Approximately one year after receiving approval from Congress for significant IRS funding, the agency has announced its intention to take action against tax preparers engaging in dubious practices. This announcement coincides with increased attention to a widely used small business tax credit.
In a letter, IRS Commissioner Danny Werfel conveyed to Senate Finance Committee Chair Ron Wyden, D-Ore. The letter conveys that they are allocating additional resources to combat dishonest tax preparers guiding their clients in underreporting income or making excessive claims for credits and deductions. The IRS’s renewed focus on tax preparers coincides with heightened scrutiny of a popular small business tax credit.
Tax professionals say these preparers pose problems for taxpayers who might encounter IRS audits or future tax obligations.
Additionally, they create difficulties for ethical tax preparers who receive resistance from clients for adhering to tax regulations, as stated by Josh Youngblood. Notably, he is an enrolled agent and proprietor of The Youngblood Group, a tax firm located in Dallas.
He emphasized that it’s essential for the IRS to prioritize this matter.
According to April Walker, lead manager of the American Institute of CPAs, this strategy is part of the IRS’s increased attention on claims related to employee retention credits.
Challenges Surrounding the ERC in Small Business Tax Credit
The government introduced the small business tax credit to incentivize growth and job creation among smaller enterprises. Many small businesses have benefited from the small business tax credit during the challenging economic times of the pandemic.
The employee retention credit (ERC), a tax benefit established during the pandemic, was created to assist small businesses that retained their employees on the payroll despite shutdowns or reduced revenue in 2020 and 2021.
Valued at thousands of dollars per employee, this program gave rise to a niche industry of specialized firms that encouraged businesses to modify their payroll returns to access this intricate tax benefit.
About one week ago, the IRS disclosed its intention to temporarily suspend the processing of the widely used small business tax credit due to a substantial increase in dubious claims.
This decision, which received support from the AICPA, means that new small business tax credit claims will not be processed until at least the conclusion of 2023.
IRS Commissioner Werfel conveyed during a press call that this valuable small business tax credit program intended to assist small businesses has been exploited by aggressive promoters.
It was not originally intended to be a vehicle for promoters to flood the IRS with numerous applications, which in turn hampers the agency’s work on matters like the ERC, Small business tax credit, and other critical issues for taxpayers.
IRS Adjustments to Audit Focus and Tax Credits
At the same time, the IRS has unveiled intentions to decrease the frequency of audits for individuals with lower incomes, focusing instead on addressing unpaid taxes from higher-income individuals, partnerships, and large corporations.
In the same letter, Commissioner Werfel outlined the intention of the IRS to significantly reduce the number of correspondence audits, which are examinations conducted through mail, for specific tax credits.
This includes the earned income tax credit, a tax benefit claimed by low- to moderate-income filers, which has experienced errors due to its intricate eligibility criteria.
Chuck Marr, the Vice President for Federal Tax Policy at the Center on Budget and Policy Priorities, remarked that correspondence audits have long been acknowledged to have numerous issues. He highlighted that many filers either do not receive these notices or struggle to comprehend them.
In the fiscal year 2020, the National Taxpayer Advocate’s 2022 report to Congress revealed that improperly claimed credits amounted to over $16 billion, representing more than one-quarter of the total paid for the credit.
Although IRS audit rates have decreased, the decline has been less significant for individuals claiming the earned income tax credit compared to higher-income earners.
According to the 2022 report by National Taxpayer Advocate Erin Collins, the IRS audits a higher percentage of taxpayers with the earned income tax credit than any other group, except those with at least $5 million of total positive income.
Addressing Disparities in Tax Audits and Preparations
IRS research indicates that “bad actors” may be more likely to file tax returns on behalf of “vulnerable filers.” That includes individuals with lower incomes, filers from diverse racial backgrounds, or those with limited English proficiency.
Commissioner Werfel’s letter suggests that this situation could contribute to the higher audit rates for these filers.
In May, the IRS acknowledged that Black Americans are considerably more likely to undergo audits, supporting the conclusions of economists from Stanford University, the University of Michigan, the U.S. Department of the Treasury, and the University of Chicago.
Over time, Commissioner Werfel believed that intensified measures to curb dishonest preparers targeting this demographic would result in better tax preparation and enhanced return accuracy. Consequently, this should reduce the number of individual taxpayers at risk of being audited.