What IRS budget increases may mean for your financial institution
Last year’s substantial rise in interest rates from previous historic lows, and the continuing rate increases into 2023 coupled with inflation has stressed many household budgets. While the labor market remains strong, uncertainty about the economy and financial markets for individuals and financial institutions prevails, fueled most recently by the national debt ceiling crisis.
The government is facing added pressure to reduce spending, further incentivizing the IRS to close the existing tax revenue gap.
The Inflation Reduction Act of 2022 added $80 billion to the IRS budget over 10 years. The dodgy economic environment has heightened fears that the IRS is going to be more aggressive with audits than they have been in the past.
Let’s break down where that money is going and what it may mean for your financial institution.
Taxpayer services: $3.2 billion
According to the nonpartisan Congressional Research Service (CRS), at the end of 2022 there were 13.3 million unprocessed tax returns. This is almost double the volume compared to the end of 2019, but substantially down from 2020.
Funds will be devoted to getting through the backlog. In addition, funds will be dedicated to improving pre-filing assistance and education, filing and account services and taxpayer advocacy, which helps resolve taxpayer issues with the IRS. The agency will also explore the possibility of creating a free, direct e-file program for individual taxpayers. It would be a bonus to have someone answering the phone there.
The IRS issues notices to taxpayers for a variety of reasons and often the notices are incorrect. It’s been a struggle for taxpayers and tax professionals to even reach someone at the service. Sometimes, you can call for days and not even get an opportunity to be put on hold.
We have also seen situations where there are substantial delays in processing amended returns, carrybacks and service responses to written letters. For example, I recently received a letter from the IRS thanking us for our letter (received by the service 18 months prior) and indicating that the service needs more time to resolve the issue.
Financial institutions have shared similar frustrations when trying to contact the service for a variety of reasons, from name changes to 1099 issues. Hopefully, additional funding will lead to much-needed service improvement.
Enforcement: $45.6 billion
With enforcement activities making up more than half of the total IRS appropriations, the biggest question from many taxpayers, including financial institutions is, “Will I be audited?” The CRS indicates that these funds will cover hiring additional agents, litigation and criminal investigation expenses, along with an investment in technology.
It currently appears that the primary focus will be on taxpayers with at least $400,000 in taxable income, large corporations and partnerships. It will take time for the IRS to hire, staff and train additional agents, so not much should change right away. The goal is to reduce the gap between total taxes owed and taxes paid on time. The IRS estimates that amount averages $381 billion per year. Some of the enforcement efforts are anticipated to focus on cryptocurrency, an area that has received little attention.
Looking back at history may help financial institutions prepare for the next wave of IRS audits. During the Great Recession, there was a significant uptick in IRS audits of financial institutions, due in part to large, bad debt deductions reported on tax returns.
Concern is growing about a potential increase in IRS audit activity if that starts occurring again. While credit quality has been good as of late, a looming recession may change that. To minimize potential IRS audit adjustments, consider making a conformity election. Once in place, if the tax charge-offs reported on your tax return are the same as book, the IRS won’t challenge them. Remember that you must obtain a conformity letter from your examination team while they are completing fieldwork in order to satisfy the requirements for a conformity election.
Keep in mind that filing an extension does not increase your chances of audit. Returns are selected for audit a variety of ways, including random selection and computer screening, as well as document matching and related examinations. In fact, filing an extension could reduce the chance of an IRS audit, or if audited, provide a lesser chance of having an adjustment. By filing an extension, more time is allowed for the tax return to be completed, reducing the chance that needed information will be omitted.
Even with an extension, remember that it’s an extension to file, not to pay. Payments are due on the original due date.
Operations support: $25.3 billion
To support the investment in taxpayer services and enforcement, the IRS is also focused on enhancing operations. This includes routine costs of doing business and possibly expenses for research and the IRS Oversight Board, an independent body that provides guidance to the service.
Business systems modernization: $4.75 billion
It’s widely recognized that the business systems and technologies used by the IRS are decades behind where they should be, particularly when it comes to the phone system. In 2021 and 2022, the agency answered only 19% and 18% of phone calls, respectively. The Taxpayer Advocates office has indicated that improving responsiveness should be a priority, including call-back technology and an option for taxpayers to receive face-to-face service through videoconferencing.
Excluded from the funding are upgrades to the IRS’ very old legacy computer systems. The IRS released a plan in 2019 to upgrade its business systems, but numerous issues have delayed that process and the completion date is now pushed out to 2030.
With a new Congress in session, changes in funding are possible, so timelines and funding amounts could be in flux. It’s important to pay attention.
How Wipfli can help
Wipfli professionals can help your financial institution stay on top of IRS changes and navigate tax challenges affecting short-term and long-term strategies for your organization. We provide you the knowledge, technology and support you need to become a more forward-facing, strategic institution. Contact us to learn how we can help.
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