Congress' recent move to shift $21.4 billion in funding away from the Internal Revenue Service as a condition for increasing the debt limit isn't deterring the tax agency from moving ahead with its strategic plans to hire more employees, improve taxpayer service and modernize its technology, but it could slow down efforts to close the tax gap and audit more high-income taxpayers and corporations.
And IRS officials are still emphasizing one of their priorities: preventing fraudulent claims for the widely advertised Employee Retention Credit.
As part of the debt limit deal negotiated by House Speaker Kevin McCarthy, R-California, and President Biden and passed earlier this month to avert an unprecedented default by the federal government, lawmakers agreed to rescind $1.4 billion of the $80 billion allocated to the IRS over 10 years under last year's Inflation Reduction Act, and to make another $20 billion of the funding available to other non-defense programs over the next two years.
IRS officials discussed those issues and more Thursday during New York University's Annual Tax Controversy Forum.
"A $20 billion cut, but there's still $60 billion remaining, and that's $60 billion we did not have a year ago," said Douglas O'Donnell, deputy commissioner of services and enforcement at the IRS. "We still have the opportunity to truly transform the agency."
He said the IRS is working now to sort out what the $20 billion cut means.
"We are going through a number of scenarios," said O'Donnell. "We don't know exactly what it's going to look like, but we do think that our original plan for the first five years will hold and it's going to be the further-out years where we're going to have more of a challenge to deal with the reduction. We'll see. There will be more to follow. It's early days."
The IRS has been facing challenges since the pandemic with processing its backlog of returns, although the extra funding from the IRA enabled it to perform better this year.
"The pandemic did not help us. The ability for taxpayers to get to us was really, really bad," O'Donnell acknowledged. "It dropped to the single digits. We were not able to keep up with the paper that was coming in. We have returns currently that cannot be filed electronically. It's not that people don't want to. It's that they cannot and that's partly due to a lack of investment. We're working to right-size that."
Both paper returns and amended returns are slowing down processing at the IRS (See "
"We still are getting a lot of amended returns," said O'Donnell. "Almost all of it is due to relief programs during COVID. The Employee Retention Credit is a huge issue. There's a lot of people who didn't know about it and deserved the credit and filed, and we're processing those. But there is a lot of noncompliance. Some of it is edging into the fraud areas. We're working with the Department of Justice to make sure that we properly administer that space. There's just a lot of problems there."
He urged tax professionals to help the IRS prevent bogus claims for the ERC.
"I've given a couple of interviews just trying to get the word out, but we need to figure out some way, and tax pros can help us with this," said O'Donnell. "These individuals who are being sold this notion that almost anyone can claim this credit by these mills — they are creating a lot of heartache for businesses because when we go out, if they've gotten a refund, we're going to pull it back and there's going to be penalties and interest associated with it. Those folks that have gotten 25% of the refund as a fee for helping them, they're gone. They're not going to represent them. Whatever you can do to help us, we'd appreciate it. You're helping the community more broadly."
The IRS has been using data analytics at its Office of Fraud Enforcement and Office of Promoter Investigations, according to Lia Colbert, commissioner of the Small Business/Self-Employed Division, to detect various types of fraud, including among promoters of dubious ERC claims.
"When I think about what happened with the Employee Retention Credit, it's almost like a veritable business case study in an underfunded and under-resourced agency having to deliver an incredibly complicated tax credit to an incredibly needy population, literally trying to deliver a lifeline of credits to a population of paper returns."
IRS employees had to use pencils to identify risk categories and fraud areas on piles of paper returns to spot trends with promoters of the ERC, weeding out bogus claims from legitimate ones. The service is now in the process of deploying more scanning technology thanks to the extra funding it received last year.
"We still did pretty OK in that space, because we were able to deliver help to nearly 2 million employers and over $150 billion in credits, but we want to do so much more," said Colbert. "This is now that opportunity where we can do a little bit more of that. When it comes to Employee Retention Credits and the Inflation Reduction Act funding, I think about now being able to imagine a world where that 941-X comes in electronically, being able to work with our digital and our scanning teams to be able to get information immediately so we can start to risk assess immediately. I think about working with our IT partners to try to design new ways to capture data more efficiently and new communication strategies. I think about ways we can coordinate across our functions better. That funding and that little bounce really helps us get to this."
Tax practitioner perspective
Dealing with inflated expectations for the ERC can be a headache for tax professionals as well.
"The ERC presents multifaceted challenges, and it's one of the things that keeps me awake at night, in large part because the ERC has probably the single largest potential for buyer's remorse from taxpayers that I've ever seen," James Creech, a senior manager with the tax team at Top 100 Firm Baker Tilly, told Accounting Today. "Baker Tilly, early on in the ERC, spent a significant amount of time developing processes and counterweights and independence, so we could do honest, good-faith credit eligibility calculations."
He noted that his firm began warning about the flood of inappropriate ERC claims with an alert it sent out in October 2021.
"There's a lot of people who get promised the moon that they're going to qualify for ERC so come claim your $20,000 per year per employee," said Creech. "I've heard verbatim from clients that if you didn't fire anyone during COVID, you qualify. There's no mention of gross receipts or suspension [of operations]. It's just if you didn't fire anyone, which isn't the law, but it's persuasive if you're looking at it from hindsight and saying, 'Well, we made it through COVID. We're signing up with a shop that is telling us that they can do this and look at the size of the check. And they're charging a contingency fee.'"
"What happens if you get caught?" he continued. "The IRS is going to ask you to repay the entire thing. They're not going to care that you paid a contingency fee. And if you get caught, you're going to look at 100% repayment, plus potential penalties, plus interest, which is now 7%."
He is seeing claims ranging from $300,000 to $2 million. "Being told you have to repay $2 million in one sitting for a credit you didn't qualify for, but you were promised the moon and the money's already been spent, could be catastrophic," said Creech.
Another Top 100 Firm, Sikich, hosted a program last month for financial clients to give them a rundown on the rules and regulations for the ERC, and in a poll of participants, it found that 58% said they are being approached daily or weekly by ERC providers offering "claim and refund-related services."
"Clients are getting solicited by some of these providers who want to provide a study for them," said Jim Brandenburg, a tax partner at Sikich. "They're getting calls on a fairly regular basis, telling them that they qualify."
Clients will ask his firm what they know about the ERC after receiving such calls or hearing about inflated claims about the ERC in ads. "In some cases, we might have looked at a company and they might qualify, but in other cases, we've made the assessment that we don't think that they're eligible for it, but yet they're still getting some of these calls," Brandenburg told Accounting Today.
He tries to educate them about how the ERC rules work, such as a reduction of gross receipts in either 2020 or 2021, and whether it was due to government order that led to a parietal or full shutdown. Brandenburg advises them to be careful and make sure they do their due diligence. He expects to see the IRS stepping up its enforcement activity in this area.
"At the IRS, they trained a number of their individuals at the end of last year on the ERC," said Brandenburg. "Some of the agents, I think, were helping out with the regular busy season filing, but my guess is perhaps this summer and into the fall, they will devote more time toward some of the ERC audits. There will probably be more activity over this coming year and even into next year."
