When President Joseph R. Biden announced his $1.8 trillion American Families Plan to a joint session of Congress, most of the attention went to his jobs plan, the new benefits he was proposing for children and families, and the proposed increase of the top income tax rate to 39.6 percent. There was less reporting on suggestions about tax preparation, tax audits, and sharing of bank account information, but these changes would have profound effects.
The president’s proposed changes to the tax codes were significant. In addition to increasing the tax rate for those at the top of the income ladder, those households with income over $1 million would also lose their lower capital gains rate. Those inheriting assets with capital gains over $1 million (or $2.5 million for couples when combined with existing real estate exemptions) would no longer be able to use a step up in basis to soften the tax blow. And hedge fund and private equity firm managers would find their carried interest tax break on the chopping block. All of these losses for the wealthy are balanced by funding for universal pre-K education, childcare, college education, nutrition programs, and paid leave, among other benefits for families: the plan would also make the expansion of the Child Tax Credit, the Child and Dependent Care Tax Credit, the Earned Income Tax Credit, the Premium Tax Credit permanent.
See this related post from Dennis Harabin: The 2022 IRS Interest Rate Hike Will Go Live April 1st
If you are required to pay quarterly estimated income tax, an upcoming change in interest rates being imposed by the IRS may have a direct impact on you. Effective April 1st, 2022, corporations and self-employed filers who submit quarterly estimated taxes will see a hike in the interest rates that the agency charges for both overpayments and underpayments.
In addition to these changes, it is notable that the American Families Plan also lays out significant changes within the Treasury itself, including expanded funding for tax audits, expansion of IRS authority over paid tax preparers, and a requirement that relevant bank account information be shared more readily by banks. The oversight of tax preparers has long been a wish list item for many Democratic leaders – in fact, a program known as the Registered Tax Return Preparer program was first rolled out by the IRS under the Obama administration to require that tax preparers register and submit to testing and continuing education requirements. The program was invalidated in 2013 after a group of independent tax preparers filed a lawsuit to stop it. The case, Loving v. IRS, was decided by a federal judge who ruled that the IRS’ program lacked statutory authority. Lawmakers, including Senate Finance Committee Chairman Roy Wyden, D-Oregon, have been pursuing legislative action to achieve the oversight goal ever since.
A fact sheet released by the Biden administration in support of the IRS oversight spells out the goals of the changes. “Tax returns prepared by certain types of preparers have high error rates. These preparers charge taxpayers large fees while exposing them to costly audits. As preparers play a crucial role in tax administration and will be key to helping many taxpayers claim the newly expanded credits, IRS oversight of tax preparers is needed. The president is calling on Congress to pass bipartisan legislation that will give the IRS that authority.”
The Biden White House is not alone in its concerns about unregulated tax preparers. A news release from the Treasury emphasized the need for oversight. “Taxpayers often make use of unregulated tax preparers who lack the ability to provide accurate tax assistance. These preparers submit more tax returns than all other preparers combined, and they make costly mistakes that subject their customers to painful audits, sometimes even intentionally defrauding taxpayers for their own benefit. The president’s plan calls for giving the IRS the legal authority to implement safeguards in the tax preparation industry. It also includes stiffer penalties for unscrupulous preparers who fail to identify themselves on tax returns and defraud taxpayers (so called ‘ghost preparers’).”
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what might be earned from a bank. The penalty is applied quarterly, so making a fourth-quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters. This can be accomplished with cooperative employers or by taking an unqualified distribution from a pension plan, which will be subject to 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory rollover limit (but check with this office before using the latter strategy).
A bigger auditing budget is part of the plan
While the public may get behind the idea of regulating tax preparers, they may be less enthusiastic about the American Rescue Plan’s proposal of an increased budget for conducting taxpayer audits. But the Treasury has said that tax evasion has led to a tax revenue shortfall of roughly $1 trillion. In the same news release, the Treasury said, “Altogether, the proposal directs roughly $80 billion to the IRS over a decade to fund an array of priorities — including overhauling technology to improve enforcement efforts, which is more effectively implemented with the assurance of a consistent funding stream. This investment will also facilitate the IRS hiring and training auditors to focus on complex investigations of large corporations, partnerships, and global high-wealth individuals. The president’s proposal directs that additional resources go toward enforcement against those with the highest incomes, rather than Americans with actual income of less than $400,000.”
Tax evasion takes many forms, and the plan hopes to address it both through increased auditing capabilities and by introducing a requirement that account flows of high-income individuals be reported by banks. According to the administration’s fact sheet, “The president’s proposal ... would require financial institutions to report information on account flows so that earnings from investments and business activity are subject to reporting more like wages already are. Additional resources would focus on large corporations, businesses, and estates, and higher-income individuals. Altogether, this plan would raise $700 billion over 10 years.”
The reason there is a need for this type of additional reporting was explained this way by the Treasury:
“GAO and IRS research confirm that providing the IRS a mechanism for cross-checking the accuracy of such tax filings is a proven way to improve compliance. This reform aims to provide the IRS information on account flows so that it has a lens into investment and business activity — similar to the information provided on income streams such as wage, pension, and unemployment income. Importantly, this proposal provides additional information to the IRS without any increased burden for taxpayers. Instead, it leverages the information that financial institutions already know about account holders, simply requiring that they add to their regular, annual reports information about aggregate account outflows and inflows. Providing the IRS this information will help improve audit selection so it can better target its enforcement activity on the most suspect evaders, avoiding unnecessary (and costly) audits of ordinary taxpayers.”
See this related post from Dennis Harabin: An Advisory for All Entrepreneurs: IRS Crisis Arises
For several years now, the IRS has required payments made to merchants through various marketplaces, payment processors (credit & debit cards), and third-party settlement organizations (TPSOs) to be reported on Form 1099-K. The purpose being to uncover merchants that do not report all of their income by comparing the 1099-K amounts to the amount reported on the individual’s or business’s tax return and following up with the under-reporters by correspondence or by audit.
As is always true of sweeping presidential proposals, there’s likely to be a lot of negotiating and significant changes between what the administration is proposing and what the Congress finally approves. Ed Zollars, a partner at Thomas, Zollars & Lynch, warned in his Current Federal Tax Developments blog for Kaplan Financial Education that it is too early to react one way or another to what is in the plan. “It’s easy to overreact to such proposals, as many parties forget (or have a vested interest in ignoring) that this remains merely a proposal at this point in time. It’s not clear how much congressional support would exist for passing this proposal 'as is' and history suggests that there will be modifications, many likely significant, made to any bill if it becomes law — another thing that is far from a certainty.”
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