The IRS is caught in the middle of a budget tug of war in Washington.
The debate seems to be fueled generally by concerns about the deficit, and more specifically in the House by concerns about the IRS’s role in the implementation of health care. However, cuts to the IRS budget could have far-reaching effects in ways that are not so obvious – ways that could adversely affect tax planning and business operations.
IRS Budget: Proposed and Enacted
H.R. 1(FY 2011 CR)
After several years of increases in IRS funding, H.R. 1, the FY 2011 Continuing Resolution passed by the House on February 19, would reduce the agency’s budget by $602 million compared to the FY 2010 enacted budget, by $1.089 billion compared to the Obama Administration’s FY 2011 budget recommendation, and by $1.740 billion compared to the President’s FY 2012 budget proposal. Further, Senate leadership has pledged support for the President’s proposed 5-year freeze on domestic discretionary spending.
How Cuts to the IRS Budget Could Affect Tax Planning and Business OperationsSimply put, a reduction in IRS funding may lead to an increase in the cost of doing business. As the nation’s revenue center, the IRS is responsible for processing tax returns, providing taxpayer services and enforcing the tax laws. Developing and issuing guidance (together with Treasury) on newly enacted legislation and pending or unresolved tax matters, helping taxpayers understand IRS policies and procedures, providing processing support, and examining tax returns are core functions that enable the IRS to fulfill these responsibilities. Cuts in IRS funding will affect the ability of the agency to conduct these activities in a timely manner and to maintain quality levels of service, and thus will affect the ability of businesses to understand and comply with changes in the tax law and new IRS administrative initiatives, as well as to successfully resolve pre-filing, filing and post-filing tax matters.
IRS Guidance Projects Could be DelayedSeveral significant tax provisions were enacted during the last session of Congress, including the Hiring Incentives to Restore Employment (HIRE) Act, containing a series of offshore compliance measures known as the Foreign Account Tax Compliance Act (FATCA); the Patient Protection and Affordable Care Act (health care), which included codification of the economic substance doctrine and information reporting; the Education Jobs and Medicaid Assistance Act, including a group of international provisions; the Small Business Jobs Act of 2010; and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, with extenders and temporary estate tax relief.
Many of these statutes address very technical and complex aspects of tax law, and substantial regulatory authority was granted to the Secretary of the Treasury to implement them. Without such guidance, it will be difficult or impossible for businesses to know what they need to do to gear up for them, or to understand and assess their effects on business results and tax burden. Regulations and other guidance projects will heavily influence the economic impact of the new legislation on businesses and the scope of the actions necessary to comply with them.
Reductions in IRS (and Treasury) funding may result in guidance being significantly delayed or not issued at all, and the quality of the guidance also could suffer. This could lead to increased costs for businesses that attempt to comply based on their understanding of the statutory language, but then learn they made strategic or operational mistakes that they may not be able to undo, or only at substantial cost. Staff that is spread too thinly may curb the ability of stakeholders to have meaningful input into the guidance process, resulting in insufficient development of fact patterns and business practices that will make implementation difficult and more costly. Staff assigned to a guidance project not in their area of expertise may lead to inefficiencies and inadequate pronouncements. Delays and insufficient vetting will result in planning uncertainty, insufficient time to assess the effect on business operations, guidance that cannot be administered because it does not accurately reflect business practices, and costly last-minute rushes to be ready once the regulations are issued.
Administrative Policies and Procedures May Be Adversely AffectedBusinesses also may incur additional costs and burden if the IRS is unable to continue certain “taxpayer-friendly” IRS administrative policies and procedures, including the popular Compliance Assurance Process (CAP) and Industry Issue Resolution (IIR) programs. Both programs are intended to resolve tax disputes and other matters on a pre-filing basis – before the tax return is filed – in order to reduce taxpayer (and IRS) burden by avoiding more costly and difficult post-filing audits and other disputes. Because these programs are resource-intensive, cuts to the IRS budget may jeopardize not only making these programs accessible to more taxpayers, but also the ability of the IRS to continue operating these programs even on a more limited basis. Alternatively, the IRS might institute or increase user fees to continue to offer certain taxpayer services and guidance.
The ability to understand and comply with the IRS's new uncertain tax positions policy also may be affected by reductions in the budget. Uncertainty regarding this highly controversial initiative has raised many questions for affected taxpayers who fear the disclosure of uncertain tax positions will be used by the IRS as a roadmap for the audit plan. Strains on staffing and other agency resources may affect the IRS’s ability to provide businesses with sufficient guidelines to understand and meet the reporting obligations associated with this new policy. Yet, due to budget constraints, the IRS may rely even more heavily on the information included in these disclosures to identify issues to be examined, creating a Catch-22 situation that could be very costly to businesses.
Additional Effects of Reduced IRS FundingWhen IRS funding is tight, hiring and training budgets are among the first to be cut. These reductions could have tangible and significant effects on businesses. The inability of the IRS to hire staffing to replace vacancies resulting from retirements and other attrition, or to educate the existing workforce on tax law changes and specialized industry issues, may result in higher costs and significant burden to taxpayers. Budget cuts may manifest themselves in longer, more protracted examinations where the taxpayer must “train” the agent about industry-specific practices and issues, unnecessary information document requests and notices of proposed adjustments, “fishing expeditions,” and delays in resolving pending or disputed tax matters. Another practical implication of reduced funding may include decreased access to dedicated IRS service center contacts by large taxpayers that facilitate quick and efficient resolution of filing, processing and posting issues. Reduced funding also could be expected to delay planned upgrades to the IRS’s antiquated information systems, some of which are still using 1960s technology and that the GAO perennially includes on its annual list of high-risk programs in the federal government.
These are just a few examples of how proposed reductions in the IRS budget could result in higher costs and greater burden for US businesses. Please contact Mary Baker or Patrick Heck of the tax policy group at K&L Gates with questions regarding the specific effects of cuts to IRS funding on your business.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.