I carried a certain amount of starry-eyed innocence with me early in my tax career. And I remember the day it started to fade. I had been anticipating finalizing a settlement for a client’s outstanding tax liability. On paper, I was convinced we would get what we wanted. Then I got the phone call.
“What about the (other) bank account?” the IRS representative asked.
I explained that I didn’t know what she was talking about. We had, I said confidently, reported all of the taxpayer’s income.
Spoiler alert: We had not.
The taxpayer—who knew better—had a secret account that he had failed to disclose to the IRS and, importantly, to his attorney. The IRS found it.
It was the first time I realized that those who went out of their way to avoid paying taxes didn’t always reside in garden spots, stashing their millions offshore. Sometimes they merely lived in suburban Philadelphia and spent well above their means.
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And it adds up. In 2019, the federal government failed to collect $574 billion in taxes that were legally due. That is equal, writes former IRS Commissioner Charles Rossotti, to all the income taxes paid by 90% of individual taxpayers. In a Bloomberg opinion piece, Rossotti reported that about 95% of income that is fully reported by third parties is accurately filed by taxpayers. However, only 45% of income not reported by third parties shows up on taxpayer returns.
Rossotti has championed additional third-party reporting as a way to resolve the tax gap. He’s not alone. Lawmakers are considering a controversial proposal by the Biden administration to increase third-party reporting. The proposal isn’t popular with banks—or taxpayers. And an increasing amount of social media memes and posts have confused the issue. Here’s what you need to know.
What’s in the proposal?
As it currently stands, the proposal would require banks, credit unions, and other financial institutions to monitor deposits and withdrawals—and subsequently report—accounts that have balances of $600 or more during the year. The threshold would be absolute, with no minimum number of required transactions.
Don’t those bank reporting requirements already exist?
There are some reporting requirements in place. For example, banks and other financial institutions must report interest income above $10 on Form 1099-INT. That form is filed with the IRS and is used to match the income reported on your tax return.
Also, under federal law, banks are required to report any transactions of cash which total more than $10,000 in any single day: This information is included on a currency transaction report (CTR) and is used to help the government track large transactions and prevent money laundering. Making cash deposits of less than $10,000 is not illegal, but it is not lawful under 31 U.S. Code §5324 to structure transactions “for the purpose of evading” those reporting requirements.
What about PayPal and other payment apps?
Form 1099-K is used to report certain payments for goods and services paid by credit card or third-party merchants. A reportable payment transaction is a transaction in which a payment card—like a credit card—is accepted as payment or settled through a third-party payment network like PayPal. To trigger reporting, payments through a third-party network must have exceeded $20,000 in gross total reportable transactions, and the aggregate number of those transactions must have exceeded 200 for the calendar year.
But that is changing. As part of the American Rescue Plan Act, beginning on Jan. 1, 2022, third-party payment networks like PayPal and Venmo must now report business transactions totaling more than $600 to the IRS (personal transactions, like gifts, are excluded).
It sounds like the IRS is chasing business accounts. Does that mean that personal accounts would be excluded under the proposal?
No, the current proposal would apply to business and personal accounts.
So how much information would my bank report to the IRS?
This is the part that is worrying taxpayers. Reports would include numbers of cash transactions per account, any transactions involving a foreign account, and transactions between accounts held by the same owner. But, according to Treasury Secretary Janet Yellen, “this is not a proposal to provide detailed transaction-level data by banks to the IRS.”
In other words, no one at IRS will see how many times you’ve ordered “27 Dresses” on Amazon.
Did Congress dream this up?
No. The original proposal was submitted by the Treasury in May of 2021.
The $600 threshold feels really (really) low. Is there any chance that it could go up?
Possibly. Many tax professionals—myself included—agree that $600 is an awfully low bar if the point is to chase high-dollar non-reporters. I assumed that the threshold would settle closer to $10,000—the same threshold for those CTRs and FBARs related to foreign accounts.
Last month, House Ways and Means Committee Chair Richard Neal (D-Mass.) indicated that he supported a threshold of $10,000, and suggested that Senate Finance Committee Chairman Ron Wyden (D-Ore.) did, too.
And there’s evidence that House leadership understands that a higher number will be needed if the proposal is to move forward. This week, House Speaker Nancy Pelosi (D-Calif.) said that the $600 reporting threshold is not firm.
“That’s a negotiation that will go on as to what the amount is,” she said.
Will there be any other exceptions?
There’s no official word yet, but it’s been reported that some common transactions, like direct deposits, will be exempt from the reporting requirements.
Will this cause my tax bill to go up?
Not if you’re already reporting and paying properly. The proposal, as written, is intended to assist the IRS with the enforcement of existing tax laws. It’s not an additional tax.
Will I have to file an additional form?
Not likely. As noted, banks and financial institutions already report interest on Form 1099-INT. According to Yellen, the additional reporting would be on the same Form 1099-INT— it would just have extra boxes.
Will additional reporting really make a difference in the tax gap?
The IRS thinks so. In a report last month, Treasury suggested that “These changes to the third-party information reports are estimated to generate $460 billion over a decade.”
In addition to handing the IRS information that can be used in audits, there’s another factor that the Treasury is counting on with this proposal: Taxpayer attitudes.
In the early years of the tax code, the Commissioner was tasked with examining every return. And in a throwback that feels eerily familiar, the IRS was overwhelmed. By the time that 1918 tax returns were filed—five times as many as the previous year—there was a backlog: the returns from 1916 and 1917 had not been audited.
Congress came up with a solution in 1954: The Commissioner was no longer required to examine every return.
Today, IRS examinations are typically targeted. Audits rates reach as high as 8.16% for taxpayers with incomes of $10 million or more, and generally less than 1% for taxpayers reporting $500,000 or less.
According to Natasha Sarin, deputy assistant treasury secretary for economic policy, the amount of information available to the IRS keeps compliance rates in check. Sarin notes that “For ordinary wage and salary income, compliance with income tax liabilities is nearly perfect (1 percent noncompliance rate)” while for “opaque income sources that accrue disproportionately to higher earners—like partnership income, proprietorship income, and rental income—noncompliance can reach 55 percent.”
Congress and the Treasury hope that this latest proposal—assuming it becomes law—will keep compliance rates high, freeing up resources to do more targeted enforcement. Negotiations on the proposal, which is included in the reconciliation bill, are ongoing.
This is a weekly column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.
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