disaster declaration is still in effect. The American Rescue Plan Act of 2021 signed into law on March 11, 2021 is the 5th major piece of COVID-19 relief enacted since mid-March 2020. The tax changes in these laws are numerous and complex in terms of new definitions, special rules, confusing interaction with other rules, and being effective before IRS can get adequate guidance released.

The IRS could not even open the 2021 filing season until February 12 - later than usual. The IRS is still processing paper filed 2019 returns.

Practitioner groups (AICPA letters of 2/23 and 3/4 and 3/24), members of Congress (2/18) and others, asked the IRS to extend the April 15 due date for 2020 returns. After all, the Rescue Plan Act also made changes to 2020 returns including to those already filed (exclusion of up to $10,200 of unemployment compensation and exception to having to pay back any excess advance Premium Tax Credit). The IRS needed to update 2020 return processing to allow for these changes and to let individuals who had already filed and those who had not yet filed, know how to reflect these changes on their 2020 return or amended return. And these 2020 changes are complex! For example, the unemployment one also affects 8 other rules where modified AGI must be measured. This is time consuming for the IRS to create new instructions and reprogram its computers and for tax prep software companies to update their 2020 products.

On March 17 the IRS issued a news release saying that for individuals, the filing and payment deadline for 2020 Forms 1040 would be extended to May 17. This only applies to individuals and does not apply to the first quarter 2021 estimated tax payment due April 15. There were later calls by many for a broader and longer extension.

On March 29, the IRS issued another press release and Notice 2021-21 to clarify what it said on March 17. For example, the May 17 date is also the last day to make a contribution to an IRA or HSA and deduct it on the 2020 return. But, still no extension for entity returns due April 15 or the 1st quarter 2021 estimate due April 15. And no mention of the 1040 extension also extending the due date for gift tax returns even though they are the same as for Form 1040 (it seems the gift tax return date of 4/15 is not extended).

I think a lot of practitioner time was wasted and will continue to be wasted explaining this to clients and letting many clients know that much of the 2020 return needs to be completed to get a good estimate for the first quarter 2021 tax payment still due April 15.

So, wouldn't it have been easier for the IRS to just say: If the due date for a return or payment is April 15, it is extended to May 17, 2021?  Yes!

We need to encourage decisions, particularly those that don't involve a loss of revenue, to be implemented as simply as possible in order to reduce confusion and wasted time for taxpayers and their tax advisers (and not diminish respect for our tax system).

The IRS has authority under IRC Section 7508A to extend all items due April 15 to May 17 (or later).

What do you think?


Sunday, March 14, 2021

Child Tax Credit Change for 2021 Brings Equity and Complexity

The American Rescue Plan Act of 2021 (P.L. 117-2; H.R. 1319; 3/11/21) provides a variety of financial and other relief for COVID-19 problems. Most of the changes are only for 2021.  At least two are for 2020 and mean that the IRS has to update forms and computer systems and get information out to taxpayers quickly including what to do if you already filed your return.  These two changes for 2020:

  1. $10,200 of unemployment compensation receivd in 2020 is non-taxable if the taxpayer's AGI is under $150,000 (if MFJ and both spouses received such comp, each get to exclude up to $10,200). [IRS guidance of 3/12/21]
  2. Not having to repay an advance Premium Tax Credit if the individual's income turns out to be over 400% of the federal poverty line.

Some of the 2021 changes are not solely tied to the pandemic as these changes help low-income families by making the tax system more equitable and have been proposed by President Biden and others. One of these changes is making the $2,000/child tax credit fully refundable and increasing the credit. 

For 2021, the credit is increased to $3,000 and to $3,600 if the child is under age 6. And for 2021, a child age 17 will qualify. 

Why equitable? I suggest at least two reasons:

  1. Very low-income taxpayers could only get up to $1,400 of the $2,000 credit refunded (occurs if their tax liabilty was under $2,000), while taxpayers with up to $400,000 could get the full $2,000 per child under age 17 applied against their tax. Why provide a bigger financial benefit to someone who doesn't need ir rather than to someone who does? 
  2. Relative to tax breaks higher income taxpayers get, the credit is low for lower income taxpayers. For example, someone with a $750,000 mortgage on their home is saving about $7,200 to $11,100 per year in taxes. That is a lot for someone who has the means to qualify for a $750,000 mortgage? Why such large tax breaks for higher income relative to lower income. And these breaks disguise the degree of progressivity in the tax systme. 
But why provide funds to someone when their tax liability has already dropped to zero? Well, financial benefits could instead be provided by a different system. But if tied to income as measured by one's tax return, perhaps the tax system is a better way to go. But, I do think looking at other government agencies such as the Social Security Administration to issue the benefits, including monthly, is something to look at particularly if it removes the complexity of these tax provisions. 

The CTC changes are estimated to raise millions of families out of poverty to help them and the economy. [See CBPP report of 3/2/21]

But what about the complexity? IRC Section 24 on the child tax credit, as modified by ARPA is lengthy with lots of special rules and definitions - it is complex! One reason is that there is a different phaseout formula for the additional CTC compared to that for the $2,000 CTC. And, the ARPA adds a new complex rule at Sectoin 7527A on how the IRS can get 50% of the credit to taxpayers "periodically" ("monthly" was changed to periodically in drafting the ARPA). This is to start by July 1, 2021. It will also require taxpayers to reconcile when they file their 2021 return and pay any excess advance back (although a safe harbor might apply to limit how much as to be paid back). The IRS has to get this system in place even though, unless renewed, it is only for 6 months!

To see the changes to IRC Section 24 and new Section 7527A, please take a look a this track changes document I assembled (it is 13 pages long, including all of section 24).

I don't believe the increased amount, refundability and periodic distribtuion of the credit are intended to be temporary as it ties to President Biden's tax reform proposals and those of others. Also, it should be a big help to millions of families, states and the economy. So, there will be near future discussions on these temporary changes. And even the $2,000 level CTC with its high phaseout are temporary through 2025 under the Tax Cuts and Jobs Act.

What do you think?


Friday, February 19, 2021

Spending in the tax law exceeds discretionary spending!

Figure from Feb 2021 CBO report
Figure from Appendix of CBO Report (Feb 2021)

On February 11, 2021, the Congressional Budget Office (CBO) released: The Budget and Economic Outlook: 2021 to 2031. It is grim as CBO estimates that the federal budget deficit for FY 2021 will be $2.3 trillion. But, that is $900 billion less than for 2020. The 2021 deficit is the second largest since 1945 (WWII) based on the deficit as a percent of GDP.

Something else interesting in the report is an appendix on tax expenditures. Tax expenditures are spending that exists in the tax law. For example, the American Opportunity Tax Credit provides taxpayers with a $2,500 tax credit for each of the first four years of college. While this government spending could have instead been given by a direct grant payable to the university to cover the students tuition, it was put into the tax law as a tax reduction. Whether as a tax credit or a direct grant, the financial effect to the government budget and the student are the same. Per CBO, there are over 200 tax expenditures (special rules) in the Federal income and employment taxes.

But, as a tax expenditure, the spending exists until Congress repeals it where as the Department of Education has to ask annually for funding for Pell Grants which are direct spending to help college students. As a tax expenditure, the spending is often overlooked as most people think government spending only exists in the budgets of government agencies.

For the past few years, discretionary spending and spending buried in the tax law have each been about $1.3 trillion. Now the CBO reports that for FY2021, tax expenditures represent $1.8 trillion of spending (8.2% of GDP) and "exceeds all projected discretionary outlays combined." [see pages 19-20 of the CBO report]

We tend to ask questions about discretionary spending such as why is $x spent on low-income housing or $x spent on something else but not ask why $25 billion is spent on subsidizing the mortgage interest costs of less than 10% of individuals who itemize and claim a mortgage interest deduction on their return (and 63% of this benefit goes to those with income of $200,000 of more [see JCT report, page 42]).

A few observations:

  • Transparency and accountability to taxpayers are violated when we bury spending in the tax law.
  • Most of these tax expenditures are exclusions and deductions which are designed to provide a greater benefit to taxpayers in higher tax brackets. How do they affect the progressivity of the tax system?
  • Special rules lead to violation of the neutrality and simplicity principles. 
  • Tax rates could be lower without the special rules.
  • How about adding a new form that lists the most common tax expenditures such as mortgage interest deduction and exclusion for employer-provided health insurance to help individuals see their tax savings from the special rules they use. That will also help them see the equivalent of "direct government spending" they are the beneficiary of.
What do you think? Should we pay more attention to tax expenditures? How?

Sunday, February 7, 2021

Ideas for States for Pandemic Tax and Budget Policies

picture of yard waste with several eatable oranges in it

My latest Moving Forward? article for Tax Notes State is: Suggestions for Pandemic State Tax Policy Endurance (12/17/20). I include a variety of suggestions to help individuals, businesses and state and local governments. I hope you'll take a look - here.

Examples:

  • Federally-declared disasters such as the COVID-19 pandemic allow the IRS to extend due datesfor tax returns and tax payments. Last year, the result was a July 15 due date rather than April 15. Most states followed suit. But a big deal for states is that their fiscal years end June 30. The shift of payments to the next fiscal year likely resulted in greater borrowing and costs for the states. However, many high income taxpayers were quite capable of paying taxes normally due on April 15 and June 15. The better message (and true for any future disaster) is to include a plea that if you can pay at the normal time, please do so to reduce costs to the state.

  • COVID-19 legislation included lots of new complexities. This, coupled with state and local rules for paid sick and medical leave, new tax credits and grants, etc. is often too much for many small businesses to deal with. A result is that some may have not claimed benefits they were eligible for or mandated to provide. State and local governments should have systems in place to provide help getting through all of the rules including some online tools. They should also seek assistance from the federal government on this as the benefits and mandates come from all levels of government. There are many retired finance and accountng experts who can help provide these services.

  • Some struggling businesses with tax obligations might prefer to give up unused assets than have outstanding bills that pile up interest and penalties or use cash that is needed for other purposes. A system to take non-cash payments such as buildings and equipment no longer needed, should be in place.

  • Despite tough times, consider clawbacks and safety requirements when grants and tax breaks are misused. For example, any tax break to help with the pandemic should have had the caveat that the business had procedures in place to reduce the spread of the virus. For example, a 1/18/21 Washington Post article reports that at least 5 anti-vaccine groups received PPP funds.

  • While many struggle in the pandemic, some individuals and businesses were doing fine or perhaps even with increased revenues. There is a need for ways to easily enable those doing well do help get supplies and other assets to those in need.  Platforms where people can match resources and needs can help, with governments providing some of the pick up and distribution outlets to help ensure safety of such a system.  My picture above of the oranges in the yard waste garbage is a good example of waste. There were many people who would have been thankful to have had these oranges someone with too many treated as garbage and likely did not have a good way to get them to someone who needed them.
There are more suggestions and perhaps the article will lead you to identify more relief ideas for now and going forward.

What do you think?