Legislative Lowdown
Negotiators Highlight Progress on Debt-Ceiling Deal Despite Lack of Public Agreement on Legislative Framework. President Joe Biden and House Speaker Kevin McCarthy (R-CA) emerged from the latest round of negotiations last night still without a deal to raise the debt ceiling before the impending federal default. Notwithstanding the absence of a finalized agreement, both leaders described the meeting as “productive,” with Speaker McCarthy noting that “the tone [Monday night] was better than any other time [they] have had discussions.” Speaker McCarthy had previously indicated that he hoped to reach a preliminary deal framework by Sunday, May 21. Estimates on when the federal government will be unable to fulfill all of its obligations are dependent on incoming tax receipts, and Treasury Secretary Janet Yellen recently reiterated that it may occur as early as June 1.
Following the meeting, discussions will continue between staff regarding the details of a potential bipartisan package. Democratic negotiators have reportedly embraced GOP proposals to claw back approximately $30 billion in unspent COVID-19 economic relief funds. President Biden has also signaled that he may accept the establishment of statutory caps on discretionary spending. Republicans’ initial proposal offered in the House-passed Limit, Save, Grow (LSG) Act would set the spending cap at Fiscal Year (FY)2022 levels and restrict annual growth at 1% for a decade thereafter, although Democrats have sought to soften such limitations.
Negotiations continue over certain proposals opposed by progressives that may ultimately be included in a final debt-ceiling compromise. The White House has reportedly indicated some willingness to agree to limited work requirements for federal entitlement programs, albeit on a much smaller scale than proposed in the LSG Act. Most Republicans and several Democrats, including Senate Energy and Natural Resources Committee Chairman Joe Manchin (D-WV), also support the inclusion of provisions to reform the energy-infrastructure permitting process in the deal. However, this effort may be limited or postponed to provide lawmakers more time to reach a mutually agreeable compromise.
Other proposals offered in the LSG Act have been outright rejected by Democrats. Included in this category is House Republicans’ proposal to cut $72 billion in supplemental Internal Revenue Service (IRS) funding provided by the Inflation Reduction Act (IRA). Senate Finance Committee Chairman Ron Wyden (D-OR) held a hearing on the topic last week, in which he argued that the proposed cut would lead to “tax evasion by the rich, worse taxpayer service for law-abiding Americans and fewer prosecutions of drug cartel members, sex criminals, sanctions evaders and money launderers.” GOP proposals to repeal certain IRA clean-energy tax credits and reverse student loan forgiveness efforts—two central elements of the Biden administration’s legislative agenda—are also reportedly off the table.
Last weekend, President Biden said that he hoped Republicans may accept tax provisions to eliminate perceived “loopholes.” Speaker McCarthy subsequently squashed expectations of tax reform in the deal, informing reporters, “No, [they] are not looking at revenues.”
GOP leadership previously pledged to allow House lawmakers at least 72 hours to examine the final legislative proposal, and Speaker McCarthy has said that he does not intend to waive the rule. With the potential deadline looming, Secretary Yellen has reportedly requested that certain federal agencies formulate strategies to temporarily reduce or delay upcoming payments to provide lawmakers additional time to reach a deal. Despite myriad outstanding factors complicating the process, President Biden highlighted that both he and Speaker McCarthy are “optimistic [they] may be able to make some progress, because [they] both agreed default is not really on the table.”
Brown and Cassidy Introduce Bipartisan 1099-K Proposal. Last week, Sens. Sherrod Brown (D-OH) and Bill Cassidy (R-LA) introduced the Red Tape Reduction Act, which would increase the reporting threshold for third-party payment platforms to issue a Form 1099-K. In reporting year 2023, payment settlement entities must provide their users with a 1099-K form unless the payee has fewer than $600 in total transaction value for the year. The Brown-Cassidy bill would increase this de minimis exception to exempt filing requirements for payees with either fewer than $10,000 in annual aggregate transaction value or less than 50 total transactions.
Before 2022, the reporting threshold was $20,000 in annual aggregate transaction value or 200 total transactions. However, the American Rescue Plan Act (ARPA) included a revenue-raising provision intended to crack down on perceived tax avoidance by lowering the threshold to its current $600 amount and entirely eliminating the transaction-count exception after Dec. 31, 2021. While the provision was projected to reduce the deficit by $8.4 billion over 10 years, it has since attracted bipartisan condemnation from certain lawmakers who believe the lower threshold imposes an undue administrative burden on small businesses and individual sellers.
After last-minute legislative efforts last December failed to delay or modify the imminent lowering of the third-party reporting threshold, the Internal Revenue Service (IRS) announced that it would delay all 1099-K modifications until 2023. Then Acting IRS Commissioner Doug O’Donnell said this decision was made to “reduce confusion during the upcoming 2023 tax filing season and provide more time for taxpayers to prepare and understand the new reporting requirements.”
Regarding his proposal, Sen. Brown told reporters that he “expects Republicans to join [him] on [the Red Tape Reduction Act],” and although “some people want to do a different number, … $10,000 seems to be an agreed-upon number.” Several other lawmakers have introduced proposals in recent years to increase the reporting threshold; Reps. Carol Miller (R-WV) and Michelle Steel (R-CA) have offered bills to restore the threshold to its full pre-ARPA amount.
At a House Ways and Means Committee hearing last month, Rep. Miller questioned IRS Commissioner Daniel Werfel on efforts to reduce compliance burdens resulting from the lowered threshold for taxpayers to receive a Form 1099-K. While Werfel would not opine on the merits of specific legislative proposals to modify the provision, he confirmed the “IRS would have an easier time” with tax administration if the threshold was raised.
1111 Constitution Avenue
IRS to Move Forward with “Scaled” Direct File Tool for 2024. On May 16, the Internal Revenue Service (IRS) sent its Report to Congress (the “Report”) evaluating the viability of an IRS-run Direct e-File option for taxpayers, as was required by the Inflation Reduction Act. The IRS also announced that it is taking steps to begin a “scaled” Direct File pilot project for the 2024 tax-filing season following a directive from the Treasury Department.
If fielded in January 2024, the IRS-created Direct File tool would represent a monumental change in the methods by which U.S. taxpayers prepare and file their returns. Notwithstanding this effort, the IRS, Treasury Department and proponents of such a government-run system sought to temper expectations for the tool in the next tax-filing season. In briefings with industry stakeholders after the release of the Report, IRS and Treasury Department officials indicated that they do not yet know the scope of the anticipated pilot project, which segment of taxpayers (or how many taxpayers) they expect to use the Direct File tool in 2024 or how the further development and refinement of the program will be funded.
The reaction from lawmakers regarding the pilot-program announcement was decidedly mixed. Sen. Elizabeth Warren (D-MA), a long-time proponent of an IRS-created and maintained tax preparation tool and member of the Senate Finance Committee, hailed the Treasury Department directive and said, “The IRS is finally taking action and standing up a pilot program for American taxpayers to file their taxes for free next year, with room to grow in years to come.”
In contrast, Senate Finance Committee Ranking Member Mike Crapo (R-ID) said in response to a Washington Post story about the IRS having built a prototype Direct File tool last year: “If true, this suggests a predetermined outcome and flies in the face of previous commitments Commissioner [Daniel] Werfel made to publicly consult Congress on a potential free-file solution, and for the IRS to not act without explicit legal authority.”
The Report concluded that many taxpayers are interested in using a free IRS-provided tool to prepare and file their taxes and that the IRS is “technically capable” of delivering a Direct File option. The Report focuses on three areas—taxpayer opinions, cost and feasibility—and includes an analysis conducted by an independent third party, the think tank New America and Loyola Marymount University Law Professor Ariel Jurow Kleiman.
- Taxpayer Opinions. The IRS used its 2022 Taxpayer Experience Survey to assert that 72% of respondents indicated they would be “very interested” or “somewhat interested” in an IRS-created Direct File tool. But of that figure, only 28% responded that they would be “very interested” in Direct File. In contrast, a MITRE survey from February found that only 15% of respondents with “simple” returns would choose Direct File, and that figure dropped to 12% if Direct File did not also provide a state tax return.
- Cost. The IRS noted that cost estimates are “subject to considerable uncertainty” and depend on the number of taxpayers who use Direct File and the complexity of their tax situations. Still, the IRS estimated that the annual costs of Direct File could range from $64 million (assuming 5 million users and a narrow scope of covered tax situations) to $249 million (assuming 25 million users and a broad scope of covered tax situations).
- Feasibility. While the IRS concluded that creating a Direct File tool is feasible, it also noted substantial challenges, including the following: fostering technical product development expertise within the agency, developing customer service capabilities and providing state tax returns.
The accompanying independent third-party analysis was notable in that it did not endorse Direct File, even though both New America and Professor Jurow Kleiman have previously and separately opined favorably on government-populated returns. Instead, their report states: “The feasibility of the IRS to successfully build a Direct File product depends critically on their [sic] ability to maintain this initiative as a leadership priority, start with limited scope, expand over time and address each of the aforementioned imperatives at each stage of design and implementation.”
These aforementioned imperatives include the following: (1) defining a clear vision for product expectations, (2) gradually rolling out and improving functionality, (3) continually improving the taxpayer experience, (4) providing a simultaneous state tax return, (5) providing dependable, effective customer support, (6) ensuring data security and privacy, and (7) ensuring a stable, ongoing appropriation that accounts for user needs and functionality, user numbers and inflation.
Questions about IRS Direct File not only persist concerning scope, functionality and cost (e.g., whether a state return will be available and whether Earned Income Tax Credit-eligible filers can use the tool) but also, more fundamentally, about whether IRS needs explicit statutory authority to build the system.
The Direct File tool is not only about facilitating tax filing. It also serves as tax preparation and thus raises questions about whether the tax auditor and enforcer should also be the tax preparer. A decade ago, the IRS promulgated regulations that imposed registration and continuing education requirements on paid tax return preparers. In the 2014 case Loving v. IRS, the U.S. Court of Appeals for the District of Columbia Circuit held that the statute upon which IRS relied did not authorize the agency’s proposed regulatory regime.
Supreme Court Ruling Upholds IRS’s Tax-Enforcement Authority. In a decision delivered on May 18 by Chief Justice John Roberts, the Supreme Court ruled that the Internal Revenue Service (IRS) can access financial records from third-party institutions without notifying taxpayers if the requests are made “in aid of collecting” taxes. The decision is a significant victory for the IRS, validating the agency’s power to probe taxpayer records without providing notice. Opponents have argued that the ruling affords the IRS excessive authority in tax enforcement and infringes on taxpayers’ privacy protection.
In general, the IRS can issue summons to banks and other third-party institutions for information if they notify the affected taxpayers. However, Internal Revenue Code (IRC) section 7609(c) provides an exception to the requirements of a notice of summonses if certain requirements are met. One such condition to which the exception applies is in the case of “any summons issued in aid of the collection of … an assessment made or judgment rendered against the person with respect to whose liability the summons is issued.” The exception was designed to prevent delinquent taxpayers from evading IRS enforcement efforts upon receipt of a summons notice.
The case, Polselli v. IRS, concerned the IRS’s summonses to several bank accounts owned by the wife and law firm of Remo Polselli, an individual who owed over $2 million in unpaid taxes. In the case, the plaintiffs argued that the IRS should have notified Polselli’s wife and the law firm because they were not the direct targets of the IRS’s efforts to recoup the unpaid taxes. Thus, the plaintiffs asserted that the IRC section 7609(c)(2)(D)(i) exception should not have applied and a notice of summonses was required. In an earlier ruling, the U.S. Court of Appeals for the Ninth Circuit affirmed Polselli’s position because Remo Polselli did not have a legal interest in the bank accounts in question. However, the U.S. Court of Appeals for the Sixth Circuit offered a conflicting opinion that the “summonses at issue fall squarely within the exception.”
Notwithstanding the split among circuit-court decisions, the Supreme Court affirmed the interpretation of the Sixth Circuit in its unanimous opinion last week. Chief Justice Roberts wrote that “[a] straightforward reading of the statutory text supplies a ready answer: The notice exception does not contain such a limitation.” Moreover, the opinion asserts that “[t]he statute does not … require that a taxpayer maintain such an interest for the exception to apply.”
The IRS is expected to significantly increase audits in the coming years following the allocation of an additional $45 billion for tax enforcement activities through the Inflation Reduction Act. The Polselli ruling validates the IRS’s expanded authority to use such funding to seek records from third-party recordkeepers without notifying targeted taxpayers in many cases.
At a Glance
Werfel Confirms Evidence of “Apparent Racial Disparity” in Audit Selection. Internal Revenue Service (IRS) Commissioner Daniel Werfel issued a letter informing the Senate of evidence indicating the presence of racial biases in tax enforcement. The letter highlights preliminary data-collection efforts undertaken by the IRS that found “Black taxpayers may be audited at higher rates than would be expected given their share of the population.” Commissioner Werfel had previously pledged to investigate potential biases in his nomination hearing last February. The conclusion validates earlier findings from a Stanford Institute for Economic Policy Research paper that Black taxpayers receive IRS audit notices “at least 2.9 times more often than non-Black taxpayers.”
Smith Demands Briefing from IRS on Treatment of Hunter Biden Whistleblower. Last week, House Ways and Means Committee Chairman Jason Smith (R-MO) requested an “urgent briefing and explanation” from IRS Commissioner Daniel Werfel on apparent retaliation against a whistleblower. The letter concerns new allegations made by the whistleblower’s lawyer that the agent was removed from an ongoing investigation into Hunter Biden’s potential illicit tax activities, which they believe constitutes retaliation from the Biden administration. Chairman Smith noted that Commissioner Werfel had previously promised to protect whistleblowers from reprisal at his nomination hearing last February. Commissioner Werfel reportedly responded to the accusation by informing Chairman Smith that the matter had been referred to the Treasury Inspector General for Tax Administration (TIGTA), and “TIGTA confirmed that [Werfel’s] role as Commissioner in any whistleblower proceeding is not an investigative one."
Brownstein Bookshelf
Biden to Nominate Maloney to be U.S. Ambassador for the OECD. Earlier this month, President Joe Biden announced that he planned to nominate former Congressman and Democratic Congressional Campaign Committee Chair Rep. Sean Patrick Maloney (D-NY) to serve as the U.S. ambassador for the Organisation for Economic Co-operation and Development (OECD).
Arrington Proposes Corporate Minimum Tax Repeal. House Budget Committee Chairman Jodey Arrington (R-TX) and Sen. John Barrasso (R-WY) introduced legislation that would repeal the 15% corporate alternative minimum tax enacted through the Inflation Reduction Act.
Bipartisan Tax-filing Extension Proposal. Reps. Judy Chu (D-CA) and Mike Carey (R-OH) sponsored a bill this week that would allow taxpayers to qualify for the six-month filing extension if they make a payment equal to 125% of their prior year’s tax liability.
Wyden Doubles Down on Harlan Crow Investigation. Senate Finance Committee Chairman Ron Wyden (D-OR) responded to Harlan Crow’s rejection of Democrats’ efforts to obtain tax information related to potential gifts to Justice Clarence Thomas by establishing a new response deadline of June 2.
Hearings and Events
House Ways and Means Committee
There are no tax hearings in the committee this week.
Senate Finance Committee
The Senate is not in session this week.
Private Sector
Tuesday, May 23
Tax Foundation
Talking Tax Reform: Review of the 2023 Tax Filing Season
Wednesday, May 24
Tax Policy Center
Enhancing Child Well-Being with Cash Assistance: Lessons from the Child Tax Credit and Next Steps for States
Tuesday, May 30
Peterson Institute for International Economics
Rethinking Fiscal Policy–Global Perspectives