Democrats’ New Plan to Catch Tax Cheats Makes More Sense
(Bloomberg Opinion) -- One of the most controversial ideas proposed so far in Joe Biden’s presidency has to do with the wonky world of Internal Revenue Service reporting forms. In an effort to ferret out tax cheats, Biden wants banks to tell the IRS at year end what the total amount of withdrawals and deposits were for each of its customers.
In a critical mistake, the initial proposal mandated reporting for just about every account, only excluding those whose total withdrawals or deposits were less than $600. Such a low cutoff (set just to eliminate supposedly dormant accounts) raised an uncomfortable question: If Democrats want to go after wealthy tax evaders, why do they care about people with small bank accounts?
In a revised version outlined by Senate Democrats earlier this week, the cutoff was bumped to $10,000, and sensible exclusions were added for things like direct deposit of wages and Social Security checks. So if a bank customer had $25,000 in total deposits for the year, but $20,000 came from Social Security payments, the bank wouldn't report her account information to the IRS.
Before the restrictions were introduced, bank lobbyists and other critics of the plan were able to capitalize on fears about how pervasive the new regime would be. It’s a shame the backlash may be too strong at this point, because the overall approach for uncovering those who don’t report all their income is actually one of the most straightforward and unobtrusive ways to do it.
First, here's why some sort of change is needed: Hundreds of billions of dollars owed in taxes go uncollected every year. Many scofflaws are those who have their own small or medium-size businesses and aren't independently audited.
Unlike those who receive W-2 forms from their employers with wage details (a copy of which is also sent to the IRS), there's no extra set of eyes. Not surprisingly, when there's a third-party reporting system in place, tax compliance is around 99%. Without it, compliance falls to about half.
Under Biden's plan, the banks would effectively serve as that third party, providing year-end information that the IRS could in turn use to root out big discrepancies between what someone says she earns and what her bank account flows indicate. Studies show that even just the existence of a new regime could spur more compliance. And it would help the IRS to be smarter about whom it's auditing.
Critics of the plan, seizing on many Americans’ distrust or dislike of the IRS, characterize it as an unprecedented intrusion of privacy. But that ignores the billions of reporting forms that the IRS already receives on taxpayers' finances — from the 1099-INT that details how much interest bank accounts accrue to the 1099-B that shows gains or losses from stock sales. It's simply how our tax system works.
Requiring the banks to include two additional boxes on the interest forms they already send to the IRS — showing withdrawal and deposit totals — won't move the needle on the information sharing. And while it would certainly entail more work for the IRS, Biden is also seeking an additional $80 billion in funding for the agency. That should help it upgrade its data systems and allay fears of hacks.
The change wouldn't require most taxpayers to do any additional work. The same can't be said of another approach that would more narrowly target small businesses.
A plan outlined by a previous presidential panel convened to study tax changes would require small-business owners to designate certain bank accounts as commercial ones. In turn, they would be responsible for reconciling cash flows and reported income.
For their part, Democrats need to be clearer about whom they're trying to go after with this reporting change. They say they want billionaires and corporations to pay their fair share, but those two groups aren’t the ones who are typically omitting income. They're taking advantage of loopholes in the tax code to minimize their tax obligations.
That's different and isn't something that increasing bank reporting to the IRS is going to change. Still, there are plenty of well-to-do business owners in the top 5% who are outright lying on their tax returns. Changing the reporting regime to fix that is something all dutiful taxpayers should want.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.
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