$80 Billion to the IRS – Impact on Self-Directed IRAs – Episode 350

Adam Talks

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses one of the provisions in the Inflation Reduction Act, $80 billion going to the IRS, and how it may impact Self-Directed IRA investors.

$80 Billion to the IRS – How Will that Impact Your Self-Directed IRA?

Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial, and on today’s Adam Talks, looks like the IRS is going to get a bundle more money and seeking to hire tens of thousands of new IRS agents. Should we all be worried? And how will it potentially impact your IRA? So, here we go.

The Inflation Reduction Act, which was just passed by the Senate, Democrats essentially, because no Republicans voted for it, just last week. And there’s a lot of provisions in this bill, including climate, health and tax-related provisions. But, the one specific provision I wanted to talk about today is the $80 billion that will be going to our favorite organization, the Internal Revenue Service. Just to be clear, there are no other Self-Directed IRA or 401(k)-related provisions in this bill. Yes, back in September of 2021, there was a period where there were some pretty nasty provisions in there that could and would have limited the powerful impact of Self-Directed retirement accounts. But thankfully, those provisions were removed quite quickly and they are nowhere to be found in the Inflation Reduction Act.

But, $80 billion are going to the IRS and this bill passed the Senate, it’s going to pass the House, and Biden will sign it in the next couple of months; so, that is guaranteed. Senator Sinema of Arizona, she pushed back on the carried interest. It was very, very close for private equity/hedge fund/venture capital managers that they potentially could have seen their very powerful and rewarding carry interest, that is currently taxed as a capital gain, have the holding period, which is currently three years, be moved to five years, which would have curtailed a lot of the benefits of the carried interest. That was kicked out thanks to Senator Sinema. And basically as a concession, this is where we stand now.

But, the Democrats were fine sending $80 billion to the Internal Revenue Service. And again, the idea is that, listen, facts are the facts; the government feels that they could bring in more revenue if they examine more people’s tax returns. And honestly, the IRS is in bad shape. They feel that for every dollar they spend, they can bring in $10 of revenue. So, if you’re a business person, that makes a lot of sense. If you’re a Democrat and you want to raise money for all your other programs, taking that formula into account, you can see why they allocated $80 billion to the IRS and we’ll see how much is going to enforcement. But the idea is that, hey, every dollar we spend, we’re going to bring in at least $10 in revenue. That helps pay, at least on paper, we’ll see what happens in reality, but on ,paper it helps to pay for a lot of programs without increasing taxes and increasing the deficit.

So, where does the IRS stand today? So, more than half of the IRS audits in ’21 were directed at taxpayers with income less than $75,000. Yeah, they’re not going after the Peter Thiels or the Warren Buffetts or the Jeff Bezos. They’re going after little guys; people that make less than $75,000. More than four in ten of its audits, so 40% of its audits, more than 40% of IRS audits target recipients of the Earned Income Tax Credit, which basically goes to low income people. And that’s one of the country’s main anti-poverty measures. So, they’re going after low hanging fruit. They’re going after people that make less than $75 grand and make sure they’re properly reporting their earned income credit. Okay, so, sounds kind of backwards, right? But, why are you going after people that make the least amount of money is, think about it, if you don’t have a lot of money, you don’t have a lot of money to hire lawyers, accountants, and you’ll tend to cave and concede when the IRS sends you a nasty letter. And that’s kind of their point. That’s why their formula, their calculation, is the way it is. One dollars spent, $10 received because most people that make under $75k don’t have the capacity to hire attorneys and accountants to fight the IRS. So, they just concede and send the IRS a check.

The Democrats are saying, hey, over the years, Republicans have starved the IRS of resources. And honestly, whether it’s attrition or some other reason, the IRS is in bad shape. Okay? So, some of the computers they’re using dates back to the 1960s and they’ve already told policy makers that some of these programs are so old that college computer science courses don’t even teach them anymore. The IRS has 60 discrete case management systems that do not communicate with one another. So, their technology is antiquated, to say the least. Okay? It’s staffing levels, this is interesting, has dropped by 17% since 2010, including a 30% decline in enforcement employees because its budget has flat-lined. Now, yeah, that’s one of the reasons also there’s attrition and they’re just not getting enough people, enough talented people.

So, adjusted for inflation, it’s annual appropriation from Congress is down 12% over the same span at $12.6 billion this year. Full-time employees, 2010: 94,000, 2022: 78,600, Right? So, the IRS is swimming upstream; they got a big battle and they do need money. The question is how much money do they need and what are they going to do with the money.

So, President Biden’s agenda is $79.6 billion to the IRS over the next ten years. So, it’s not all coming tomorrow. It’s going to come over the next ten years. More than half of the money is going to enforcement. Not all of it is going to get agents on the street going after our tax returns, but around 50% to 60% will be going to enforcement, and the IRS is aiming, they’re not guaranteeing, but they’re aiming, they’re going to collect more from corporate and high net worth tax dodgers and not people that make less than $75,000 that are using the Earned Income Tax credit. Okay?

The remaining part of the funding is going to be going to operations, taxpayer services, technology, which they need, and direct free e-file systems. They believe those improvements are projected to bring in $203 billion over the next ten years; so, that’s the revenue projection. A lot of that money comes from enforcement. Okay? That’s what they believe.

Just to give you some numbers by year, I pulled this directly from the Congressional Budget Office. So they feel in ’23 they’re going to be up, if you look at their impact, so it’s about $2.9 billion, ’23, ’24: $7 billion, $13 billion in ’25, $19 billion in ’26, $24 billion in ’27, $29 billion in ’28, and ’31, they’re going to generate over $35 billion in additional revenues from their audits. And, if you look at ’22 to ’26, that’s $43,so they say about $203 billion they’re going to generate through these programs. So, we’ll see; this is all paper, right? There’s no guarantee, but this is what they expect and this is what they’re using as a budget number to carve the way for some of their other programs.

So, let’s look at what they’re doing now. Their audit rates have dropped, right? Why? They have less people. They went from 90,000 to 76,000. Most of the declines are amongst the wealthy. Why? Wealthy people have more money to fight the IRS and they don’t just fall on the sword and give in. The audit rate for Americans making $5 million or more have dropped to about 2% in 2019, compared to 16% in 2010. Okay, the agency said it’s working to improve these numbers. So, the Inflation Reduction Act, this is what it’s attempting to stop, right? It’s attempting to give the IRS more money to go after more high net worth individuals, not just individuals making less than $75,000, but to go after the big old rich people that are potentially cheating. At least they feel that there’s $203 billion of cheating going on, at least, that they’ll find. Who knows? That’s at least what they think.

So, what does the IRS commissioner say? Well, of course he’s in favor of this. Who wouldn’t be, right? There’s someone’s going to hand you a check for $80 billion in the next ten years, you’re going to smile and say, thank you very much, and you’re going to say, yes, we need the money. He says the increase in audits will not go to people making less than $400,000. Now, he didn’t guarantee it; and I’ll get to what the language actually says in the Act, which is interesting. So, the commissioner, Charles Reddick, he wrote to the lawmakers last week, and he said, “the agency was committed to upping enforcement in areas of challenge and that’s large corporate and global high net worth taxpayers.” He added, “these resources are absolutely not about increasing audit scrutiny on small businesses or middle income Americans.” Right? He’s got to tow the lines. Hey, all this money, give it to me; we’re going to go after those mean, rich people that are cheating, not the little guy, like we’re doing now.

And he said, “the Resources and Reconciliation package will get us back to historical norms and areas of challenge to the agency large corporate and global high net worth taxpayers.” Okay, here’s some numbers to chew on before I go and get into the impact on Self-Directed retirement accounts.

So again, it’s $80 billion. The annual budget of the IRS is only about $12.6 billion today. Think about that. So, nearly six times the annual budget of the IRS. Now, yes, the $80 billion is going to come over ten years, but it’s still a big number. Of this, $45.6 billion is going for enforcement, right? A little over 50%, 57% to be exact. And almost 60% of the $80 billion is for enforcement. So, 57% to 60% are going to enforcement. Some estimates that $46 billion for an army of auditors. And this is coming from Mike Crapo of Idaho’s Republicans, so this is definitely partisan, but this is what he’s saying. He says, “$46 billion for an army of auditors allow the IRS to hire as many as 87,000 new agents. This would make the IRS one of the largest federal agencies, larger than the Pentagon, State Department, FBI, and Border Patrol combined.” So, the IRS will have more employees than the Pentagon, State Department, FBI and Border Patrol combined. That’s scary. Okay, he also said, “multiple studies showed that in order to raise the money that they are acquiring to be raised on this bill, around $200 billion or more tax revenue from Americans is going to have to come from auditing.” Okay? So, they have no choice. That’s how they’re going to raise the money. Mike Crapo is a ranking member of the Senate Finance Committee.

Okay, so this is what the bill actually says. It says nothing in this bill is intended, and that’s the key word, nothing in this bill is intended to increase taxes on those making less than $400k. It doesn’t say, nothing in this bill will increase taxes on those making less. It says intended. What is the word, intended? Well, it’s obviously pretty generic word; hey, our intent is to go only go after the rich people. Why is that $400,000 number so relevant? It’s the number used by President Biden in most of his legislation and public rhetoric on taxes that, hey, this is only going over after rich folks, not people that make less than $400K. And here the bill says nothing in this bill is intended. So hey, whatever happens, happens, but it’s not our intention to go after little guys, even though they’re going after little guys right now, because they’re going after low hanging fruit based off the Earned Income Credit.

So, what does all this mean for IRAs? Well, IRAs don’t have their own audit department. Will they? Probably not. There’s approximately $12 to $13 trillion in IRAs, 60 million or so IRAs. 93% to 97% are involved in traditional investments, like stocks. So, there’s not a lot of abuse. Even the 3% to 7% involved in alternative assets, what percentage of those are up to no good? Listen, I’ve been doing this business, I’ve been in the industry twelve years, 23,000 clients. I’m telling you, obviously, I haven’t spoke to each one, but people that want to get access to their retirement funds are not looking to cheat. They’re not looking to take the money and just spend it. They’re looking to invest and grow. So, I bet, and I bet a good chunk of change, that if the IRS audited all 23,000 of my clients, they probably would find a handful that mistakenly did something not good, right.? They wouldn’t find 10,000 people. So, there’s a reason that IRAs are not audited and there’s no statistics for IRA audits.

There are statistics for 401(k) audits, not IRA audits. Why? Because the IRAs don’t have their own audit division. IRAs are generally audited under the small business self employed, the SBSE, division, and generally, that falls under, hey, I’m looking at your tax return, you’re over 72, you have to take RMDs. Hey, what did you invest in? Just want to confirm that you’re actually using the proper valuation for your required minimum distribution number. That’s generally how the audits fall. It’s very rare that they just kind of pick your name out of a hat and say, hey, Joe, hey, Jane, what did you buy with your IRA? Let me check it out. Very rare. I’ve been through a few audits, and all of them have been triggered by simple valuation questions from IRS agents for taxpayers over the age of 72. Now, if you have a Roth and you’re over 72, probably less likely, because there’s no tax benefit for the IRS.

Now, on top of that, let’s think about what’s going on here. The IRS wants to raise money, right? They say they’re going to raise over $200 billion with the enforcement. They’re going to go after people, companies with large amounts, right? IRAs are tough. Why? Because a lot of gray areas in IRAs, right? If you invest in a private placement, maybe you’re a board of director of the company, or you own 30%. Is it worth the IRS and their lawyers spending months, if not years, targeting a taxpayer who invested $130,000 into a small business where they own 30%? And, maybe the IRS argue it’s self-dealing, conflict of interest; taxpayer says, no, I own less than 50%. The value is right. Statute says it’s not prohibited.

Those “facts and circumstances” cases are long and hard, and there’s no guarantee of winning. The IRS doesn’t like to lose. Just like state prosecutors, federal prosecutors, they want to win, so they’re going to go after cases they know they can win, slam dunk cases. Or they’re going to go after large Fortune 500 multinational companies that have a huge budget and will cave and at least pay something. So, the easy money is people that make less than $75K because they don’t have the ability to fight, or really, really large corporations who will generally fight a little bit but have the money to settle and just write the IRS a check.

The gray area stuff, which involves a lot of IRA prohibited transaction stuff; it’s very rare that you have a client who just takes his IRA and puts in his pocket or buys himself a watch and it’s on his wrist, or invests in her kid’s business, right? Most of the prohibited transaction stuff, and you’ve seen it in case law, is facts and circumstances-based. That stuff takes time and money. And if you look at a lot of the Tax Court cases, they’re two, three, four-year period cases. They’re not, hey, we audited you in 2021, the case is settled, or the case is ruled on in 2022. It’s usually a three-four year period. And if they need to raise $203 billion, at least that’s what they’re telling the Budget Committee, the Budget Office, then they’re going to go after sure things. And IRAs, especially in the prohibited transaction context, are very hard to contest, especially if there are facts and circumstances-related, which most of the potential prohibited transaction, gray area-type scenarios can be found.

So, what’s the impact? Well, there’ll be additional audits on IRAs; I can’t say when you get $80 billion over the next ten years that some of those 40-50,000 extra agents are not going to trip over someone’s tax return and ask questions on their IRA. It’s just the facts, okay? But, do I think IRAs and Self-Directed IRAs to be a hot audit area? No! Because facts are, they don’t even have their own division, okay? So, they’d have to involve the Department of Labor, potentially the IRS, who enforces prohibited transactions. The DOL has authority over what’s a prohibited transaction. So, you got multi-agency issues, and you also have potential for long, drawn-out cases, which don’t prove very economical to the IRS.

Again, they want to stick to their proposition that it’s every dollar invested, it’s $10 in revenue. And, if they have to sit in court arguing 4975(c) and self-dealing and conflict of interest, and gray area details with attorneys, those types of cases aren’t slam dunks, and they’re generally not going to pursue them. It’s one of the reasons you don’t see a lot of Self-Directed IRA prohibited transaction cases. No audit division, and IRS generally looks at them, and if it’s not a slam dunk, they’re not going to fight them.

So, lots of money coming to the IRS. It will impact all of us; whether you make $50 grand or $50 million, there’s going to be tens of thousands of more agents, and we’re all going to figure out somehow come into their cross-hairs. It’s just the way it is. They need to raise money. That’s going to be their focus. That is going to be their main target, is raising money. And whether they’re doing it for folks that make less than $75K, big multinationals, or folks that make over $400K, they’re coming for us, all of us. And, just the way it is. Now, some people say, well, if you just file your taxes and do everything the way you should, then it doesn’t matter. Well, it’s not the case. Trust me. I’m a tax lawyer. I have a Masters in tax law.

A deduction that you think is legit, an agent can look at it and say, well, maybe it’s not. Even if you’ve properly accounted for all your business deductions, all your entertainment over the last year, now imagine you get audited, and you have to come through and go through your Amex bill and show and prove that that dinner you took on Thursday night in your local restaurant was not with your spouse and with a client. It’s a pain. They can go after, and they can find something if they want it, okay? Whether you’re using your frequent flyer miles from your business for personal use, trust me, they spend enough time, they’re going to find something. That’s just the way it is. The issue is, is it worth their time to spend on your tax return? That’s why they’re going after the Earned Income Credit stuff. It’s quick and easy. Taxpayers just fall over and pay up. Larger taxpayers fight, and the big, big ones will just generally settle because they have enough money to settle. So, I don’t think Self-Directed IRAs will be a target, but I do think, with more agents out there looking for more money, it’s just natural that more IRAs will be caught in their net and will become part of an audit in a way higher percentage than they are today. Just the way it is. More money, more numbers, more people, more eyeballs on returns, and more interest and ability to capture more revenue. It’s just the way it’s going to be.

So, this is happening. Not much we can do about it. Yes. Listen, the IRS does need help. Do they need 40,000 more agents? I don’t think so. Their technology needs an upgrade. They need more money. Yes, they should have more agents. They shouldn’t have less agents than they did ten years ago. So, I’m all for people paying what they owe in taxes. I’m not in favor of tax dodgers, but I’m just telling you, if you let me review and spend time on anyone’s tax return, no matter they got the best accountant in the world to do it, you can always find something wrong with it okay? Just the way it is. So, that’s my concern. The more agents out there that are harassing us, eventually everyone has a price and just settles or folds because it just gets out of hand.

So, that’s kind of what’s going to happen. And it’s not a Democrat or Republican thing. They’re going to be going after just more people, whether you make a little or a lot; not necessarily in your IRA, but, all of us are going to be dealing with more IRS communications and probably audits for the foreseeable future. At least, probably for the next ten years. So, that’s it.

Hope this podcast didn’t just ruin your day. Don’t worry, it’ll be okay. Use a good accountant, do the right thing, and don’t fight if you don’t have a good foundation to stand on; settle up and move on. But, IRAs, again, just remember, if you’re a client of IRA Financial and you have questions, just contact us. We’ll help you go through and navigate the situation. We help our clients with audits. We’re not going to defend you in court, but we will help you if you, God forbid, do get audited in terms of documents, presentation, and at least coming up with strategies and potential solutions for the inquiries. Now, if you are about to do a transaction or investment and want help understanding prohibited transaction rules, contact us. That’s what we’re here for. We have a great compliance team, great customer service team, and we will do our best to help you navigate the rules and help you understand all the IRS prohibited transactions and unrelated business taxable income questions.

So, with that, I hope you guys enjoyed today’s podcast. Thanks for listening. If you’re watching on YouTube, much appreciated. Great, great day and hope you’re enjoying your summer. Take care and talk to everyone again next week. Be well.

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