Revenue lost from tax cheating is huge. $441 billion fell through the cracks yearly from 2011 through 2013, per an IRS calculation last done in 2019. Of that, IRS recouped $60 billion through audits, leaving a net tax gap of $381 billion. The Treasury Dept. says the number rose to nearly $600 billion in 2019.
But the tax gap figure is likely much higher.
Maybe even as large as $1 trillion per year, according to the IRS commissioner, when accounting for noncompliance from virtual currency transactions, undisclosed offshore transactions, abuse through use of pass-through entities and exempt organizations, plus illegal-source income.
There is now a new push by the Biden administration to close the tax gap.
The president calls it tax fairness. But the added revenue is a big motive, too. Joe Biden says that giving IRS $80 billion over 10 years plus some other proposals would bring in 700 billion more in tax dollars to the Treasury over the same period … a nice chunk of money to help pay for his desired domestic policy programs. Note that some experts dispute the size of the tax gap and this investment return.
Among Biden’s proposals: Give IRS lots of money for enforcement efforts so that it could audit more wealthy individuals, big corporations and pass-throughs. IRS audits have fallen over the past decade, especially for these groups of taxpayers. This downward spiral correlates with big drops in IRS funding and agency personnel.
IRS would use the money for the following: Hire and train revenue agents to specialize in complex audits. Overhaul outdated technology to allow the agency to effectively detect tax evasion. And improve customer service in a variety of ways. Treasury says audit rates won’t rise for individuals with incomes under $400,000.
More reporting from financial institutions and digital currency exchanges. Tax compliance is higher when income sources are reported to IRS by third parties. Think wages, unemployment benefits, dividends and interest, and pensions. Biden wants banks to report on Form 1099-INT information on aggregate outflows and inflows in business and personal accounts, with a carve-out for small accounts. This reporting proposal would also apply to payment settlement entities such as PayPal, foreign financial institutions, custodian accounts and cryptocurrency exchanges. Virtual currency exchanges would also have to report on transactions over $10,000. Treasury says these ideas would improve voluntary compliance and help the agency sniff out hard-to-verify income of wealthy individuals without burdening taxpayers.
Provide IRS with statutory oversight over preparers. We assume this means requiring unenrolled preparers to take a test and complete continuing education classes. The Service, preparer organizations and tax policy groups have been pushing for this ever since a court struck down IRS’s regs in 2014. Biden would also hike penalties for ghost preparers … those who charge people fees but don’t sign the return.
IRS is on track to implement statutory changes to the 2021 child tax credit.
It says it will begin making advance payments of the credit on July 15. IRS will look to 2020 returns (or 2019 returns) to determine eligibility for the payments. Most families who qualify for the credit will get six payments, one each month from July through Dec. Payments will be directly deposited if IRS has account data. If not, eligible taxpayers will get a paper check or a debit card monthly in the mail.
And IRS is expected to launch its online child credit portal by July 1. Taxpayers will be able to access the tool on IRS’s website to enter changes to their family circumstances or AGI, or to opt out of receiving advance payments.
IRS plans to mail letters with program details to potentially eligible families.
How do taxpayers who don’t file returns get the child credit payments?
IRS is offering a simple return option for those who aren’t otherwise required to file returns because their income is below the filing threshold (Rev. Proc. 2021-24). See www.kiplinger.com/ktl/nonfilers for details on how to fill out a simplified return.
A tip for college grads who are starting a full-time job this summer:
Use part-year withholding to boost your paycheck and have less tax withheld. The standard federal tax withholding tables assume you’ll earn a full year’s income when figuring how much income tax to take out. The part-year method is for people who work 245 or fewer days in a year and sets withholding according to what you earn during the part of the year you are on the job. Ask your employer for this in writing.
Many students with summer jobs can escape federal income tax withholding from their checks if they owed no income tax for 2020 and don’t expect to owe for 2021. Just write “Exempt” below step 4(c) of the W-4 and fill out steps 1(a), 1(b) and (5).
Hiring your children can lower your tax bill. No FICA tax is due if sole proprietors or husband-wife partnerships employ their under-age-18 children. Ditto if the kids work for a parent’s one-person LLC that’s disregarded for tax purposes. Also, federal unemployment tax is not owed on their salaries until they reach 21.
People who are filing an amended federal return can do so electronically. You can use tax software to e-file Form 1040-X to amend a 1040 or 1040-SR for 2019 or 2020 that was filed electronically. If the original return was filed on paper, then you must use paper filing for the amended return. Ditto for amended returns that reflect a different Social Security number or filing status from that shown on the original return. Amended returns for earlier years must also be filed on paper.
It can take up to 16 weeks for IRS to process an amended return.
Here are some more tips on amended returns. You generally have three years from the date you filed your return (or the due date of that return if later) to amend it and claim a refund. If amending for multiple years, use a separate 1040-X for each year. If you’re due a refund on your originally filed return, don’t file an amended return until you get the refund. To check the status of an already-filed amended return, use the “Where’s My Amended Return” tool on IRS’s website at least three weeks after filing the 1040-X. You’ll need to enter your SSN, date of birth and ZIP code.
Employers are looking for ways to help workers with their college debt.
One way may be through workplace retirement plans. A bill in Congress would allow employer 401(k) matches conditioned on student loan repayments. IRS blessed such a program in a 2018 private ruling. In that situation, the firm contributed to its 401(k) plan on behalf of employees paying down their college debt. The employer matches took place regardless of whether employees also paid in. Participation was voluntary and employees had to elect to enroll in the program.
Businesses without gross receipts generally can’t deduct cost of goods sold, the Tax Court says. An oil and gas company claimed estimated drilling costs as cost of goods sold on its 2008 and 2009 returns. The firm did not do any drilling in those years, nor did it have any gross receipts attributable to the sale of natural gas. The company argued it could take the deduction because it assumed the obligation to drill a well. The Court disagreed, saying that to recover costs of goods sold, a taxpayer generally must have gross receipts from the sale of goods to offset. The firm’s cost-of-goods-sold write-off is toast (BRC Operating Co., TC Memo. 2021-59).
A tax break for partners in hedge funds could be on the chopping block. For years, hedge fund and private equity managers have lowered their tax bills by treating their share of partnership or LLC profits received as compensation as long-term capital gain and not ordinary income. This long-standing break is referred to as carried interest, and Democrats have repeatedly called for axing it.
Biden is proposing to get rid of this break in his American Families Plan. And Sen. Joe Manchin (D-WV), a lawmaker Biden needs on his side, supports repeal.
IRS differs with a court ruling on S firms and split-dollar life insurance. In 2018, an appellate court ruled on the tax treatment of the economic benefit an S corporation shareholder/employee realizes from the firm’s payment of premiums under a split-dollar life insurance arrangement. According to the Sixth Circuit, those economic benefits are shareholder distributions. This reversed the Tax Court, which treated those benefits as employee compensation. IRS now says it disagrees with the Sixth Circuit’s holding and won’t follow it outside that court’s jurisdiction.
A taxpayer can challenge IRS guidance on microcaptive insurance schemes, the Supreme Court decides. In 2016, the Service issued Notice 2016-66, which labeled abusive microcaptive insurance schemes as transactions of interest and required taxpayers and material advisors to disclose them to IRS or face penalties. An advisor filed suit, asserting the notice was invalid. A lower court tossed the case, saying that a federal law that bars taxpayers from challenging taxes in court before they are owed applies to the threat of penalties in the notice. The Supreme Court has now reversed, allowing the lawsuit to go forward on the merits (CIC Services).
Recovering legal costs after beating IRS in court isn’t the easiest of tasks.
You’re out of luck if IRS’s position in the underlying case is reasonable. Here, the Service audited a man and disallowed his Schedule C expenses as personal. After years of haggling over the issue, IRS’s Office of Appeals conceded the case. The man then sued IRS for payment of litigation costs. According to the Tax Court, the agency demonstrated that its position on his expense deductions was reasonable and substantially justified, so he is out of luck (Jacobs, TC Memo. 2021-51).
A limousine company’s installment plan falls flat with IRS and a court. A firm proposed to satisfy its tax debt by making monthly payments of $2,000. An IRS officer figured the firm could pay $23,000 a month. In making this calculation, the officer didn’t account for principal payments the firm was making on vehicle loans because the company chose to increase its limousine fleet rather than pay its tax debt. IRS’s rejection of the plan was proper (American Limousines, TC Memo. 2021-36).
If your small business owes delinquent payroll taxes, consider this option:
Apply for an In-Business Trust Fund Express Installment Agreement. Firms that owe $25,000 or less in payroll taxes can enter into this installment plan to pay their debt over 24 months without having to give financial information to IRS. Businesses that owe more can pay down their tax debt to $25,000 and then apply. You can apply online or call 800-829-4933, or the number on the bill sent by IRS.
Employers get guidance on the temporary COBRA premium assistance credit. Involuntarily terminated workers who elect continuing COBRA health coverage while they are unemployed are eligible to receive a subsidy of 100% of their premiums from April 1, 2021, through Sept. 30, 2021. Ditto for workers whose hours are cut. Firms that provide the subsidy get a payroll tax credit that they claim on Form 941. They can get the break quickly by reducing employment tax deposits owed to IRS by the amount of the premium assistance credit the business qualifies for. Employers can seek advance payment by filing Form 7200. Businesses that take the credit must include it in gross income. See Notice 2021-31 for details in a Q&A format.
Relying on an attorney to file an extension isn’t enough to avoid a penalty. A lawyer for an executor failed to timely file Form 4768 to get an extension to file an estate tax return. As a result, the executor ended up filing the return late and IRS assessed delinquency penalties, which the executor unsuccessfully challenged in federal court. The executor’s reliance on the attorney isn’t reasonable cause to waive penalties on the late-filed estate tax return (Andrews, Ct. of Fed. Claims).
Enrolled agents whose enrollment expired on March 31 will hear from IRS. Those whose Social Security numbers end in 7, 8 or 9 originally had to apply for their three-year renewal by Jan. 31, 2021, and pay the fee. IRS is mailing letters, telling enrolled agents who haven’t renewed for the 2021 cycle that their enrollment is inactive. Anyone in inactive status can submit a late renewal for approval.
IRS is eyeing continuing education requirements of enrolled agents. It’s sending letters, asking for copies of continuing education certificates of completion from a random sample of agents. A similar review in 2018 uncovered problems, such as some EAs failing to give their preparer tax ID numbers to the CE provider and others not retaining completion certificates for the requisite four-year period.
The Service has an updated guide for examining the construction industry. A big focus is on accounting methods. Agents will ensure that companies properly report income from long-term contracts, including policing the exceptions to the percentage-of-completion reporting method for home construction contracts and small contractors. Agents are also instructed to probe for unreported income and improper deductions. Home builders and land developers get scrutiny, too. Go to www.kiplinger.com/letterlinks/constructionaudits for a copy of the handbook.
Some LLC members who don’t pay self-employment taxes are on IRS’s radar. IRS’s Large Business and International Division has an ongoing risk campaign on the issue of when limited partners and LLC members in professional service firms owe SECA tax on their distributive share of the firm’s income. In 2017, the Tax Court ruled that law firm members who actively participated in the LLC’s business operations and in management weren’t mere investors and were liable for self-employment taxes. LLC owners in law, medicine, accounting, architecture, consulting and other sectors are being eyed. According to IRS, these self-employment tax audits are ongoing and have been pretty successful. Look for the Service to make these exams a priority.