The current plan for financial account information reporting appears to be to collect information first and figure out what to do with it later. There's still no proposed legislative text being considered publicly by Congress, but lawmakers have indicated that a variation on the Biden administration proposal will be in the reconciliation bill as an offset provision. No one has offered a complete answer to the central questions of what will be done with annual gross inflow and outflow account information, or why collecting information from the accounts of all taxpayers — regardless of the risk that they might be underreporting income — is preferable to a more targeted and less invasive alternative.
The outline of the administration’s proposal contemplates collecting gross annual inflow and outflow data from nearly every account held at a financial institution in the United States. Various limits have been suggested to narrow that to a subset of accounts based on a threshold level of cash flow or the total income of the account holder. One of the possible concessions that has been floated is to raise the threshold gross cash flow below which accounts wouldn't be reported from the $600 threshold that the administration proposed to $10,000. Another is to have banks report only on the accounts held by taxpayers with incomes over $400,000.
However, those limitations don’t solve the fundamental problem with this proposal — that it would capture far more data than would be necessary to accomplish its goals, and yet it wouldn't capture the information the IRS would need to readily identify tax mistakes or misdeeds. The information it would give the IRS would only suggest possible situations in which taxpayers had underreported or unreported income. And while it could be used to help eliminate taxpayers from the pool of potential audit candidates, that isn’t a guarantee under the rough outlines of the plan.
The stated goal of the policy, whatever form it may ultimately take, is to ensure the collection of tax due from high-income taxpayers with business income. If that's the goal, the proposal is overbroad because most taxpayers don't have any business income of the types that are the likeliest to be underreported.
The income types that are most likely to be underreported because of a lack of third-party reporting include non-farm proprietor income, rents and royalties, farm income, and income that should be reported on Form 4797 from the sale of business property. IRS data show that in 2017, almost 72 percent of all individual income tax returns had no small business income or losses. Even assuming that some small businesses fail to report any income or losses, most taxpayers pose no risk of underreporting business income because they don’t have any.
The estimates for this proposal in Biden’s budget plan increase over the 10-year budget window, nearly doubling from $32.4 billion to $62.7 billion in deficit reduction in the years between 2023 and 2031. There's also an expected huge leap between the projected $8.4 billion the provision could raise in 2022 and the $32.4 billion in 2023. That leap in collections is likely attributable to the deterrent effect the new policy would have on taxpayers who know they aren't in compliance. Many of those taxpayers might be expected to voluntarily get into compliance in the first year or so of the policy taking effect. Of particular note is the projected near-doubling of the revenue over the rest of the decade, which could be attributable to the IRS adding revenue agents and training them, as well as the collective experience they would gain over time that would allow them to be more effective at uncovering underreported income.
Taxpayer Data Privacy
One of the arguments for the reporting proposal is that it protects taxpayers’ privacy because the IRS wouldn’t share taxpayer information with financial institutions. That argument is based on a prior proposal in which the IRS would have identified for banks which of their account holders had incomes above an established threshold, probably $400,000, and required reporting only on those taxpayers’ accounts.
That version of the proposal would have resulted in less IRS information collection overall, but it would still have suffered from the same problems as the much broader version being considered. Broadening the scope of reporting so that banks simply report on every account held by a taxpayer with income over $400,000 is an insufficient response to the general and future privacy problems that the proposal raises because how the IRS will handle the data is a legitimate privacy concern.
The IRS makes mistakes in its custodianship of sensitive taxpayer data. In a recent report, the Treasury Inspector General for Tax Administration noted that the IRS failed to fully implement an encryption security measure that TIGTA had identified as a weakness three years earlier. The IRS hadn’t been encrypting taxpayer information that was sent to outside contractors in order for the contractors to collect tax debts. The IRS made some changes and deemed TIGTA’s recommendation completed, but TIGTA’s subsequent study determined that the information hadn’t been encrypted.
Those types of missteps are directly relevant to the proposed collection of taxpayers’ financial account information because the IRS would likely use outside contractors to do some of the data analysis that would be necessary for the information to be used. Taxpayers and their elected representatives in Congress should know what the plan is for ensuring that data is carefully safeguarded and how it is being processed.
What Will the IRS Do With Taxpayer Data?
How the data proposed to be collected would be processed and potentially evaluated is important because the IRS is prohibited under section 7602(e) from using “financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the Secretary has a reasonable indication that there is a likelihood of such unreported income.” That prohibition should constrain the IRS from using much of the financial account information because it won’t have the required reasonable indication of a likelihood of unreported income that triggers the authority to use financial status techniques on all the newly collected data.
Accordingly, if the IRS were to begin collecting financial account gross inflow and outflow data, it would effectively become a repository of sensitive, but largely unused, information. As Steven Rosenthal of the Urban-Brookings Tax Policy Center pointed out, “For the IRS to use the information, Congress would need to amend the law, yet it seems unnecessary.”
Congress added section 7602(e) in the Internal Revenue Service Restructuring and Reform Act of 1998 with Republican majorities in both the House and Senate, and President Clinton signed it into law. The bill explained that its purpose was to restate the IRS’s mission “to place a greater emphasis on serving the public and meeting taxpayers’ needs.” It was intended to change the IRS’s “organizational culture, restructure, modernize, and improve taxpayer protections and rights,” as TIGTA explained in a review of the bill’s implementation.
The justification for section 7602(e) was that financial status audit techniques are intrusive and should be limited to situations when the IRS already has indications of unreported income. Computational developments in the years since 1998 that make it increasingly possible to analyze and synthesize large quantities of data haven’t changed the fundamental question whether financial status or economic reality examination techniques are intrusive. To the contrary, the increased computational power that can be applied to data makes these types of investigative techniques much more intrusive than they were before 1998.
Ensuring that taxpayers pay the taxes they owe is critical, and it's reasonable to focus on specific types of business income that tend to be underreported. The IRS could benefit from added statutory tools to aid its efforts to ensure compliance in those areas. But comprehensive information reporting on essentially every taxpayer’s financial accounts is far too broad to effectively achieve the stated goal and presents potential risks that Congress hasn’t explored.