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- Category: Tax Law
In his American Families Plan, President Biden unveiled a tax compliance initiative aimed at closing the gap between taxes that are owed and what are paid. Most of the anticipated revenue, which the Administration estimated at $460 billion over 10 years, would come from requiring financial institutions to report account information that Treasury says would be similar to W-2 reporting for wages and other income reporting.
However, Biden’s plan would not simply mimic wage and other income reporting. Also, Biden’s plan requires too many reports yet reveals too little useful information. Biden could improve his plan substantially by adding elements of a recent, more targeted proposal by former IRS Commissioner Charles Rossotti, first recommended by the 2005 Bush Federal Tax Reform Panel.
Biden would require banks and other financial institutions to tell every account holder and the IRS total deposits and withdrawals for the year, adding two new boxes to the current Form 1099-INT that now is used to report interest income (regardless of whether the bank reported any interest for the account).
For example, a bank might report that an account had a total of $1 million of deposits, $800,000 of withdrawals, and $5,000 of interest. The IRS, in theory, could use this information to help construct a financial profile for the account holder, which the IRS would compare to the tax returns filed by holder.
In practice, the IRS’ task would be daunting and, in fact, bury the agency in a sea of unproductive information.
Biden’s plan is expansive: deposits and withdrawals must be reported for every account, individual or business, at every financial institution. Then, to construct taxpayer-specific information, the IRS must collate taxpayer-account information across many different financial institutions. That is because taxpayers often hold multiple accounts. Yet, whether collated or not, deposits and withdrawals are not income, unlike wages or interest. And deposits and withdrawals cannot be netted to calculate income, without substantial adjustments.
Moreover, Biden would not require taxpayers to reconcile the bank reports with the income they report on their income tax returns, as with stock proceeds and basis reports. And the IRS could not match total deposits or withdrawals to income or expenses reported on tax returns.
Indeed, some taxpayers may be confused by the new information requirements while others may find ways to circumvent the rules. Taxpayers might park business receipts with a relative or entity that is not required to report. Or taxpayers might convert business receipts into assets that are not held at financial institutions, such as cash, bitcoin, or real estate. Taxpayers also might hold their accounts through shell entities or nominees. And how would the IRS allocate deposits and withdrawals for accounts that are held jointly by non-spouses, a common practice today that could grow with the new reporting?
In recent years, Congress has been reluctant to give the IRS too much examination power over taxpayers without good cause. In 1998, Congress added Code sec. 7602(e), which prevents the use of “financial status or economic reality examination techniques to determine the existence of unreported income… unless the Secretary has a reasonable indication that there is a likelihood of such unreported income.” Congress feared these audit techniques would be intrusive, so it limited them only where the IRS already has indications of unreported income.
But Biden would take this reporting further. He’d require reporting for all accounts, regardless of the likelihood of unreported income. For the IRS to use the information, Congress would need to amend the law, yet it seems unnecessary.
Most individuals earn all of their income from wages and investment returns, which already are reported to the IRS. And larger businesses often are audited by public accounting firms. While those businesses have many ways to reduce their taxes, omitting income rarely is one of them. Why drag these individuals and businesses into the new program?
However, income from certain businesses is underreported, which justifies seeking additional information. The largest source of the tax gap is pass-through businesses, such as sole proprietorships or partnerships, that fail to report all their income. The resulting unreported income and employment taxes accounted for over a third of the annual tax gap between 2011 and 2013, according to the IRS.
The Rossotti proposal noted above would target businesses that are prone to underreporting. He’d require individuals with more than $25,000 of business income, and pass-through businesses with more than $25,000 of receipts, to designate bank accounts where their business income is deposited. At year-end, these banks would provide the taxpayers and the IRS with a report of all their deposits and withdrawals. Taxpayers would reconcile the gross amounts reported by the bank with the income and deductions they report on their tax return.
Rossotti’s proposal was a fine start: He targeted the solution to a serious problem the IRS already has identified. He also sidestepped most of the problems with Biden’s proposal, largely by requiring businesses to designate bank accounts. The president would do well to incorporate more of those ideas in his own plan.