This is the second entry in a two-part series setting the stage for tax developments to monitor this year. Part 1 featured predictions for the remainder of the lame duck session, as well as an analysis of how a split Congress may affect tax policy and the politicization of IRS realignment. Part 2 focuses on the agency itself and what is on the IRS’ plate in 2023.
Entering the new year, all eyes are on the IRS, an agency that has been beleaguered by customer service, operational, and enforcement shortcomings stemming from diminished year-over-year funding.
Changing of the guard.
On November 12, Chuck Rettig’s term as IRS commissioner ended. Rettig, who oversaw the IRS from 2018-2022, ruminated on the agency’s role in his farewell address.
“The IRS is more than a tax administration agency,” he wrote. “We make it possible for the government to perform its vital functions, helping fund the great work of our nation on everything from education and defense to our roads and other infrastructure.”
Rettig’s term coincided with the initial breakout of the COVID-19 pandemic, and the proceeding two years. In his goodbye, he emphasized the challenges the IRS faced in fulfilling its duties as tax collector and benefits administrator, while remaining grateful towards his staff. “At the same time, we realize that there is still much for us to improve on to help taxpayers and the tax system,” said Rettig. “Our employees know we need to do more.”
His tenure concluded a few months after the $80 billion additional appropriation to the IRS, which he long advocated for since the proposal’s initial release, was enacted in the Inflation Reduction Act (PL 117-169).
Doug O’Donnell, a 36-year IRS veteran, was brought up from his post as deputy commissioner for services and enforcement and was named acting commissioner in late October. Mere days later, O’Donnell spoke in his new capacity as interim head of the IRS at a tax conference in Washington, D.C. He tackled short-term plans to gear up for the next tax filing season, “wild inaccuracies” of claims about how the funding will be used, and the IRS’ commitment to wholesale modernization. Recognizing that now is the best chance the agency has had in over a decade to operate as a 21st Century government entity, he said everyone is taking its task to use the new funding effectively “very seriously.”
President Biden announced November 10 his intention to nominate Daniel Werfel—who previously served as acting IRS commissioner and controller of the Office of Management and Budget—as Rettig’s successor. A Senate confirmation hearing is pending.
On the same day, Senate Finance Committee Chair Ron Wyden, Democrat of Oregon, expressed his support with Biden’s pick. “Danny is committed to government that works and rebuilding the IRS, with a focus on modernizing decades-old technology and improving administration,” Wyden said in a statement. “He understands that American taxpayers deserve top-rate service, and will work tirelessly to achieve that goal.”
Representative Richard Neal, a Massachusetts Democrat who was chair of the House Ways and Means Committee when the announcement was made, also put his stamp of approval on Werfel. “Mr. Werfel will be charged with fulfilling the promise of the Inflation Reduction Act, and finally doing away with our two-tiered tax system that has allowed the wealthy and well-connected to follow one set of rules while everyone else follows another,” Neal also said in a November 10 press release. “Guided by his prior IRS and private sector experience, he will be able to hit the ground running, and I look forward to working with him. This nomination is critical to the nation’s faith and trust in the IRS, and I urge the Senate to take this up as soon as possible.”
Former Representative Kevin Brady, a Texas Republican who retired from Congress after the 2022 midterm election, indicated that Werfel may face an uphill battle quelling the nerves of Republican detractors. Brady said November 10 that to “gain support for his nomination Mr. Werfel will need to address several key questions: (1) How will he obtain the confidential taxpayer information that comprised last year’s massive criminal leak to ProPublica? (2) Does he support President Biden’s dangerous plan to surveil American bank accounts? (3) Will he cooperate with congressional oversight efforts, such as the pending requests related to the continuing large tax return backlog, Child Tax Credit administration, and the agency’s suspicious solicitation of millions of additional tax credit claims right before an election, among many others?”
If confirmed, Werfel will face certain hostility from a GOP-controlled House that already signaled well ahead of the midterms that should Republicans take the House, efforts will be made to, at the very least, revoke the inflation bill’s money set aside for hiring additional enforcement staff. Representative Kevin McCarthy of California, a front-runner for House speaker, said September 23 at an event in Pennsylvania that on “the very first day that we’re sworn in,” House Republicans will move to prevent “87,000 IRS agents” from being onboarded.
McCarthy was referencing a May 2021 Treasury report estimating that the $80 billion appropriation would yield about 87,000 new staff, which some Republicans have warned will all be assigned auditor responsibilities. O’Donnell dismissed that claim in his conference speech, reiterating as Rettig and Treasury Secretary Janet Yellen have that hiring across all areas of the agency—and not just enforcement—is a current priority. The Treasury report’s estimation, notably, was a total through a 10-year period.
“It is not possible to double the workforce in any component of our organization that has any size. It’s just not going to happen,” said O’Donnell, clarifying that the number of IRS auditors will not immediately multiply.
Yellen directed the IRS to, within six months of the inflation bill’s enactment, submit a spending plan for the $80 billion appropriation. The plan is due in February. An earlier version of the bill required such a plan, but the statutory requirement was nixed during revisions, prompting Yellen to retain the same deadline through her own authority.
The IRS’ waning and aging workforce has been a well-documented problem. In its fiscal year 2021 Progress Update, the agency reported that it “lost more critical full-time positions between FY 2010 and FY 2021, which included key enforcement personnel. These losses included Revenue Agents and Revenue Officers who audit returns and perform collection activities, as well as Special Agents in our Criminal Investigation organization who investigate tax related crimes and other issues.”
“Although our workforce increased since FY 2019, the IRS FY 2021 permanent workforce is still below the FY 2010 permanent workforce level,” the report added.
In its strategic plan for fiscal years 2022-2026, the IRS estimated that 52,000 employees are eligible to retire or resign within the next six years, and that the IRS’ attrition rate of 7.3% is higher than the average attrition rate of 5.8% for federal agencies. The agency said that recruitment and success strategies are in the works that will create a pipeline of incoming and future talent.
“Without this, the organization will lose vital institutional knowledge and face a workforce ill-equipped and understaffed to carry out its mission,” read the plan.
National Taxpayer Advocate Erin Collins stressed in her 2022 Objectives Report to Congress that workforce instability has been ongoing. “The size of the IRS workforce has declined significantly since FY 2010,” wrote Collins. “During this decline, the IRS has been unable to keep pace with its projected hiring, causing positions that help carry out its crucial mission of tax administration to go unfilled.” She added that each year, about 5,600 IRS employees leave for the private sector or another job.
“If the IRS does not make significant changes, these staffing shortages will compound and pose significant threats to the U.S. Treasury and indirectly harm taxpayer services and voluntary compliance,” said Collins.
One of the first signs relating to the use of the $80 billion came November 9, when the IRS announced that it is seeking to hire 700 customer service staff at its nationwide Taxpayer Assistance Centers. See IRS to Hire New Wave of Customer Service Reps (11/15/2022). On October 27, the IRS in a news release announced it hired 4,000 phone assistors. In recent years, partly due to COVID-19 limitations and increase call volumes, the IRS has only answered a small fraction of taxpayer phone calls.
The IRS’ customer service performance during the 2023 filing season will be closely monitored by oversight agencies, lawmakers, and policy organizations. Much of what hinges on the IRS’ success will be how the agency progresses in its efforts to improve technologies in its correspondences with taxpayers and practitioners.
Rob Kovacev, a member of Miller & Chevalier Chtd., told Checkpoint in an interview that he is looking forward to having “more digital communications with the IRS,” but that “there’s still a long way to go.”
“We’re in this unusual situation now where we have once in a generation tax reform that seems to happen every four years,” Kovacev said, explaining that radical changes to the Code creates uncertainty among taxpayers, which in turn leads to more calls to IRS help lines or to their preparers.
Kovacev anticipates an integration of artificial intelligence in tax administration (as well as enforcement, such as transfer pricing audits), which the IRS has thus far explored in the form of chat and voice bots to unclog the phones. The IRS will endeavor further down that road, as well as find ways to eliminate paper-based communications.
“I think I speak for all top tax practitioners when I say that I can’t wait to get rid of the fax machine,” Kovacev said.
What also remains to be seen is if the backlog of unprocessed tax returns will be cleared before 2022 returns start funneling in, particularly paper returns. While there was optimism that the outstanding inventory would be finished by the end of 2022, it appears processing is still behind schedule. According to a December 20 Treasury Inspector General for Tax Administration report, 9.6 million returns were awaiting processing as of October 28, compared to 10.8 million the previous year.
“Our assessment of the increased production levels (i.e., the number of returns processed) and inventory remaining to be worked indicates that the IRS will not meet all of its goals by the end of CY 2022,” TIGTA found. “As a result, the IRS will continue to have a backlog into the 2023 Filing Season.” TIGTA said that it expects the backlog to persist “because not all hiring goals were met (including goals for contract employees), the initiatives did not start until later in the filing season, the time it took to hire and/or train new or reassigned employees, and the time needed for those employees to become proficient.”
Per the IRS’ fiscal year 2023 Budget in Brief, the agency requested $14.1 billion, $2.2 billion (or 18.3%) more than the fiscal 2022 annualized continuing resolution level of $11.92 billion. The IRS’ budget priorities (normal annual appropriations aside from the $80 billion) are broken down into three objectives:
- Enhance Taxpayer Service—increase telephone level of service to at least pre-pandemic metrics, as well as upping in-person service.
- Critical Information Technology Operations—continue to “transform its technological landscape” and further progress on modernization with more sophisticated tools, both external services to taxpayers and professionals, and internal IT operations.
- Focused Strategies for Reaching Underserved Communities—partner with state labor and human services officials to “cultivate new opportunities for adults and students,” particularly those attending Historically Black Colleges and Universities, in the form of IRS employment training programs.
The IRS’ 2022-2023 Priority Guidance Plan year began July 1, but the plan document was not released until November 9. In it, over 200 guidance projects were outlined, but lacked projected deadlines. The latest plan added more than 60 new items from the prior year.
Checkpoint reported in August that there would likely be an emphasis on implementing tax provisions of the Inflation Reduction Act, such as the 15% corporate alternative minimum tax (AMT) and the two so-called Superfund excise taxes under Code Sec. 4661 and Code Sec. 4671.
Kovacev said that the energy tax credit provisions of the inflation bill are a “must-do for Treasury right now in terms of getting guidance out.” He said some of the credits have a “direct pay mechanism and some of them have a transferability mechanism, which is very rare for federal tax credits.” Because of this, according to Kovacev, it is a “top priority” for there to be guidance on how such energy credits work.
Kovacev expects associations and stakeholders representing various industries impacted by provisions of the inflation bill to continue weighing in on issues presented by the bill where “perhaps Congress didn’t provide any details.” He said that because there are “major changes” to the tax code in the Inflation Reduction Act, “taxpayers need answers, they need certainty. And Treasury is the only agency that can provide that.”
Guidance was sparse until the end of the year. Since the week of Thanksgiving, the IRS released the following:
- Proposed foreign tax credit regs
- Final centralized partnership audit regime regs
- Guidance on claiming clean vehicle credits for manufacturers and sellers
- Guidance on the sustainable aviation fuel credit
- Guidance on reporting transfers of publicly traded partnership interest
- Corporate AMT guidance
- Intention to release guidance on 1% stock repurchase excise tax
- Final regs addressing the exception for interests held by foreign pension funds
- Proposed foreign government income exemption regs
- FAQs on Form 1099-K reporting
- Proposed reg on retirement plan notification retirement plan notification
- Updated guidance on accounting methods for specified research or experimental expenditures
- A list of cars potentially eligible for the 2023 clean vehicle tax credit; commercial clean vehicle credit guidance; and related FAQs
It will be important to examine how closely IRS guidance implementing tax legislation like the inflation bill matches statutory language, according to Kovacev. He explained that a taxpayer, when considering whether to proceed with a tax challenge through litigation, may look at if a regulation does not agree with the statute, such as of the plain text says to do X but the underlying reg implies to not do X.
That same taxpayer “may see successful challenges to regulation coming up in federal courts around the country” and follow suit, a pattern that has “definitely led to an uptick overall in regulatory challenges,” Kovacev added. When bills are “drafted without sufficient consideration to certain to the ramifications for some taxpayers, there are definitely going to be issues that can’t be that can’t be addressed without guidance.”
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