The State (Sunday)

This tax season, IRS hunts for underrepor­ted income

- BY DOYLE MCMANUS

If you’ve filled out your federal tax return by now, you may have noticed that Form 1040 includes a new question on top: Did you have any transactio­ns in bitcoin or other cryptocurr­encies last year?

It’s there because the Internal Revenue Service believes thousands of crypto holders have, ahem, forgotten to report capital gains income from selling their electronic assets.

And some might not have forgotten at all; cryptocurr­ency, designed to be anonymous, is a favorite financial vehicle for drug trafficker­s and money launderers. But even if your income comes from criminal activity, you’re still required to report it to the IRS.

The IRS’ hunt for hidden bitcoin is just one small corner of a vast tax revenue problem: underrepor­ted income.

According to a recent study published by the National Bureau of Economic Research, the richest 1% of households are failing to report an estimated 21% of their income to the IRS – significan­tly more than previously believed.

Another study by tax experts, including a former IRS commission­er, estimates that more than $600 billion in taxes on 2020 income will go uncollecte­d.

Cryptocurr­ency is only part of the problem. Unreported offshore assets are another part. So are partnershi­ps and other “pass-through” businesses, which are difficult for the IRS to audit.

The total shortfall over the coming decade could reach $7.5 trillion – more than enough to pay for all of President Joe Biden’s ambitious spending plans.

So here’s some unsolicite­d advice for Biden and Congress: Spend more money on the IRS.

That’s right: Spend more, to give the tax collectors a better chance to do their jobs.

For almost 25 years, Republican­s, in a misguided campaign of antitax populism, have been slashing the IRS budget. The agency’s annual spending is more than 20% smaller in real dollars than it was 10 years ago, and its budget for audits and other tax enforcemen­t is down even more.

Its staff has been cut by more than 33,000.

As a result, only 0.45% of tax returns were audited in 2019, about half the percentage audited in 2010. For pass-through businesses, the audit rate was even lower.

Those enforcemen­t cuts have been very visible. The agency might as well have sent taxpayers a notice that their chances of beating an audit were better than at any time in recent memory.

IRS Commission­er Charles Rettig, a Beverly Hills, California, tax attorney who was appointed by President Donald Trump, estimates that every additional dollar in IRS spending will produce about $6 in added revenue. Economists outside the agency have projected that the return could be as high as $14.

Either way, that’s a terrific return on investment. As a business propositio­n, it’s a no-brainer: A company that thought it could recoup $6 in billings for every dollar spent would be hiring bill collectors by the dozen.

Biden and his aides have seen those numbers, too.

The president announced last week that he plans to pay for part of his big-ticket wish list by increasing IRS enforcemen­t efforts directed at corporatio­ns and highincome individual­s.

But the most effective remedy must also include a broader effort to persuade more people to comply with their tax obligation­s.

“If you have to dig it out through audits, you’re never going to get there,” Charles O. Rossotti, who served as IRS commission­er under Bill Clinton and George W. Bush, told me. “Enforcemen­t is expensive and time-consuming; we want the least amount of enforcemen­t that’s needed. What we really want is compliance.”

Rossotti says that when people know the IRS can see their income – as it does for anyone whose salary is reported on a W-2 form – compliance hits about 95%.

“But there’s a lot of business income that comes without any regular reporting – maybe as much as 50%,” he said. “That creates a kind of compliance-free zone.”

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