Treasury issues Guidelines for Shrinking Tax Gap

The Treasury Department has released guidelines for how the Biden Administration intends to close the Tax Gap, which is the difference between the taxes that are owed and what is collected.

Treasury estimates that in 2019 the Tax Gap totaled nearly $600 billion and will rise to roughly $7 trillion over the next ten years if the Tax Gap is not addressed. This equates to roughly 15% of the taxes that are owed not being collected, according to Treasury estimates. 

“The magnitude of the Tax Gap means that compliance initiatives have the potential to raise substantial revenue,” the Treasury Department stated in its report titled “The American Families Plan Tax Compliance Agenda,” which was released on May 20^th.

The American Families Plan fact sheet that the Administration released in late April proposed gathering additional revenue through increased tax enforcement on taxpayers earning more than $400,000 a year. Those actions are expected to “raise $700 billion over 10 years,” the Plan states, but it did not provide details on the actions that would be taken.

Shortly after the Plan was made public, the Treasury Department released a short report on the steps that would be taken to improve tax compliance:

• Regulate paid tax preparers.
• Improve taxpayer service and deliver tax credits.
• Overhaul outdated technology to help the IRS identify tax evasion.
• Provide the IRS with more complete information.
• Provide the IRS the resources it needs to stop sophisticated tax evasion.

Today’s report includes the same steps, but it also adds more meat to the bones.  Regarding the regulation of tax preparers, it proposes increasing penalties on preparers that “commit or abet evasion.” This includes “additional penalties for ghost preparers.”  It would also provide “the IRS with the authority to regulate and establish minimum competency standards for all paid tax preparers.”

When combined, increased compliance efforts would collect $700 billion in additional tax revenue over the next ten years, and roughly $1.6 trillion in the following decade, according to the Treasury’s Office of Tax Analysis.

It should also be noted that the “American Families Plan” proposes tax increases, which include:

• Raising the top income-tax rate to 39.6% from 37%.
• Raising the top tax rate on capital gains and dividends to 39.6%% from 20%. This rate does not include the Net Investment Income Tax (NIIT).
• Expanding the 3.8% NIIT to apply to types of income currently not subject to it. The fact sheet does not provide details. It states that “high-income workers and investors generally pay a 3.8 percent Medicare tax on their earnings, but the application is inconsistent across taxpayers due to holes in the law. The President’s tax reform would apply the taxes consistently to those making over $400,000, ensuring that all high-income Americans pay the same Medicare taxes.” This proposal would primarily affect passthrough owners that are active participants in the business.
• Ending the step-up in basis for gains of more than $1 million at death. This would be $2.5 million per couple when combined with the $500,000 real estate exemption. Family-owned businesses and farms would be shielded from this tax increase, according to the fact sheet. The estate tax and exclusion were not changed, according to the fact sheet.
• Ending the tax deferral of like-kind exchanges over $500,000.
• Eliminating the "carried interest" tax break. This change seems to only pertain to hedge fund partners, according to the fact sheet.
• Permanently extend the limitation of excess business losses from the 2017 tax reform bill.

The American Families Plan does not include effective dates for any of the proposals. Such information could be a part of President Joe Biden’s budget and Greenbook, which details the president’s tax proposals. Both publications are expected to be released next week. Still, effective dates are only enforceable if Congress puts them into legislation that is passed and signed into law by the President. So far, no legislation has been introduced that addresses any of the aforementioned proposals.