The IRS also said approximately 1.6 million taxpayers who have already paid these penalties will automatically receive an estimated $1.2 billion in refunds or credits.  Those who have not paid the penalties will see automatic abatement.  The caveat is that any return still unfiled for the two tax years must be filed by September 30, 2022 to be eligible for this relief.

That’s simply not the case.  In an August 10, 2022, letter to IRS Commissioner Charles Rettig, Treasury Secretary Yellen said she is directing “that any additional resources—including any new personnel or auditors that are hired—shall not be used to increase the share of small businesses or households below the $400,000 threshold that are audited relative to historic levels. … small businesses or households earning $400,000 per year or less will not see an increase in the chances that they are audited.” 

In her letter, Secretary Yellen clarified that additional resources should be applied toward “high-end compliance” noting that the top one percent of high-income filers are estimated to not be paying $160 billion in owed taxes each year.  Yellen explained: “This is challenging work that requires a team of sophisticated revenue agents in place to spend thousands of hours poring over complicated returns, and it is also work that has huge revenue potential: indeed, an additional hour auditing someone making more than $5 million annually generates an estimated $4,500 of additional taxes collected.”

• Unreported income.
• General allegations of fraud, tax fraud, wire fraud, insurance fraud and related allegations.
• False dependent exemptions.
• Employee vs. subcontractor.
• Failure to file.
• Wage under reporter.
• Capital gains tax.
• Wages being paid in cash or under the table.
• Rental income.
• False deductions or expenses.

• all residential property is reduced to 6.765% (from 6.95% for single family property and 6.80% for multifamily property); and
• nonresidential property (other than oil and gas, agricultural, and renewable energy producing property), is reduced to 27.9% (from 29%).

When determining the 2023 assessed values, assessors must apply assessment rates to the actual value of the residential property, less $15,000, and to the actual value of improved commercial property, less $30,000. However, these subtractions cannot cause the valuation for assessment of the property to fall below $1,000.

IRS Commissioner Charles Rettig also stressed the need for increased funding, in a separate post.  The IRS’ “already scant resources are stretched thin—and consistent underfunding has significantly hindered the service we’re able to provide,” Rettig wrote. “Over the course of the last decade, the IRS’ budget fell more than 15 percent in real terms. Because of this decrease, in 2021 we realized less than 79,000 full-time positions, which is close to 1974 levels. Since 2010, IRS enforcement personnel fell by 30 percent, while the nation’s real Gross Domestic Product increased by 29 percent, and the filing population has increased by 14 percent. Over the next six years, we estimate we will need to hire 52,000 employees just to maintain our current levels.”

I wanted to wait until my client received his check before reporting this.  It is possible to recover “reasonable litigation costs” pursuant to 26 U.S.C. 7430.  As VitalLaw puts it:

“An individual was entitled to reasonable litigation costs. The taxpayer was tied up in litigation relating to his failure to file his tax returns and pay taxes for two years at issue and bankruptcy proceedings. Once the litigation regarding his outstanding tax liabilities concluded, the taxpayer filed a motion for costs in the Tax Court.

At trial, in deciding whether the government’s position was substantially justified, the court relied on United States vs. Johnson, 920 F.3d 639. The IRS contended that its position was substantially justified overall even though, in its initial response to the taxpayer’s motion, it previously conceded that at least one substantive issue and its related costs were not substantially justified. By contrast, the taxpayer argued that applying a holistic approach of Johnson to this case was not appropriate and would create an absurd result.  However, the court believed that the taxpayer’s hyperbole was misplaced.

Nonetheless, the court concluded that the IRS failed to prove that the position of the government was substantially justified under the Johnson standard. Further, since the IRS had otherwise conceded that the taxpayer was a prevailing party, the taxpayer was entitled to an award under Code Sec. 7430.

Additionally, the taxpayer contended that he was entitled to an enhancement of the statutory rate because it would have been impossible to retain qualified counsel at the statutory rate and because of the difficulty of the issues presented in this case. However, this did not justify a departure from the statutory rate and the taxpayer failed to prove his entitlement to such a departure. Accordingly, the taxpayer was entitled to an award at the statutory rate.”

According to the agency’s fiscal year 2021 Financial Report of the U.S. Government, released February 17, the gross tax gap is generally composed of three elements: non-filing ($39 billion), underreporting ($352 billion), and underpayment ($50 billion).

Individual income tax accounts for the majority of the net tax gap ($271 billion), followed by employment tax ($77 billion), and corporation income tax ($32 billion). The balance is made up of estate and excise tax ($1 billion).

The letter states: “When our constituents cannot get assistance from the IRS and TAS, they contact us, and we have our hands tied at this point as well.”  Among other things, the lawmakers are asking the IRS to suspend automated tax collection for 90 days, streamline the “reasonable cause” penalty abatement process, and provide targeted tax penalty relief for taxpayers who paid at least 70% of the tax due for 2020 and 2021. 

Darren Guillot, Commissioner of the IRS Small Business/Self-Employed Collection Division said the goal is to avoid (as much as possible) escalating a case to enforcement proceedings.  His message on November 15 to attendees of the AICPA & CIMA National and Sophisticated Tax Planning Conferences in Washington, D.C., was simple: “Just tell the truth. We want to get you in compliance. We want you to file on time and pay what you owe. Every case is not criminal. We don’t want any case to be criminal, or enforcement or a seizure.”

To that end, he highlighted some of the activities the IRS is engaged in to target high income non-filers, defined as those earning at least $100,000 in income from a third-party source.  The IRS employs data analytics to identify these individuals with at least 3 years of unfiled returns, then engages these taxpayers through what is called High Income Delinquent Filer (“HiDeF”) Sweeps, which began in December 2018.

In 2019, there were 9.5 million non-filers and of them, more than 843,000 were high income non-filers. He said the HiDeF program will continue for years.  For those instances involving egregious noncompliance and/or potential fraud, the IRS has what is called Operation Surround Sound, a collaboration between the Office of Fraud Enforcement, Collection and Examination Operations.

Guillot also highlighted another target the agency recently began focusing on: ghost employers. These involve employers who provide a W-2 to their employees but do not file the proper forms or pay the money owed to the IRS or the Social Security Administration.  For some, revenue officers were able to help launch criminal investigations.

He also noted that during the pandemic, the agency has been receiving a significantly higher number of phone calls. By August 2021, the agency received 246 million calls being handled by less than 15,000 customer service representatives. He said that on March 15, the calls were coming in at a rate of 1,500 calls per second. By comparison, the IRS received 42 million calls in 2019 and 44 million calls in 2020.

With that in mind, Retting stated that taxpayers and the tax professionals who help them deserve the timely responses they may not be getting, whether by mail or over the phone, because of workplace protocols make some of these processes challenging and cause delays and issues between departments within the agency.

“Level of service is an appropriated item,” meaning the IRS simply could not hire more people to man the phones or open the mail without getting more money from Congress to do so. “This should help frame up for you the importance of a properly funded Internal Revenue Service.”  He also noted that in the next six years, the agency is going to lose 52,000 employees.

1. Provide the IRS the resources it needs to stop sophisticated tax evasion.

2. Provide the IRS with more complete information.

3. Overhaul outdated technology to help the IRS identify tax evasion.

4. Improve taxpayer service and deliver tax credits.

5. Regulate paid tax preparers.

These reforms were introduced, as stated in the release, because “[A] robust and sustained investment in the IRS is necessary to ensure it can do its job of administering a fair and effective tax system.”  Noncompliance is a major problem.  According to the release, “a recent study found that the top 1 percent failed to report 20 percent of their income and failed to pay nearly $175 billion in taxes owed annually.”  Left unaddressed, this tax gap (the tax owed and the tax actually paid) will total about $7 trillion over the next decade, according to the Department.

The press release may be found here: https://home.treasury.gov/news/press-releases/jy0150

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Investing in the IRS and Improving Tax Compliance

April 28, 2021

A well-functioning tax system requires that all taxpayers pay what they owe. An unfortunate characteristic of the current system, however, is an asymmetric adherence to tax law by the nature of income received. While roughly 99% of the taxes due on wages are remitted to the Internal Revenue Service, compliance across other forms of income is substantially less, as the IRS has difficulty verifying whether income from opaque sources is properly reported. Noncompliance is concentrated at the top of the distribution: A recent study found that the top 1 percent failed to report 20 percent of their income and failed to pay nearly $175 billion in taxes owed annually.

Lower levels of compliance not only impact tax progressivity, but they also lower tax revenue and deteriorate our nation’s fiscal position. Left unaddressed, this tax gap— the difference between taxes owed to the government and taxes actually paid—will total about $7 trillion over the course of the next decade. This massive gap in revenue means policymakers must choose between higher taxes elsewhere in the tax system, lower spending on fiscal priorities, or rising budget deficits.

The tax gap has many underlying causes, chief among them being insufficient resources. Budget cuts over the past decade have resulted in an agency that lacks the capacity to address sophisticated tax evasion efforts. Over this period, audit rates for taxpayers making over $1 million in income have fallen by almost 80 percent.

A robust and sustained investment in the IRS is necessary to ensure it can do its job of administering a fair and effective tax system. The IRS requires more resources to conduct investigations into underreported income and to pursue high-income taxpayers who evade their tax liability through complex schemes. It requires 21st century technology to unpack complex tax returns and track income across various opaque sources. And, it requires access to better information so that the agency can target its efforts at the most egregious offenders, while helping compliant taxpayers avoid unnecessary and costly audits. This investment will also put the IRS in a position to provide taxpayers with timely answers to questions.

These considerations provide the basis for a series of proposals in the American Families Plan that overhaul tax administration and provide the IRS the resources and information it needs to address tax evasion. All told, these reforms will generate an additional $700 billion in tax revenue over the course of a decade, net of the investments made. Specifically, the tax administration reforms will:

• Provide the IRS the resources it needs to stop sophisticated tax evasion. Over the last decade, a declining IRS budget has deprived it of the resources it needs to effectively enforce our nation’s tax laws. After accounting for inflation, the IRS budget has fallen by about 20 percent, and its workforce has been depleted, with the number of complex revenue agents (who are dedicated to high-end evasion and large corporate cases) falling by 35 percent. As a result, IRS audits have fallen across the board, and particularly for the highest earners.

The IRS has made clear that it needs additional resources to pursue costly tax evasion. These are not easy cases to resolve; the average investigation of a high-wealth individual takes two years to complete and often requires the IRS to commit substantial resources. Moreover, the lack of adequate investment in compliance has significant revenue consequences. Indeed, several hundred taxpayers who committed the most egregious form of evasion—failing to file taxes all together—cost the federal government $10 billion over a period of just three years.

A key component of this initiative is the provision of a sustained, multi-year stream of funding. 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.

• Provide the IRS with more complete information. When the IRS has information from third parties, income is accurately reported, and taxes are fully paid. However, high-income taxpayers disproportionately accrue income in opaque sources—like partnership and proprietorship income—where the IRS struggles to verify tax filings. As a result, up to 55 percent of taxes owed on these less visible income streams is unpaid, with disproportionate levels of non-compliance for those at the top of the income distribution.
  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.
• Overhaul outdated technology to help the IRS identify tax evasion. Elements of IRS IT systems are antiquated and make it difficult for the IRS to identify those who are not paying their taxes and to help those who want to comply. The President’s proposal provides the IRS much-needed resources to modernize its technological infrastructure. Leveraging 21st century data analytic tools will enable the IRS make use of new information about income that accrues to high-earners and will help revenue agents unpack complex structures, like partnerships, where income is not easily traced.
• Improve taxpayer service and deliver tax credits. A well-functioning tax system requires that taxpayers be able to interact with the IRS in an efficient and meaningful manner. Inadequate resources often mean that IRS service agents are unable to provide taxpayers timely answers to their tax questions. Service enhancement will improve the ability of the IRS to communicate with taxpayers securely and promptly. Importantly, the proposal also includes the necessary resources to ensure that the IRS effectively and efficiently delivers tax credits to families and workers, including newly expanded Child Tax Credits and Child and Dependent Care Tax Credits.
• Regulate paid tax preparers. 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”).

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The Tax Court noted that a completed Revenue Agent Report (“RAR”), along with official IRS correspondence, supports the existence of an “initial determination.”  Since the RAR was presented by the revenue agent at the audit closing conference, and the penalty was asserted in the RAR without approval from the supervisor, the Tax Court determined the IRS could not meet its burden of proof, and granted Summary Judgment for taxpayers.

Congress disagrees, so stay tuned for further possible legislation.  Senate Finance Committee Chairman Chuck Grassley, R-Iowa, ranking member Ron Wyden, D-Ore., and House Ways and Means Committee Chair Richard Neal, D-Mass., wrote in a May 5 letter to Sec. Mnuchin: “[A]s was expressed to Treasury during the development of the PPP, we did not intend to deny the deductibility of ordinary and necessary business expenses, nor did these small businesses expect to lose deductions for their business expenses when they applied for a PPP loan.”

The Internal Revenue Service today, March 25, 2020, announced important steps it will take to provide relief to taxpayers on a wide variety of issues ranging from tax collections to delaying compliance actions. The IRS will continue to protect all statutes of limitations, but it will also implement the follow steps to ease burdens on taxpayers undergoing audits, and those with tax liabilities.

Existing Installment Agreements – For taxpayers under an existing Installment Agreement, payments due between April 1 and July 15, 2020 are suspended. Furthermore, the IRS will not default any Installment Agreements during this period.

New Installment Agreements – The IRS reminds people unable to fully pay their federal taxes that they can resolve outstanding liabilities by entering into a monthly payment agreement with the IRS. See IRS.gov for further information.

Offers in Compromise (OIC) – The IRS is taking several steps to assist taxpayers in various stages of the OIC process:

Pending OIC applications – The IRS will allow taxpayers until July 15 to provide requested additional information to support a pending OIC. In addition, the IRS will not close any pending OIC request before July 15, 2020, without the taxpayer’s consent.

OIC Payments – Taxpayers have the option of suspending all payments on accepted OICs until July 15, 2020, although by law interest will continue to accrue on any unpaid balances.

Delinquent Return Filings – The IRS will not default an OIC for those taxpayers who are delinquent in filing their tax return for tax year 2018. However, taxpayers should file any delinquent 2018 return (and their 2019 return) on or before July 15, 2020.

New OIC Applications – The IRS reminds people facing a liability exceeding their net worth that the OIC process is designed to resolve outstanding tax liabilities by providing a “Fresh Start.” Further information is available at IRS.gov

Field Collection Activities – Liens and levies (including any seizures of a personal residence) initiated by field revenue officers will be suspended during this period. However, field revenue officers will continue to pursue high-income non-filers and perform other similar activities where warranted.

Automated Liens and Levies – New automatic, systemic liens and levies will be suspended during this period.

Passport Certifications to the State Department – IRS will suspend new certifications to the Department of State for taxpayers who are “seriously delinquent” during this period. These taxpayers are encouraged to submit a request for an Installment Agreement or, if applicable, an OIC during this period. Certification prevents taxpayers from receiving or renewing passports.

Private Debt Collection – New delinquent accounts will not be forwarded by the IRS to private collection agencies to work during this period.

Field, Office and Correspondence Audits – During this period, the IRS will generally not start new field, office, and correspondence examinations. We will continue to work refund claims where possible, without in-person contact. However, the IRS may start new examinations where deemed necessary to protect the government’s interest in preserving the applicable statute of limitations.

In-Person Meetings – In-person meetings regarding current field, office and correspondence examinations will be suspended. Even though IRS examiners will not hold in-person meetings, they will continue their examinations remotely, where possible. To facilitate the progress of open examinations, taxpayers are encouraged to respond to any requests for information they already have received – or may receive – on all examination activity during this period if they are able to do so.

Unique Situations – Particularly for some corporate and business taxpayers, the IRS understands that there may be instances where the taxpayers desire to begin an examination while people and records are available and respective staffs have capacity. In those instances when it’s in the best interest of both parties and appropriate personnel are available, the IRS may initiate activities to move forward with an examination — understanding that COVID-19 developments could later reduce activities for an agreed period.

General Requests for Information – In addition to compliance activities and examinations, the IRS encourages taxpayers to respond to any other IRS correspondence requesting additional information during this time if possible.

Independent Office of Appeals – Appeals employees will continue to work their cases. Although Appeals is not currently holding in-person conferences with taxpayers, conferences may be held over the telephone or by videoconference.

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Strategies include holding income tax refunds when a taxpayer has at least one unfiled return in the five years surrounding that return, sending letters alerting taxpayers to potential liability if the IRS has to file a return for them, and automatically filing the return for them, which frequently results much higher tax, due to the disallowance of deductions.            

In addition, the IRS reminded taxpayers that many non-filers were actually owed refunds, and they were also encouraged to look into filing their tax returns.  The deadline for claiming refunds on 2016 tax returns is April 15, 2020.  

Last year, the IRS audited 0.45 percent of individual Form 1040 income tax returns, which is down from 1.1 percent of tax returns audited in 2010.  “The IRS lost more than 29,618 full time positions between fiscal year 2010 and fiscal year 2019, which includes Information Technology, Operations Support, Taxpayer Service and Enforcement personnel.

These losses directly correlate with a steady decline in the number of individual audits during the past nine years,” the IRS report notes.  Further, the IRS anticipates that up to 31 percent of its workforce (nearly 19,719 full-time employees) will retire within the next five years.

The IRS gets very picky about a few things, though, and a front-line revenue agent conducting an exam will go by the book and disallow certain expenses if you do not properly substantiate them. In particular, mileage expenses, food expenses, and promotional expenses are particularly troublesome to those experiencing an IRS audit. For each of these expenses, a short rule of thumb is to keep all receipts and a log recording the “who, what, when, where, and why” of the expense.

Internal Revenue Code Section 274(d), for example, requires taxpayers who deduct mileage to keep a log detailing the mileage, the starting point and destination, and the business purpose of the trip, or the entire deduction is subject to disallowance. Even the normally more-reasonable Appeals Officers will sustain a disallowance if a taxpayer cannot substantiate a mileage expense. For meals, a taxpayer is permitted to deduct only 50 percent of the expense, and must keep a contemporaneous recording of who attended the meal, the business purpose of the meal, and what was discussed. Legibly writing these details on the receipt is permitted. Because of huge abuses in the past, revenue agents closely scrutinize promotion expenses for all three of the basic requirements: are the promotion expenses ordinary, necessary, and reasonable? Generally, the test is one of production—i.e., do the (usually high) promotion expenses actually result in increased clients and revenues?

Additionally, employment taxes are an important part of running a business. The IRS closely monitors employment tax payments. If they are not paid, the IRS (and the state taxing agency) is quick to enforce collection of the taxes due. Sometimes collection action will occur within two quarters of nonpayment. This can cause some undercapitalized businesses to “pyramid” in the nonpayment of taxes, which only makes an IRS revenue officer more determined to get the business into compliance through lien filings, bank levies, and other direct collection action, or to shut it down.

The IRS considers the nonpayment of payroll taxes equivalent to making the United States an unwilling business partner or lender. Unlike debts to a business partner or lender, though, Trust Fund Recovery Penalties assessed against “responsible persons” who “willfully fail” to collect and pay payroll taxes are not dischargeable in bankruptcy.

Solo practitioners and small law firms, like other businesses, should consult with a Certified Public Accountant or qualified tax lawyer for tax help. Remember, this year you have until April 18 to file. For more information, visit www.irs.gov.

David A. Sprecace is a solo practitioner in Denver, providing legal services in federal (I.R.S), state, and local tax controversy and litigation; business and bankruptcy litigation; and business planning, formation, and operation.

The law firm failed to meet its burden of proving the officer of the firm, the three associates, and a law clerk were true independent contractors. The Court analyzed the facts using the factors identified by the 5th Circuit in deciding whether the lawyers were common law employees: (1) The degree of control the principal has over the worker, (2) the worker’s opportunity for profit or loss, (3) the worker’s investment in facilities, (4) the permanence of the relationship, and (5) the skill required in the operation. While the factors vary in wording and number from circuit to circuit, they are substantially similar.

Degree of Control. The Court noted that “[W]hether petitioner had the right to control the details of the associate attorneys’ work is an intensely factual question.” On one hand, the firm provided minimal training and supervision. On the other hand, the firm officer “controlled the assignment of cases to the associate attorneys and determined whether the associate attorneys would be reimbursed for case-related and other work-related expenses.” The Court concluded “that the analysis regarding control tips in favor of an employer-employee relationship. Petitioner’s ability to affect the course of litigation by its decisions regarding the funding of litigation, work assignments, and working conditions, including the supervision of associate attorneys who worked on cases generated by petitioner and/or Donald Cave, weighs in favor of an employer-employee relationship.”

Opportunity for Profit and Loss. Attorney compensation was based on a percentage of the gross fees petitioner collected in the cases they handled. The percentage varied depending on who secured the case. The associates bore little, if any, risk of loss from the cases and clients that they handled, even if they brought them into the firm. The Court considered this factor neutral.

Investment in Facilities. The Court decided this factor indicated an employer-employee relationship because the firm provided all of the tools and facilities necessary for the associates to complete their work, including office space, office furniture, computers, telephones, fax machines, copying machines, office supplies, secretarial services, telephone and Internet service, and access to petitioner’s computer server, law library, and online legal research services.

Permanence of the Relationship. All of the associates had long-term relationships with the law firm—three, ten, and twelve years. There were no written contracts of employment or covenants not to compete. Further, there was no evidence that any of the associate attorneys ever provided or offered to provide services to another law firm or directly to the public during the periods at issue. These indicated and employer-employee relationship.

Skill Required in Operation. The Court noted that the associates were “highly educated professionals.” Considering the issues from another angle, though, the Court opined “the associate attorneys, who were newly licensed lawyers when first hired by petitioner, were not specialists called in to solve a particular problem but instead performed the essential, everyday professional tasks in petitioner’s business. This factor is neutral.”

While it should be clear to all that the firm director is and was a statutory employee of the professional corporation for the two years at issue, this ruling clarifies that practicing attorneys who could otherwise hang out their own shingle will probably be considered employees on IRS audit, even under normal circumstances. One possible and legitimate solution would be for contract attorneys to form their own professional corporations, offer services to other firms and the public, and comply with federal, state, and local return-filing and tax-paying statutes.

David A. Sprecace is a solo practitioner in Denver, providing legal services in federal (I.R.S), state, and local tax controversy and litigation; business and bankruptcy litigation; and business planning, formation, and operation.