On May 24, 2021, Sen. Warren introduced Senate Bill 1788, the “Restoring the IRS Act” (the Proposed Legislation). The Proposed Legislation generally (1) imposes new information reporting obligations on financial institutions relating to various types of transaction information associated with an account of an individual or business at that institution, (2) provides for significantly increased IRS funding, (3) requires certain reports to Congress relating to IRS enforcement priorities, the tax gap, and racial disparities relating to IRS enforcement, (4) increases underpayment penalties under section 6662 based on the taxpayer’s taxable income, and (5) applies certain False Claim Act procedural rules to tax claims. The Proposed Legislation seeks to effect a clear policy position: namely, a stronger IRS armed with more complete information and the ability to assert increased penalties will generate additional tax revenue by reducing the “tax gap.” Treasury estimates that the tax gap totaled nearly $600 billion in 2019 and will rise to about $7 trillion over the course of the next decade, roughly equal to 15% of taxes owed.1 The Proposed Legislation seeks to eliminate the tax gap by eliminating financial privacy, creating an all-seeing, all-knowing tax enforcement agency that has the wherewithal to severely penalize high-income non-compliant taxpayers.
While it is certainly too soon to say whether the Proposed Legislation will be enacted, the Proposed Legislation is in line with broader calls from the Administration and in Congress for significant increases to IRS funding and expansion of the information reporting landscape in the near future both in scope and breadth. Opponents of the Proposed Legislation are likely to stress the need for the IRS to better utilize the information currently collected by the IRS before creating new obligations that are likely to be very costly and burdensome to the financial services industry.2
Prior Treasury proposals relating to enhanced information reporting
Section 4 of the Proposed Legislation reflects Sen. Warren’s approach in implementing Treasury’s proposal relating to transactional reporting of bank account data that is included in its Report on the American Families Plan’s Tax Compliance Agenda.3 The Treasury proposal generally contemplates modifying the reporting requirements associated with the Form 1099-INT to include additional data regarding gross inflows and outflows on all business and personal accounts at financial institutions, including bank, loan and investment accounts. The Treasury proposal also contemplates exceptions for accounts below a low de minimis gross flow threshold, and notes that its proposal “preserves significant flexibility for the Secretary and the IRS to design the new reporting requirements in the way that will be most effective for tax compliance efforts.”
Treasury’s proposal also contemplates that other accounts that are similarly situated to financial institution accounts would also be covered under this new reporting regime—for example, payment settlement entities would also be required to report gross receipts and gross purchases. The reporting regime would also apply to foreign financial institutions and crypto-asset exchanges and custodians. The Treasury proposal is envisioned as a means to collect additional revenue to pay for President Biden’s infrastructure proposal.
Treasury emphasizes that the financial account inflow and outflow reporting would not be required to be reconciled to a taxpayer’s return. Treasury contemplates that the proposal would be effective for tax year 2023, and that the Administration would concurrently seek out ways to reduce any new burden on financial institutions associated with this information reporting requirement.
Enhanced information reporting applicable to accounts maintained at financial institutions
The Proposed Legislation, and a slightly more restrained bill introduced in the House,4 contain elements of the Treasury proposal.5
The Proposed Legislation, consistent with the Treasury proposal, would create new section 6050Z of the Internal Revenue Code, which would impose additional information reporting obligations on financial institutions described in forthcoming regulations. As currently drafted, the Proposed Legislation presents numerous uncertainties that require clarifying guidance. For example, there is no indication that the Proposed Legislation would be limited to US financial institutions, and it seemingly may apply to non-US financial institutions. Moreover, there is no statutory de minimis value threshold before reporting would apply, unlike the de minimis provisions for reporting under the Foreign Account Tax Compliance Act (FATCA).6 It is also unclear whether accounts beneficially owned by non-US persons would be subject to information reporting under the Proposed Legislation. Finally, as Treasury has significant discretion in the manner in which it chooses to define financial institutions, it is possible that this obligation would be imposed beyond banks, insurance companies, brokers or other traditional financial institutions.
The Proposed Legislation requires the disclosure of typical identifying information, including name, address and TIN of persons on whose behalf the account is maintained. Unlike other tax information reporting statutes that focus on identifying the party receiving a payment of income, the Proposed Legislation would seek to identify the beneficial owner of the account, even if such person is not the legal owner of the account. It is relevant to note that this approach seems to incorporate the forthcoming FinCEN guidance regarding the identification of the beneficial owner of a financial account.
On a substantive level, the Proposed Legislation imposes different data reporting requirements depending on whether the account is “related to a trade or business.” Those accounts that are related to a trade or business are subject to simplified reporting, and financial institutions only need to report “monthly gross inflows and outflows.” All other accounts are subject to enhanced reporting, and financial institutions must provide information regarding cash transactions, “foreign transactions” and transfers to related accounts. Presumably, regulations will provide guidance regarding what constitutes a related account, a “foreign transaction” or a trade or business for purposes of the Proposed Legislation.
As is the case for other Chapter 61 information reporting filing obligations, the Proposed Legislation requires that a copy of the IRS filing is provided to the taxpayer whose name is on the IRS filing and imposes penalties on financial institutions that fail to file an accurate information return with the IRS or to provide a copy of the filing to the named taxpayer. Given the number of accounts potentially subject to this information reporting obligation, filers are at risk for substantial penalties.7
It is notable that the Proposed Legislation requires Treasury to issue regulations relating to section 6050Z within twelve months after its enactment. In addition, the Proposed Legislation contains a broad grant of regulatory authority that would permit Treasury to issue regulations that require the reporting of additional information maintained by financial institutions that would assist in closing the tax gap, as defined later in the Proposed Legislation. Given other Treasury and IRS priorities, it is unclear whether thoughtful and administrable rules can be developed, with industry input, within that timeframe.8
Enhanced IRS funding and furnishing enforcement-related reports to Congress
For many years, IRS funding has been cut. At the same time, IRS audit rates have declined. This has led to the perception that the IRS would be able to better enforce existing tax laws if sufficient funding is provided. Accordingly, the Proposed Legislation seeks to substantially increase IRS funding with the goal of spurring increased IRS enforcement activities. In this regard, the Proposed Legislation also mandates that the IRS submit certain reports to Congress detailing (1) an audit plan containing a comprehensive description on how the IRS will “shift more of the auditing and enforcement assets…toward high-income, high-wealth tax filers and corporations[,]” (2) a tax gap analysis detailing “the amount of the tax gap attributed to high-income, high-wealth tax filers and corporations” and how additional information reporting, including additional third-party reporting of corporation and partnership ownership, can reduce the tax gap, and (3) an analysis detailing whether there are any racial disparities in IRS enforcement activities.
If the Proposed Legislation is enacted into law, it may be many years before the IRS is able to hire and train a new generation of IRS agents or to effectively develop new IT technologies that can be integrated into IRS legacy systems.
Underpayment penalty increase
As a means to increase taxpayer voluntary compliance, the Proposed Legislation increases the underpayment penalties imposed under section 6662 for certain taxpayers based on their taxable income. The existing section 6662(a) 20-percent underpayment penalty would be retained only for taxpayers with taxable income of less than $2 million. The penalty would be increased to 30-percent for taxpayers with taxable income greater than $2 million but less than $5 million and further increased to 40-percent for taxpayers with taxable income greater than $5 million.
The Proposed Legislation would make similar changes to the penalties imposed with respect to (1) gross valuation misstatements under section 6662(h), (2) nondisclosed noneconomic substance transactions under section 6662(i), and (3) undisclosed foreign financial asset understatement under section 6662(j). The current 40-percent penalty is retained for taxpayers with a taxable income of less than $2 million. For taxpayers with taxable income greater than $2 million but less than $5 million, the penalty is increased to 45-percent. And for taxpayers with taxable income greater than $5 million, the penalty is increased to 50-percent.
False Claim Act adjustments
Finally, Section 7 of the Proposed Legislation amends the exception to liability under the false claims rules so that certain taxpayers may become liable for such claims. Currently, the false claims rules provide a general exception for claims made under the Internal Revenue Code. The Proposed Legislation would amend the exception so that it would not apply if the person making a claim has gross income equal to or greater than $10 million for the taxable year with respect to which the claim is made and the damages suffered by the government exceed $1 million. Under the Proposed Legislation, high-income taxpayers could potentially be liable for additional civil penalties and costs for making false claims under the Internal Revenue Code.
1 Where the IRS can verify tax filings with information reports, Treasury estimates that compliance rates exceed 95%. Without information reporting, compliance rates fall below 50%. See, Treasury Releases Report on the American Families Plan’s Tax Compliance Agenda, available at https://home.treasury.gov/news/press-releases/jy0188#.
2 See, TIGTA Report 2018-30-040 “Despite Spending Nearly $380 Million, the Internal Revenue Service Is Still Not Prepared to Enforce Compliance With the Foreign Account Tax Compliance Act”; see, TIGTA Report 2021-30-002 “Billions in Potential Taxes Went Unaddressed From Unfiled Returns and Underreported Income by Taxpayers That Received Form 1099-K Income.”
4 H.R. 1200, the “Stop Corporations and High Earners From Avoiding Taxes and Enforce the Rules Strictly Act” or the “Stop CHEATERS Act” was introduced in the House in February 2021 by Representative Khanna. H.R. 1200 also contains an information reporting obligation designated as section 6050Z that is similar in purpose to the Proposed Legislation. The difference between H.R. 1200 and the Proposed Legislation is that H.R. 1200 provides for information reporting only on demand by the IRS and contains certain limits on the taxpayers subject to such reporting.
5 In addition, Section 9674(a) of the American Rescue Plan of 2021, enacted earlier this year, lowered the threshold under section 6050W for the Form 1099-K, which reports third-party network transactions, from $20,000 and 200 transactions to $600, effective for returns for calendar years beginning after December 31, 2021. Text of the American Rescue Plan of 2021 is available at https://www.congress.gov/bill/117th-congress/house-bill/1319/text.
6 FATCA exempted individual accounts valued below $50,000 or preexisting entity accounts below $250,000.
7 Penalties are generally capped at $280 per filing to the IRS and $280 to each taxpayer, not to exceed approximately $6.8 million in total. These amounts may be reduced, if corrected filings are made promptly, and would double, with no aggregate cap, if an information reporter intentionally disregards the requirements.
8 Cf. Prop. Reg. §1.1471-2 (gross proceeds withholding under FATCA was indefinitely suspended pursuant to proposed regulations due to the inability to develop an administrable approach to effect the statutory reporting mandate and taxpayers may rely on the proposed regulations until final regulations are issued).
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