Jim de Bree | Making Sense of IRS Bank Account Scrutiny

Jim de Bree
Jim de Bree

Earlier this year, the Treasury Department proposed requiring banks to report certain information to the IRS. The proposal has become a highly charged political issue, and consequently, media and politicians have misrepresented the proposal and have stirred up populist, anti-IRS sentiments. 

The proposal, which as of this writing, has not been introduced as part of any tax legislation, would require banks to report to IRS the total amount of inflows and outflows of a taxpayer’s bank account during a calendar year. The reporting threshold is $600. The reporting mechanism is similar to that of forms 1099, which report other information to the IRS. No further details would be reported to the IRS and the IRS would not obtain any information about specific transactions. 

The Treasury Department believes this provision will raise $460 billion over 10 years because it will enable the IRS to focus its audit efforts on taxpayers who are most likely to cheat on their taxes. The IRS routinely audits many taxpayers, finding no changes as a result of the examination. For example, people who are generous in their charitable giving or are chronically ill are routinely pestered by the IRS.  

Each year the IRS audits fewer taxpayers. That means in order to prevent a revenue loss, the IRS has to make those audits count by targeting abusive tax avoidance rather than the general population. 

Since 1963, the IRS has used its Taxpayer Compliance Measurement Program (“TCMP”) to develop audit selection parameters. That process apparently no longer effectively establishes selection criteria that identify taxpayers who engage in abusive tax avoidance. 

When a taxpayer’s return is selected for a field examination, the IRS agent routinely asks to see all of the taxpayer’s bank statements. The agent then reconciles the cash deposits to the income reported by the taxpayer and compares the amount of cash disbursements with the deductions claimed in the return. The IRS has presumably aggregated these reconciliations, and used data analytics to develop a statistical model identifying trends where tax avoidance is most likely to exist. Doing so augments the TCMP process to identify potential tax avoidance situations. 

The IRS could ask taxpayers to report their total cash receipts and deposits on their tax returns, but this is burdensome to taxpayers. 

Alternatively, the IRS could obtain this information from the banks who maintain the bank accounts and have this information at their fingertips, but doing so requires congressional authorization.  

Many wealthy individuals and large corporations have structured complex transactions in order to aggressively reduce their taxes. We know from the 2020 SEC filings of the S&P 500 that the statute of limitations expired before the tax authorities had a chance to examine aggressive positions taken by those corporations avoiding more than $200 billion in taxes. Many of those transactions are designed to be reported on tax returns in a stealthy manner to avoid detection.  

Banks and other financial institutions have complained about the administrative burden of the proposed rules, but they already supply this information to their customers. Statements provided to customers routinely contain a summary of deposits and withdrawals. 

Cynics have suggested that the real reason banks oppose the new reporting requirement is because structuring tax avoidance transactions is a lucrative business for them and they fear further IRS scrutiny that may impede that business.  

In response to concerns about the invasiveness of the new rules, the Treasury Department proposal was ignored until several congressional Democrats wanted to repeal the limitation on the state and local tax (SALT) deduction that was enacted as part of the 2017 Tax Cuts & Jobs Act. (Our local Rep. Mike Garcia was among many congressional representatives who introduced legislation repealing the cap on the SALT deduction.) However, doing so costs about $500 billion, so an alternative revenue source had to be found. 

Conveniently, that loss of federal tax revenue can be largely offset by enacting the Treasury Department’s bank reporting proposal, which also has the political benefit of increasing tax collections without actually raising taxes.  

When the bipartisan infrastructure bill moved through Congress this past summer, House Democrats considered repealing the SALT cap and paying for it with a version of the Treasury Department’s bank reporting proposal. However, there is no way that a bill with those provisions would pass the Senate, so they were deferred until the second bill that is now moving through Congress using the reconciliation process. 

Neither SALT cap repeal nor bank reporting are included in the House Ways & Means Committee’s proposal that was released last month. However, congressional Democrats seeking to repeal the SALT cap are attempting to include the bank reporting requirements in the bill. In order to alleviate concerns of perceived IRS invasiveness, they proposed increasing the $600 reporting threshold to $10,000 and exempting deposits already reported to the IRS from the reporting requirements.  

We are likely to see some form of this provision become law. 

Jim de Bree is a semi-retired CPA who resides in Valencia.

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