Will Biden’s IRS be coming after your clients?

President Joe Biden wants to give the Internal Revenue Service sharper teeth. He’s proposed increasing the agency's funding by almost 70% so it can better police tax avoidance and evasion. The focus is supposed to be on wealthy taxpayers and corporations, since they're the ones who account for the majority of tax misconduct, but what does that mean exactly? Who should be on notice?

Most at risk are taxpayers whose earnings aren’t reported to the IRS by an outside source like an employer or brokerage firm. Studies show that when there's third-party reporting, compliance rates are around 90%, but when there isn't, the rate drops to 50%.

Others who have been targeted by recent IRS compliance efforts are also probably going to get more scrutiny too.

Andrew Harrer/Bloomberg

Here are some leading candidates.

Pass-through owners

The biggest source of the tax gap, the amount of money owed to the IRS that doesn't get paid, comes from underreported income that flows to owners of pass-through businesses (so called because the profits pass through to the owners directly). There's more net business income in pass-throughs than in corporations.

To help narrow the gap, Biden is proposing to require banks to report everyone’s deposit and withdrawal activity to the IRS. Such a sweeping plan is likely to meet considerable pushback, but a more streamlined proposal from former IRS Commissioner Charles Rossotti could be a clue to what enhanced reporting (if it happens) might actually look like.

Under Rossotti's plan, taxpayers with more than $25,000 in business income or businesses with more than $25,000 in receipts would be required to designate which banks they use for business income. Those banks would report the account activity to the IRS.

Owners of partnerships, such as LLCs, LPs and LLPs, should also expect the IRS to focus more audits on the partnership itself, and not just the partners who run it. That would probably let the IRS extract more money when auditors uncover unreported or erroneously reported income.

Crypto investors

IRS Commissioner Chuck Rettig said at a recent congressional hearing that the $1 trillion tax gap could be narrowed by more stringent cryptocurrency reporting requirements. No third party tracks and reports sales or trades of digital currencies, in contrast to the stock and bond activity sent to the IRS by brokerage firms. (Crypto gains are subject to capital gains taxes, just as stock and bond profits are.)

The agency has created a team it calls “Operation Hidden Treasure,” dedicated to ferreting out unreported gains. It has also included a new question prominently located on the 2020 tax form asking about crypto holdings. Still, a lot more could be done, and lawmakers have said they're working on legislation to standardize crypto reporting. In addition, crypto holders should expect that transactions above a certain threshold may have to be reported annually to the IRS.

High-income non-filers

The IRS recently started targeting taxpayers who earned more than $100,000 but hadn't filed tax returns. The agency planned on subjecting those potential scofflaws to in-person audits, but the pandemic put those plans on hold. So it's reasonable to expect those non-taxpayers to be near the top of the agency's go-get-them list as COVID-19 recedes. While the amounts recouped are unlikely to be huge, faith in the tax system can be strengthened by demonstrating that people can’t get away with not filing taxes at all.

Offshore account holders

The IRS has been trying to recover money held by taxpayers in unreported offshore accounts, either through voluntary disclosure, penalties or criminal action. The 2010 Foreign Account Tax Compliance Act set up third-party reporting by some banks, which has helped. But a recent report by the Government Accountability Office found that depleted resources have handicapped IRS efforts to match the information a bank provides with the correct taxpayer.

The deceased

So far, Biden hasn't proposed any changes to the estate tax threshold; a 40% tax is assessed on estates worth more than $11.7 million. The 2017 Republican tax law increased the amount at which the estate tax kicks in from $5.5 million. Even if the limits stay the same for the next few years (they're supposed to revert back to lower levels at the end of 2025), it's possible that the agency will make a more concerted effort to ensure that estates are valued correctly. Assets such as land holdings, jewelry and art may require special valuation experts who will make sure the inheritors are correctly reporting the value of the estates.