As the 2022 tax season gets underway, many individuals and families are now busy gathering their tax documents and wondering what the results of their 2021 tax filings will yield. In the back of many taxpayers’ minds is an uneasy feeling that they may be one of the unfortunate few to have their returns audited by the IRS.
However, taking a closer look at the current state of the IRS, it is clear that the agency has many systemic issues and pandemic-related challenges, which have hindered their enforcement efforts in recent years and will continue to do so in the near future. Those thinking that the lack of scrutiny will last forever, though, may be in for a rude awakening.
Understaffed and underfunded.
The root of the IRS’s current issues stems back to a decade of funding cuts and lack of resources, which has led to a reduction in their workforce and extremely antiquated computer processing systems. Look no further than the 24 million paper-filed tax returns from the 2020 tax year that still need to be manually processed by IRS agents, a problem they expect to persist through the end of 2022, if not longer.
While millions of timely filed paper tax returns are awaiting processing, the legacy IRS computer systems are spitting out millions of notices for unfiled tax returns and supposedly unpaid tax liabilities. As taxpayers and practitioners look to resolve these notices, written responses and phone calls to the IRS are going unanswered. According to Money.com, only 11% of the 282 million phone calls received by the IRS in 2021 were answered. This has led to a swelling of taxpayer anger and frustration, not to mention an earful for congressional representatives.
New challenges.
The immense pandemic-induced government stimulus and the IRS’s responsibility for determining eligibility and payment have put the agency even further behind.
The agency was tasked with drafting new forms and regulations to incorporate the tax consequences around the stimulus payments into taxpayers’ tax returns. While systems were hastily put into place, the repercussions of taxpayers seeking missing stimulus checks and credits that they did not receive are only in the early stages of being felt. The additional taxes, penalties, and interest related to the unintended consequences of the stimulus payments and credits are also around the corner as taxpayers begin filing their 2021 tax returns throughout 2022.
The incredible rise of cryptocurrency and digital assets like NFTs over the past year also has the high likelihood of further draining the IRS’s resources over the coming years. Digital assets are an incredibly complex and quickly evolving area of finance. While the IRS has taken steps over the past few years to acknowledge their existence and provide some guidance on treating certain transactions for tax purposes, they are falling further and further behind in their efforts as the environment changes almost daily.
Changes are coming, eventually.
Congress and the IRS have become acutely aware of their shortcomings over the past few months. The Biden administration proposed a significant funding injection for the besieged IRS through the Build Back Better Plan, which, despite being knocked down at the end of 2021, is picking up steam in smaller pieces in 2022. The administration also recently put the public on notice by creating a task force that will focus on regulating the cryptocurrency and digital asset industry. The task force will almost certainly include new tax regulations—and subsequent enforcement—as part of their efforts.
The IRS has also looked inward, recently suspending the mailing of many of the computer-generated notices that have (1) been caused by their internal processing issues and (2) led to the huge influx of written and phone call responses to those notices from taxpayers and practitioners, further draining human resources from the Service.
Slow- but not stupid.
There is an old adage that “the IRS is slow, but not stupid.” In our opinion, never has that warning been more important to heed than now. With the eventual bipartisan support of bolstering the IRS on the horizon, and the acute need to step up enforcement and collection efforts to address our ballooning federal deficit, the IRS will undoubtedly get around to auditing taxpayers again. When that happens, they will likely have a close eye on tax years about to expire due to the three-year statute of limitations, or perhaps returns even further back if they have reason to suspect a material misstatement or fraud. The explosion of digital assets in 2021 will make it a keen year of interest to the IRS as well. You just might not see the tax notice in your mailbox until early 2025.
Additionally, it is important to note that many state tax agencies are much better positioned from personnel and system standpoints. They have just as much interest in making sure that taxpayers accurately report their income as the IRS does. As taxpayers spent the last few years working remotely and across state lines, states like New York and California are eagerly awaiting filling their coffers by challenging residency claims and allocations of income.
Proceed with caution.
While many taxpayers are tempted to look at the current state of the IRS as an opportunity to dodge a tax liability, we urge everyone to remember the previously mentioned adage. The IRS is slow, not stupid.
With the personal stresses of a pandemic and geopolitical turmoil all around us, the last thing anyone needs is an audit letter from the IRS and to have to navigate through a broken, underfunded system to get a resolution. There’s invaluable peace of mind knowing your taxes were filed accurately and that there are no material liabilities or costly penalties lurking around the corner for the next few years.