The IRS Strategic Operating Plan’s potential impact on taxpayers

In April, the Internal Revenue Service (IRS) released its Strategic Operating Plan (the Plan), with an overall objective of “deliver[ing] a best-in-class experience for taxpayers.”[1]  As outlined in the 146-page Plan and discussed below, the IRS seeks to utilize over half of the $80 billion provided by the Inflation Reduction Act toward enforcement, particularly with respect to large partnerships, large corporations (including multinational corporations) and high-income/high-wealth individuals (Targeted Taxpayers).

Since 2010, the IRS budget has decreased 22 percent. As noted in the most recent Internal Revenue Service Advisory Council (the IRSAC) Public Report, issued in November 2022 (the 2022 IRSAC Report), “[o]ver the past several years, numerous stakeholders – including the IRSAC – have encouraged higher and more sustained, multiyear IRS funding to enable improved IRS taxpayer services, enforcement and modernization.”[2]

The IRS describes the August 2022 Congressional enactment of the Inflation Reduction Act, authorizing $80 billion in funding to the IRS over the next decade, as providing “a historic opportunity to transform the administration of the tax system and the services provided to taxpayers.”[3] Tax revenue collected by the IRS is the primary source of funding for operations of the United States government, and the IRS anticipates that the $80 billion in funding will increase federal revenue by an amount in excess of the Congressional Budget Office’s estimate of $180 billion over the next decade.

The Plan, which includes a “[h]igh-level roadmap” of 200 “target milestones” over the next five (fiscal) years,[4] sets forth five interrelated objectives relating to both enforcement and service.  In response, National Taxpayer Advocate Erin Collins commented “[a]s always, the devil is in the details, and the proof is in the pudding.  Developing a plan and successfully implementing it are two different things.”[5]  The Plan’s five overall objectives, supported by a series of initiatives and projects aligned to each are:

The success of each objective essentially depends on the success of the other four objectives, as evidenced by the summary of allocations of funds, set forth below.  In his memorandum accompanying transmission of the Plan to Treasury Secretary Werfel, IRS Commissioner Daniel Werfel cautioned that implementation of the Plan also depends on “sustained annual resources for IRS operating costs.”[6] Commissioner Werfel echoed this in his testimony during an April 19, 2023 Senate Finance Committee hearing on the IRS’s fiscal 2024 budget. 

The IRS’s allocation of $80 billion in funding

As noted above and set forth below, the IRS’s Plan includes estimates of how the funds will be allocated.  

IRS targets large businesses, high-income/high-wealth individuals

As indicated above, the focus of increased enforcement efforts will be on large partnerships, large corporations (including multinational corporations) and high-income and high-wealth individuals with complex tax filings and high-dollar issues.  In acknowledging this focus, the Plan notes that audit rates for Targeted Taxpayers have decreased in recent years due to limited resources.  For large corporations, the audit rate has decreased from 10.5 percent in 2011 to 1.7 percent in 2019.  For large partnerships, the audit rate has decreased from 0.5 percent in 2011 to 0.1 percent in 2019 while the number of partnerships with assets exceeding $5 million has increased by 75 percent.  For individual taxpayers earning $1 million or more the audit rate has decreased from 7.2 percent in 2011 to 0.7 percent in 2019.

The focus on Targeted Taxpayers tracks the Treasury Department’s stated objectives as set forth in an August 10, 2022 letter from Treasury Secretary Janet L. Yellen to then Commissioner of the IRS Charles P. Rettig.  Instead of an increase in audits of households earning $400,000 or less annually, Secretary Yellen wrote in her letter:

[E]nforcement resources will focus on high-end noncompliance.  There, sustained, multi-year funding is so critical to the agency’s ability to make the investments needed to pursue a robust attack on the tax gap by targeting crucial challenges, like large corporations, high-net-worth individuals and complex pass-throughs, where today the IRS has resources to initiate just 7,500 audits annually out of more than 4 million returns received.[7]

As is clear from Secretary Yellen, the Plan’s focus on Targeted Taxpayers, which the IRS indicates is intended to help close the so-called “tax gap,” will likely increase the number of audits for such taxpayers. 

Noting that “[l]arge corporations have complicated, voluminous tax filings that involve a variety of tax issues such as cross-border activities, financial product issues and transfer-pricing transactions,” the Plan recognizes enforcement related to such filings requires specialized knowledge, more time, and significant resources to examine these types of taxpayers.[8]  Therefore, it is not surprising that the IRS plans to increase hiring of specialists, such as data scientists, auditors, lawyers, international and financial products specialists, economists, and engineers.  An IRS target milestone relating to such enforcement is to complete a “wave” of initial hiring of specialists in FY 2023 to begin working toward increasing enforcement coverage rates for Targeted Taxpayers.[9]  Therefore, we anticipate that there will be a notable increase in the number of such taxpayers who will be subject to IRS examination as the IRS continues to expand over the next few years. 

In focusing its increased enforcement efforts on Targeted Taxpayers, the IRS also plans to leverage its investment in technology and analytical tools as provided for in Objective 4 (related to delivering cutting-edge technology, data, and analytics to operate more effectively) to streamline its efforts.  Specifically, the IRS anticipates that improved data analytic tools will help identify potential issues for enforcement by analyzing specific types of tax filings and types of taxpayers. 

We expect that the IRS’s focus on increased enforcement with respect to Targeted Taxpayers will also impact the IRS’s Large Business and International division’s (LB&I) collaboration with international taxing authorities.  LB&I manages the IRS’s relationship with the Organisation for Economic Co-operation and Development (OECD), including membership in the Forum on Tax Administration (a network of over 50 global tax administrations that identify and discuss global tax trends and work together to provide tax certainty for multi-national taxpayers) and the IRS’s involvement in the Joint International Taskforce on Shared Intelligence and Collaboration (which coordinates efforts to combat tax avoidance with tax administrations from more than 40 jurisdictions).

Increasing collaboration among tax authorities across borders will likely lead to more information sharing, multi-country task forces, joint audits and initiatives like the OECD’s International Compliance Assurance Programme (ICAP).  This trend is set to continue as new international treaties seek to converge and harmonize domestic rules governing the taxation of multinational companies and business owners as well as their enforcement.

A possible silver lining of the increased hiring and training of specialists focusing on Targeted Taxpayers may be more streamlined examinations and more productive dialogues between tax professionals and the IRS audit teams, as well as more productive engagement with international taxing authorities, which may help to ensure proper tax treatment of multinational taxpayers.  In that regard, in focusing on Targeted Taxpayers, the IRS plans to utilize tailored solutions in addressing and resolving tax issues specific to particular taxpayers, which may provide opportunities for creative dispute resolution. 

Going forward

In the wake of historical multi-year funding, taxpayers, including Targeted Taxpayers, should benefit from improvements in customer service and access to IRS resources.  However, Targeted Taxpayers will likely also face increased enforcement actions and increased disputes with the IRS.  Although the IRS states that its increased enforcement efforts are designed to ensure compliance with the tax laws, taxpayers and the IRS are sure to disagree from time to time as to what constitutes compliance, particularly as to their interpretation of the tax laws and the correct application of such laws to particular taxpayers’ set of facts and circumstances.

Taxpayers are encouraged to work with tax advisors, particularly those with experience in tax controversies and disputes, to help them navigate all aspects of the complex tax dispute process, from proactive audit risk planning during structuring of transactions through interacting with the IRS, with the goal of limiting potential disputes and exposures.

To receive the sources for any of the information mentioned in this alert, please contact any of the authors.