Over the past few years, if you had tax problems with the IRS, it took an extremely long time before you got a resolution. Currently, 17 million taxpayers are waiting for refunds. There is a backlog of 21 million unprocessed tax returns. This was partly due to shutdowns and reduced workloads due to the COVID-19 pandemic in 2020 and 2021. But the IRS has suffered a 19% funding reduction since 2010. As a result, staffing has been reduced. According to a report from the Treasury Inspector General for Tax Administration, due to lack of resources, the IRS was unable to work on almost 880,000 cases involving high-income taxpayers who did not file tax returns.
The federal government seeks to resolve the above problems by increasing funding to the Internal Revenue Service by almost $80 billion over nine years as part of the pending Inflation Reduction Act. The funds are to be used for improving taxpayer services, maintaining operations, modernizing infrastructure and business systems, and enforcement of tax laws. The Congressional Budget Office projects that the funding will result in a net gain of $124 billion over nine years.
One of the more interesting items is the establishment of a task force that will research the feasibility of a free direct tax filing system. This could be useful for low- to middle-income taxpayers with only one W-2 whose simple tax returns can be processed quickly.
But the most controversial aspect of the funding increase is enforcement where over $45 billion will be allocated. The bill specifically states that the funds will be used to determine and collect owed taxes, provide litigation support, conduct criminal investigations, and provide digital asset monitoring and compliance activities.
Democrats argue that increasing enforcement funding is necessary to target wealthy taxpayers to ensure that they pay their fair share. But Republicans believe that the IRS will use the extra funds to increase audits on small businesses.
The news of increased funding should be welcome news to most taxpayers and tax professionals, even those who represent taxpayers before the IRS in tax disputes. Increased staffing can translate into reduced hold times before reaching an IRS representative and faster resolution of simple tax disputes.
As for how the IRS will use its enforcement funding remains to be seen. Since the purchase of infrastructure and operational expenses are covered in other parts of the bill, it is safe to assume that most of the funds will be used to hire more personnel. This means more auditors, collections staff, investigators and likely experts in cryptocurrency and other digital assets like non-fungible tokens.
In a letter, IRS Commissioner Charles Rettig told senators that the funding increase will not result in a rise in audit rates for households making under $400,000. While this may sound reassuring to people who are under this threshold, the IRS has to somehow verify that certain taxpayers are indeed making under $400,000.
Full time W-2 employees — even those earning more than $400,000 — have a low chance of being audited unless they report large deductions on other schedules on their tax returns. This includes itemized deductions, deductions from passive real estate activities, or deductions from a side business.
But the real enforcement targets are the self-employed. Some income could be verified through 1099s reported by customers or clients. But the remaining income and expenses are usually reported on the honor system. How a tax return is selected for audit is unclear and somewhat random. But claiming unusual or suspicious deductions as business expenses could significantly increase the likelihood of an audit.
While honest taxpayers should technically have nothing to fear from an audit, it is still a time-consuming process and many have to retain a tax professional to represent them. There is also the possibility that the IRS auditor will not believe the taxpayer or the records they provide. This means that the taxpayer will have to choose between paying a tax they do not legally owe or spend time and money to fight the audit.
For the most part, the new bill, if passed, will provide the IRS with the funding needed to improve services to taxpayers and raise additional revenue for the government. This can mean faster refund payments and processing of older tax returns which could be important for loan purposes. But it remains to be seen how the IRS will use the money for enforcement purposes.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at firstname.lastname@example.org. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.