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The Battle Between Tax Cheats and the IRS Is About to Heat Up

The agency says an army of new auditors could help raise as much as $1 trillion by forcing tax evaders to pay their fair share.

(Bloomberg) -- For the first time in years, rich Americans who cheat on their taxes face a growing threat from the Internal Revenue Service.

And, despite the Republican Party's best efforts to invoke the tax bogeyman in this month's midterm elections, it's a menace that's unlikely to go away.

At issue was the $80 billion earmarked to the IRS over the next decade in President Joe Biden's Inflation Reduction Act. Advocates argued reinvigorating the agency after a decade of debilitating budget cuts would raise as much as $1 trillion by forcing tax evaders to pay their fair share; opponents doubted their estimates and decried paying tens of thousands of agents to pick apart Americans' finances.

Charles Rettig, the IRS commissioner appointed by former President Donald Trump, made little secret where he stood after overseeing an agency with the fewest experienced auditors since World War II.

He often expressed his long-held wish through a reference to HBO’s Game of Thrones: “Funding to bring on the fire-breathing dragons.”

His term expired days after the 2022 midterms, and just before it became clear on Wednesday which party would control each chamber of Congress: Democrats retained a slim majority in the US Senate, while Republicans eked out more House seats. Democrats' better-than-expected margins make it more likely that former acting Commissioner Danny Werfel — Biden's nominee to succeed Rettig — will keep getting the money in future years.

“Overseeing the implementation of these investments will be a big focus in the next Congress,” Ron Wyden, an Oregon Democrat who chairs the Senate Finance Committee, said in a statement Wednesday.

Wyden and his allies have argued new employees are needed to help the IRS keep up with high-priced advisers of the ultra-rich and their complex tax strategies. Of the $80 billion, $45.6 billion is devoted to increased enforcement, which the Biden administration has vowed to target only at the well-off. Much of the new enforcement money will go toward technology, like hiring data scientists to deploy artificial intelligence to identify who should — and shouldn’t — be audited.

No one knows how many Americans are cheating on their taxes, and the rise of cryptocurrencies makes past estimates even more questionable. An IRS study released in October, based on random audits from 2014 to 2016, found Americans owe almost $500 billion more each year than they pay. Recent academic research suggests the number could be higher, with the richest Americans using offshore structures and private businesses to hide more than a fifth of their income from the IRS. Salaried workers have fewer options to cheat, since their income is reported automatically.

Despite perceptions of widespread cheating by businesses, the vast majority comply with the law, said Brian Reardon, president of the S Corporation Association, which represents privately owned companies that file their taxes on individual — rather than corporate — tax returns.

`Magic Money’

By boosting enforcement, “they’re not going to get this ‘magic money’ that they think,” Reardon said, arguing the extra auditors may even backfire. “If you dial up enforcement on people who are otherwise following the rules and paying what they owe, you create resentment and anger. You undermine people’s confidence in the tax system.”

Advocates of more funding argue that the combination of dubious tax strategies among the wealthy and plunging audit rates on that same group makes it likely that many people and corporations are slipping through the cracks.

Should he be confirmed as the next IRS commissioner, Werfel will be charged with deploying the funds while managing a workforce and technology system suffering from years of cuts. In the past 12 years, the IRS has lost more than 23,000 employees. Another 50,000 of its roughly 80,000 workers are projected to retire by 2027.

“The IRS is going to have to be very strategic in the way it allocates those resources,” said former IRS Commissioner Charles Rossotti.

With Republicans holding a narrow majority in the House and promising increased oversight, Werfel, currently a global leader at Boston Consulting Group, will need to answer to conservatives and business lobbyists who have excoriated the IRS for decades.

Rossotti, who served when the IRS was also under attack from 1997 to 2002, estimates he was called to testify before Congress almost 50 times. His advice to Werfel is to try to defuse any criticism with candor.

“You have to try to be very careful and very honest and forthcoming about what you’re doing,” said Rossotti, who’s now at private equity firm Carlyle Group Inc. “It’s a big part of the job.”

Though nominated by Trump, Rettig — a veteran Beverly Hills, California, tax lawyer — lobbied vociferously for the Biden administration’s funding proposal, and warned his former colleagues to be careful how they advised wealthy clients.

“This is not the same old IRS,” he told a roomful of New York’s most sophisticated tax practitioners this year, saying the agency is scrutinizing a range of “abusive” transactions by the ultra-rich and boosting sanctions on tax advisers who lead clients astray.

He also defended his employees when false claims circulated that the agency was hiring thousands of “armed” agents. Only a fraction of them ever carry weapons, and the 3,000-employee criminal investigation unit — the subject of the rumors — has lost a quarter of its staff in 12 years.

These investigators, Rettig frequently noted, are responsible for tracking sanctioned Russian oligarchs, policing the theft of cryptocurrencies and cracking down on child exploitation. The unit shut down the largest online criminal marketplace in April and seized a record $3.6 billion of stolen digital currencies in February.

More pressing for wealthy Americans and their advisers is the prospect that the Biden administration could use the $104.5 million earmarked for the Treasury’s Office of Tax Policy to hire legal staff to write new regulations shutting down questionable tax-avoidance strategies. A document released this month sets out more than 200 separate priorities that could get attention in the coming year, including rules for digital assets and charitable tax breaks.

Advisers are preparing for more IRS scrutiny, though many tax lawyers and accountants say they’re also hopeful the extra funding can repair its customer service, which hit crisis levels during the pandemic.

“These resources are going to be transformative" in terms of improved customer service, said Natasha Sarin, a US Treasury counselor for tax policy and implementation, adding the IRS “is going to be an exciting place to work, and that’s how you recruit top talent.”

“Obviously audits are going to go up,” said Eli Akhavan, a partner at Steptoe & Johnson in New York. But he tells his high-net-worth clients “you have nothing to worry about other than some headaches” as long as you follow good advice and “have all your ducks in a row.”

”If there’s nothing to find, there’s nothing to find,” he said.

To contact the author of this story:
Ben Steverman in New York at [email protected]

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