The Department of the Treasury estimates the annual federal “tax gap” (the difference between what taxpayers should have paid and what they actually paid on a timely basis) exceeds $450 billion. IR-2012-4 (January 6, 2012). This figure correlates with a voluntary tax compliance rate of just shy of 86 percent.
Studies conducted by the National Research Program (“NRP”) conclude that the $450 billion “tax gap” is comprised of three components, namely non-filing of tax returns ($28 billion), underreporting of income ($376 billion) and underpayment of taxes ($46 billion).
On September 26, 2006, the Treasury’s Office of Tax Policy published a document titled “A Comprehensive Strategy for Reducing the Tax Gap.” Subsequent updates on “Reducing the Tax Gap” have been published. In these documents, Treasury emphasized its renewed commitment to dramatically reduce the tax gap.
Four key principles are set forth in these documents to guide IRS efforts to improve compliance:
- Address both unintentional taxpayer errors and intentional taxpayer evasion;
- Target sources of noncompliance with specificity;
- Combine enforcement activities with commitment to taxpayer service; and
- Policy positions and compliance proposals should be sensitive to taxpayer rights and maintain an appropriate balance between enforcement activity and imposition of a burden on the taxpayer.
To accomplish its goals, these documents set forth several strategies, including:
- Continuing research to unveil common areas of noncompliance;
- Continuing improvements in information technology to enhance detection of noncompliance;
- Continuing expansion of examination and collection efforts;
- Continuing enhancement of taxpayer service to reduce unintentional errors;
- Continuing to seek tax law simplification to reduce unintentional errors, reduce opportunities for evasion, and simplify the Service’s job of administering tax laws; and
- Coordinating efforts with local and foreign governments to enhance compliance and collection activities.
In 2006, IRS Commissioner Mark W. Everson stated, in support of the Service’s increased compliance activity, that “[t]he magnitude of the tax gap highlights the critical role of enforcement in keeping our system of tax administration healthy.” IR-2006-28 (February 14, 2006). Given the size of the tax gap and the fact that federal budget deficits are in the hundreds of billions of dollars, tax compliance should be a renewed priority of the IRS. While we saw a few years ago the IRS begin to increase its audit staff and start auditing taxpayers in greater numbers and more aggressively than in the past years, severe budget cuts have recently derailed this momentum. That said, given that the IRS is virtually the only federal agency that generates revenue, logic suggests lawmakers should work hard to restore the Service’s budget.
On February 4, 2016, Senator Ron Wyden (D-OR), ranking member of the U.S. Senate Finance Committee, alerted IRS Commissioner John Koskinen (by letter) that $67 billion of the tax gap each year is attributable to corporations. He advises the Commissioner that a proper analysis of the causes of the tax gap is necessary in order for lawmakers to be able to create effective tools to eradicate it. Senator Wyden, in a direct and strong manner, alerts the Commissioner to some interesting things, including:
- The IRS tracks the portion of the tax gap attributable to corporations based on audit results, but it has no mechanism to track the specific sources of the corporate tax gap; and
- Without knowing the sources of the tax gap attributable to corporations, lawmakers cannot effectively design policies to reduce this portion of the tax gap.
Senator Wyden requested the Commissioner to provide him with certain information before the U.S. Senate Finance Committee’s February 10, 2016, hearing on the IRS budget and a more full response within 60 days. He specifically requested:
- A specific explanation of the methodology used to estimate the corporate portion of the tax gap;
- Whether the IRS maintains a centralized repository of corporate audit issues;
- A list of top corporate audit issues and each issue’s contribution to the corporate portion of the tax gap;
- A copy of all data and work papers used by the IRS to compute the corporate portion of the tax gap; and
- Any steps the IRS has taken to improve compliance as outlined in the 2006 Treasury Office of Tax Policy study (referenced above).
What is interesting is that Senator Wyden’s robust letter to Commissioner Koskinen was delivered just days before the U.S. Senate Finance Committee held its hearing on the IRS budget. The timing seems to indicate that lawmakers mean business – they want the tax gap addressed. That said, without a sufficient budget, the IRS likely does not have the resources to tackle this major problem.
Of interesting note, the annual tax gap has increased by approximately $150 billion since 2001. Yet, the IRS has had its budget slashed by over $1 billion in the last five (5) years.
According to Commissioner Koskinen, the funding of the IRS this fiscal year ending September 30 is back to the 2008 funding level. He recently suggested the results will be felt by taxpayers and tax advisors, including:
- At least 46,000 fewer business and individual audits will conclude this fiscal year;
- Taxpayers will encounter about a thirty (30) minute wait when calling a service center to reach an IRS representative;
- 3,000 to 4,000 IRS employees will lose their jobs, and there is the possibility that employee furlough days will be implemented this fiscal year, reducing the ability of the IRS to provide taxpayer service;
- Approximately 280,000 fewer collections will be made this fiscal year;
- IT systems will not be replaced or updated this fiscal year as scheduled; and
- Implementation of taxpayer identification theft protections will have to be delayed until a future fiscal year.
Commissioner Koskinen predicts these most recent IRS budget cuts will ultimately result in a loss of $2 billion or more in tax revenue that would have otherwise been collected this fiscal year. Lawmakers need to work with the IRS to help eradicate this major problem. Without an adequate budget, however, the IRS will make little, if any, progress. Hopefully, lawmakers will properly fund the IRS. Time will tell.
As reported in previous blog posts (January 17, 2014, January 21, 2014, and January 20, 2015), federal budget setbacks continue to severely impact the Internal Revenue Service (“IRS”) and its ability to carry out its lofty mission:
“[T]o provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.”
Senator Ron Wyden (D-OR), Ranking Member of the United States Senate Committee on Finance, understands the critical role the IRS plays in maintaining our tax system. In a letter to IRS Commissioner John Koskinen, dated September 2, 2015, Senator Wyden professionally, but directly, questions the agency’s reallocation of IRS limited resources away from information technology (“IT”), enforcement and collection.
As reported in my January 20, 2015 blog post, IRS Commissioner Koskinen pronounced that, as a result of the budget cuts facing the IRS, in addition to several other expense cutting measures, (i) the IRS would not update and/or replace IT systems as previously scheduled; and (ii) the IRS would implement staff reductions and furloughs, resulting in 280,000 fewer collection matters being pursued and 46,000 fewer audits being conducted this fiscal year.
In his letter, Senator Wyden points out some interesting facts that call into question Commissioner Koskinen’s expense cutting decisions. Foremost, Senator Wyden raises the fact that about $5.10 of taxes owed are collected for every dollar spent on enforcement efforts. Consequently, it is troubling that the Service is curtailing collection efforts, the very function that creates revenue. Isn’t there a better place to reduce expenses within the agency?
Senator Wyden predicts that as a result of Commissioner Koskinen’s expense cuts, in addition to reduced tax collections, the number of tax cheats will rise. This is especially true if the IRS does not use its available resources to improve IT systems.
It is difficult to disagree with Senator Wyden’s predictions or his criticism of the cost cutting measures being implemented within the IRS. In fact, Senator Wyden concludes the combination of reduced enforcement activity and funding cuts for IT systems is a “dangerous cycle” that will likely lead to increased tax fraud in this country. He states:
“Shouldn’t the American public view diminished enforcement and reduced IT spending for what they really are: tax cuts for tax cheats and kickbacks to crime syndicates?”
The facts are the facts. The budget cuts facing the IRS are significant. Commissioner Koskinen is presented with a very difficult dilemma. One thing is clear – cutting the funding for collection, enforcement, and IT systems will not serve our tax system well. That said, where should the cuts be made?
Budget cuts that negatively impact taxpayer service will also likely result in a reduction in tax collections. With the Code as complex as it is, taxpayer service is paramount to maintaining tax revenues. The Service plays an important role in providing guidance to taxpayers about their tax obligations. Numerous empirical studies reveal good taxpayer service improves taxpayer voluntary compliance, leading to increased collections. Consequently, there may be no good place for Commissioner Koskinen to cut the agency’s expenses going forward without negatively impacting collections and compliance.
Maybe the best answer for our country is to have lawmakers rethink which government agencies should take the brunt of expense reductions. Logic would tell us that the IRS, the very agency that collects revenues, should probably be last on the list.
Senator Wyden asked Commissioner Koskinen to respond to his letter by October 2, 2015. I suspect the response will be an interesting read. Stay tuned!
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Developments in the World of IRC Section 1031 Exchanges Including the TCJA," Oregon Society of Certified Public Accountants (OSCPA) Forest Products ConferenceEugene, OR, 6.22.18
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18-7.27.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18