On May 28, 2021, the U.S. Department of the Treasury released its General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, also known as the “Greenbook.” It provides additional details on proposals announced as part of the American Families Plan and Made in America Tax Plan to improve compliance and tax administration, as we discussed here and here. While it remains to be seen whether these proposals will be enacted into law, they raise a number of issues for taxpayers to consider and plan for in anticipation of future IRS audits.
Additional Funding for the IRS
The Administration is proposing approximately $80 billion in funding for the IRS over the next decade. This proposal was also described in the recently released American Families Plan Tax Compliance Agenda, as we discussed here. This proposal would include additional funding for enforcement and operations above current levels. The Administration has indicated that the additional funding would “go toward enforcement against those with the highest incomes, rather than Americans with actual income of less than $400,000.”
Comprehensive Financial Account Reporting
The Greenbook provides additional details on the Administration’s proposal to require “comprehensive financial account reporting.” Under this proposal, “financial institutions” would report on an annual information return gross inflows and outflows with a breakdown for physical cash, transactions with a foreign account, and transfers to and from another account with the same owner. This requirement would apply to all business and personal accounts, including bank, loan, and investment accounts, with the exception of accounts below a gross flow threshold of $600 or fair market value of $600. The reason cited by the Administration for this change is that it would increase visibility of gross receipts and deductible expenses of businesses. This proposal would be effective for tax years beginning after December 31, 2022.
This proposed account reporting would also apply to accounts “with characteristics similar to financial institution accounts.” In particular, the Administration is proposing that payment settlement entities would file a revised Form 1099-K for payee accounts. There would be similar reporting requirements under this proposal for “crypto asset exchanges and custodians.” Separately, reporting requirements would apply in cases in which taxpayers buy crypto assets from one broker and then transfer them to another broker, and businesses that receive crypto assets in transactions with a fair market value of more than $10,000 would have to report such transactions.
Baker Botts Notes:
- Large Businesses. Even large businesses that report all their income may face new challenges due to increased financial account reporting. For example, the IRS may raise new questions regarding cash flow, expenses, and matching accrual reporting with account inflows and outflows, as well as questions regarding transactions with foreign accounts and entities.
- Small and Mid-Sized Businesses. We expect the IRS to focus on reported gross inflows and outflows, so businesses may want to consider improving their accounting practices now if there are transactions within business financial accounts that are not currently being tracked.
- Crypto Assets Reporting Similar to Cash Reporting. This proposal would treat crypto assets similarly to U.S. dollars (cash) for reporting purposes despite the IRS treating crypto assets as property (and not cash) for tax purposes. Even taxpayers who do not use exchanges are subject to audit risk, as there would still be reporting requirements similar to those for cash for businesses receiving crypto assets in transactions with a fair market value of more than $10,000. Businesses who accept payments in crypto assets will need to comply with reporting either under, or similar to, currency transaction reports (“CTRs”). The failure to comply with CTRs carries with it substantial civil and criminal penalties, which would presumably apply to businesses accepting crypto asset payments.
- Collection. Increased reporting is likely to be helpful to the IRS in collections by providing information about which accounts a taxpayer has and can be levied.
- Unreported Gifts. Deposits that exceed reported income may not only be unreported income but may also be unreported gifts providing the IRS with a useful tool to identify otherwise difficult to discover unreported gifts.
- Cash. These new reporting rules would not affect reporting of cash transactions that are not deposited in applicable accounts. As a result, these reporting requirements may be less impactful than expected.
Increased Oversight of Paid Tax Return Preparers
While CPAs, attorneys, and other individuals who practice before the IRS are already subject to regulation by the IRS Office of Professional Responsibility under regulations known to as “Circular 230,”1 other paid tax return preparers are not. This proposal would provide Treasury the authority to regulate all paid preparers of Federal tax returns, including by establishing mandatory minimum competency standards.
The Administration is also proposing to increase penalties on so-called “ghost preparers,” which is a term used to refer to paid tax return preparers who fail to identify themselves on tax returns. Internal Revenue Code section 6695 currently provides a penalty of $50 for a paid tax return preparer who fails to sign a return or furnish his or her preparer tax identification number (PTIN). This proposal would increase the penalty to the greater of $500 per return or 100 percent of the income derived per return by the ghost preparer.
Expanded Requirement of Electronic Filing of Forms and Returns
The Administration is proposing to expand the requirement to electronically file forms and returns. Specifically, electronic filing would be required for the following returns: (1) income tax returns of individuals with gross income of $400,000 or more; (2) income, estate, or gift tax returns of all related individuals, estates, and trusts with assets or gross income of $400,000 or more in any of the three preceding years; (3) partnership returns for partnerships with assets or any item of income of more than $10 million in any of the three preceding years; (4) partnership returns for partnerships with more than 10 partners; (5) returns of REITs, REMICs, RICs, and all insurance companies; and (6) corporate returns for corporations with $10 million or more in assets or more than 10 shareholders. Electronic filing would also be required for certain forms, including Form 8886, “Reportable Transaction Disclosure Statement,” and Form 8918, “Material Advisor Disclosure Statement.” The reason cited by the Administration for this change is that expanding electronic filing will help provide tax return information to the IRS in a more uniform electronic form, which in turn will enhance the ability of the IRS to better target its audit activities.
Baker Botts Notes:
- Improvements to IRS Databases. This proposed expansion of the requirement to electronically file forms and returns should increase the efficiency of IRS enforcement and compliance activities and may increase the number of tax audits of flow-through entities. For example, the IRS uses a database called yK1 that links relationships from flow-through entities to tax paying entities, and the ability of the IRS to populate this database accurately should be improved by this proposed expansion of electronic filing.
- Identifying Returns for Audit. Similarly, electronic filing of Forms 8886 and 8918 should allow the IRS to identify more efficiently reportable transactions for audit. This proposed expansion of electronic filing should also reduce instances in which the IRS cannot locate forms or returns, as could happen with the paper versions. This proposal may help the IRS detect (i) lifetime transfers for potential inclusion in a decedent’s gross estate under Internal Revenue Code sections 2036 or 2038 by matching estate and gift tax returns after a taxpayer dies, (ii) disguised gifts or unreported income resulting from installment sales and private annuity transactions by matching disclosed non-gift transactions on gift tax returns with income/capital gains on income tax returns, (iii) transfers to annuity trusts and unitrusts where trust administration issues in subsequent years may affect the size or characterization of reported gifts or charitable deductions, and (iv) cases where accuracy-related penalties under Internal Revenue Code section 6662(k) may be imposed for inconsistent estate basis reporting.
Expanded Broker Information Reporting with Respect to Crypto Assets
The Administration is proposing to require “brokers who report on crypto assets to include reporting on certain beneficial owners of entities holding accounts with the broker.” This proposal would also “require brokers, including entities such as U.S. crypto asset exchanges and hosted wallet providers, to report information relating to certain passive entities and their substantial foreign owners when reporting with respect to crypto assets held by those entities in an account with the broker.” This proposed reporting would allow the United States to share such information with other jurisdictions in order to reciprocally receive information on U.S. taxpayers. This proposal would be effective for returns required to be filed after December 31, 2022.
Baker Botts Notes:
- Proposed Regulations. The Treasury Department has been working for some time on proposed regulations for brokers in virtual currency (RIN: 1545-BP71). These proposed regulations were initially slated for June 2020 but were delayed due to the global pandemic. We expect these proposed regulations, once published, to reflect the Administration’s proposals for brokers in crypto assets.
- Identifying Additional Taxable Transactions, But Not All. To the extent taxable transactions are occurring on exchanges, these proposed rules will identify all of these transactions, likely many that are currently unreported and are difficult for the IRS to discover outside of John Doe Summonses such as those issued by the IRS on Coinbase, Kraken, and Circle.
- Definition of Broker. The Greenbook proposal would be significant to the extent that it includes exchanges within the definition of “brokers.” At least some exchanges have taken the position that they are not brokers.
- Basis Reporting. This proposal could also raise issues for taxpayers to the extent that an exchange or other third party providing information to the IRS does not have information about the taxpayer’s basis in crypto assets. In 2019, the IRS had sent out mismatch notices (CP2000 notices) to virtual currency holders, identifying discrepancies between their tax returns and third-party information returns and asking for justification. Many of these taxpayers did not owe any taxes and were targeted because the IRS had third-party information only on gross receipts and not basis. We expect the same problem could persist under this proposal frustrating both taxpayers and IRS compliance efforts.
Elimination or Modification of Written Supervisory Approval of Certain Penalties
The Administration is proposing to eliminate or modify the requirement under Internal Revenue Code section 6751(b) for written supervisory approval of certain penalties. This proposal would eliminate that requirement under section 6662 for underpayments of tax, section 6662A for understatements with respect to reportable transactions, and section 6663 for fraud penalties. Under this proposal, penalties to which the requirement applies could be approved “at any time prior to the issuance of a notice from which the Tax Court can review the proposed penalty and, if the taxpayer petitions the court, the IRS may raise a penalty in the court if there is supervisory approval before doing so.” For any penalty not subject to Tax Court review prior to assessment, supervisory approval could occur at any time before assessment.
Baker Botts Note:
- Elimination of Approval Requirement for Certain Penalties. The approval requirement was added as part of the Internal Revenue Service Restructuring and Reform Act of 1998, and the legislative history indicates that it was enacted based on the belief that “penalties should only be imposed where appropriate and not as a bargaining chip.”2 If this proposal is enacted into law, it could again be a concern for taxpayers that penalties may be imposed in inappropriate cases.
Change to Adjustment Taken into Account by Partner Under “Push-Out” Election
The Administration is proposing a change to how adjustments are determined where a partnership has made the election under Internal Revenue Code section 6226 to “push out” adjustments to partners. The Greenbook explains that under current law, if the calculation of the adjustment to be taken into account by a partner results in a net decrease that exceeds the partner’s income tax liability in the reporting year, then any excess of that amount not offset with an income tax due in the reporting year at the partner level does not result in an overpayment that can be refunded. This proposal would change the law to provide that the amount of the net negative change in tax that exceeds the income tax liability of a partner in the reporting year may be refunded.
Baker Botts Note:
- The Greenbook notes that the reason for this change is that the inability for reviewed year partners to receive the full benefit of any reductions in tax as a result of partnership adjustments could lead to a partner being taxed more under the centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 (BBA) than outside of the centralized partnership regime. Under section 6221, partnerships with 100 or fewer partners can elect out of the centralized partnership audit regime. This change could make the centralized partnership audit regime more favorable, and those partnerships should consider the effect of this change when deciding whether to elect out of the centralized partnership audit regime.
Other Proposals to Improve Tax Administration
Other proposals to improve tax administration being proposed by the Administration include the following:
- Requiring that Form W-9s for all reportable payments be signed under penalties of perjury.
- Extending the statute of limitations on assessment for returns reporting benefits from listed transactions from three years to six years.
- Imposing liability on shareholders for unpaid income tax of certain corporations involved in “Intermediary Transaction Tax Shelters” under Notice 2001-16.
- Authorizing the sharing of business tax return information with other agencies “to measure the economy more accurately.”
We will continue to monitor developments and will provide further updates as more details are released. In the meantime, Baker Botts would be pleased to assist you in your analysis of these proposals.
1 31 C.F.R. §§ 10.0 to 10.93.
2 Williams v. Comm’r, 151 T.C. 1, 8 (2018).
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