For the business owner and tax practitioner, the most important part of the Inflation Reduction Act of 2022 was not the tax credit for flashy new electric cars. It was something much more basic: a long-term budget commitment to help the struggling, failing IRS.
The Inflation Reduction Act invests an additional $80 billion in the IRS over the next 10 years. This is the biggest budget increase the IRS has ever received. To put this into perspective, it is nearly six times the IRS’s annual $13.8 billion budget. Some politicians have drawn the picture of 87,000 new gun-toting revenue agents scouring the land, looking for tax evaders. This is, without a doubt, ridiculous. That being said, the new funding will impact all taxpayers. The average taxpayer should benefit because the IRS will be able to upgrade its operations and improve its less than desirable customer service. On the other hand, the well-above-average taxpayer should look out: the bulked-up IRS will be gunning for you.
How Will the IRS Use the Additional Money? The new IRS funding will be appropriated as follows:
• $3,181,500,000 for taxpayer services
• $45,637,400,000 for enforcement
• $25,326,400,000 for operations support
• $4,750,700,000 for business systems modernization
The appropriated funds will remain available until September 30, 2031. This is a mandatory appropriation. This means that Congress can’t reduce the appropriation without passing a new law. There are no limits on how much the IRS can spend in any given year. The Biden administration plans to have the IRS phase in the new spending by implementing no more than $1.5 billion the first year and gradually building up to $15 billion in 10 years time. The IRS is going to issue a detailed spending plan within six months. Note that $35 billion of the new money is NOT for enforcement. Among other things, the IRS plans to use these funds to update its antiquated IT systems (some of which date back to the 1960s), improve phone service, and speed up the processing of paper tax returns. Taxpayers should see improvements in IRS services relatively soon. Over the next six months the IRS plans to hire 5,000 additional phone representatives, fully staff every IRS Tax Assistance Center, and improve the processing of paper returns by implementing scanning technology.
How Much Will the IRS Grow? The IRS budget fell by 18.5 percent over the past decade, leading to a 20 percent decline in the agency’s workforce. As of 2021, the IRS had only 78,661 employees. By comparison, it had 90,290 employees in 2012 and 116,673 in 1992. Staff losses have been most significant for revenue officers, who collect taxes (a 50 percent decline to 8,200), and revenue agents, who audit complex returns (a 35 percent decline). Today, the IRS has fewer auditors than at any time since World War II. The IRS will be adding new employees, but not anywhere close to the 87,000 number touted by the media. Much of the new hiring will just offset the decline in agents. The IRS has an aged workforce and expects a whopping 35,000 employees to retire in the next six years, along with another 17,000 who’ll leave before retirement. That’s 52,000 employees who’ll need to be replaced! Thus, the IRS needs to hire 8,600 new employees per year just to stay even over the next six years. If all goes well, at the end of 10 years the IRS may grow by 20,000 to 30,000 employees, but it will still be smaller than it was in 1992. Yet, the number of revenue agents could increase to 17,000 by 2031—over twice as many as today.
Will Audits Increase? In a word: yes. Treasury Secretary Yellen has promised that IRS audit rates will remain at “historical levels” for taxpayers earning less than $400,000 per year. “Historical levels” is an ambiguous term. Does it encompass the audit levels of the past decade or so? In 2010, audit rates were at 1 percent compared with the current historic lows of about 0.25 percent. Thus, audits for those earning less than $400,000 could increase fourfold, but this from a very low level. In any event, audit rates will definitely rise for taxpayers earning more than $400,000 per year. This may take some time. The investment in the IRS is expected to raise some $124 billion over the next 10 years.
Here are a few special areas of concern:
- Cryptocurrency. You can expect increased IRS audits dealing with cryptocurrency transactions. If you’re one of the millions of Americans who engage in such transactions, make sure you keep good records and report any income you earn.
- S Corporations. If you’re an S corporation shareholder-employee, you should have your S corporation pay you an arguably reasonable salary and benefits, and document how you arrived at the amount.
- Offshore Accounts. You’re supposed to report these to the U.S. Treasury. Failure to do so subjects you to substantial penalties. In recent years, the IRS has gone after banks and bank account holders who hide assets in offshore accounts. In future years, we can expect the IRS to place even greater emphasis on identifying and tracking such offshore assets.
- Partnerships. Partnerships and multi-member LLCs taxed as partnerships (this describes most of them) are already the subject of the Large Partnership Compliance program, which uses data analytics to select large partnership returns for audit. The IRS will likely devote more resources to this program in the future.
If you have any questions about this infusion of money into the IRS, please call our office at 951-633-1040.
Nicole Albrecht, EA