Tax Gap Projections and Increased IRS Enforcement

Transcript of Podcast Episode 261

Hello this is Bill Rainaldi, with another edition of Security Mutual’s SML Planning Minute. In today’s episode: Tax Gap Projections and Increased IRS Enforcement.

On October 12, 2023, the IRS released new gross tax gap projections for the tax years 2021 and 2022.[1] The projections showed a tax gap of approximately $688 billion in tax year 2021. IRS enforcement action and late payments are estimated to yield $63 billion, bringing the tax gap down to $625 billion. Nevertheless, that’s a significant increase from prior year tax gaps which were less than $200 billion. Well, what does that mean? The tax gap is the difference between estimated ‘true’ tax liability for a given period and the amount of tax that is paid on time. It is an aggregation of results from the non-filing of taxes, underreporting of taxes and underpayment of taxes.

What that really means to all of us is that the IRS is expected to increase tax enforcement and take a variety of steps to help improve voluntary compliance. Improving taxpayer services and offering new technology tools should help with voluntary compliance. The IRS estimates that even a 1% increase in voluntary compliance will yield approximately $46 billion in taxes. Studies have also shown that third party reporting of income (i.e., 1099s and W-2s), as well as withholding taxes on income, greatly increases voluntary compliance.

So, how will the IRS increase tax enforcement? In 2022, the Inflation Reduction Act was passed into law.  One of the key provisions of that law was to provide additional funding to the IRS to the tune of nearly $80 billion over 10 years. The majority of that funding was earmarked for enforcement activities which includes collection of taxes, litigation, investigations, digital asset monitoring and the enforcement of various laws. The next biggest tranche of funding was for operations support which includes administration activities, research, telecommunications, information technology development, and more. A smaller amount of funding was designated for business system modernization.  As that phrase implies, that includes modernizing the systems used by the IRS. Finally, the remainder of the increased funding will go towards taxpayer services. These include programs for pre-filing assistance and education, filing and account services, and other services.

In a previous announcement issued on September 20, 2023,[2] the IRS noted that there are now more than 3,700 new positions to be filled. These positions will help with enforcement activities focusing in on corporations, high-net-worth and high-income individuals, and complex partnerships. In that announcement, the IRS stated that they are “honing-in on areas where we believe non-compliance among our wealthiest filers has proliferated over the last decade of IRS budget cuts, and pass-throughs are high on our list of concerns. This new unit will leverage Inflation Reduction Act funding to disrupt efforts by certain large partnerships to use pass-throughs to intentionally shield income to avoid paying the taxes they owe. These efforts are consistent with our broader commitment to use Inflation Reduction Act dollars to end the era of historically low error rates for wealthy and large entities, while making sure middle- and low-income filers continue to see no change in audit rates for years to come.”

For our high income, high net worth, and business owner clients, you have been put on notice that there may be increased tax enforcement action.  As a result, you should consult with your own tax and legal advisors to review your own unique situation.

[1] IR-2023-187, Oct. 12, 2023

[2] IR-2023-176, Sept. 20, 2023

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