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Tax Law and Why It Matters to Public Plans
IRS funding and staffing reductions may impact the agency's ability to provide much-needed guidance on the tax law changes contained in the SECURE Act and the SECURE Act 2.0.
By: Tony Roda, Williams & JensenBloomberg Tax recently reported on an article from Cosmos Magazine explaining that 133 lines of Greek text on a papyrus from about A.D. 130 was discovered in the Judean Desert. It was translated and provided some interesting insights into the enforcement of tax law throughout the ages.
It seems from the notes of the prosecutor that two Romans, Gadalias and Saulos, were engaging in a scheme to either falsify sales for the purpose of claiming tax credits or creating forged documents to minimize their income, either way having the effect of lowering their tax liability. The same two approaches are still the basis of most modern tax law fraud cases.
Fast forward and we find that the U.S. Internal Revenue Service (IRS) has long believed that with more resources – personnel and IT modernization, principally – it could uncover hundreds of billions of dollars of unreported income and turn it into a windfall of revenue for the federal government. The search for the modern day Gadalias and Saulos is never ending.
On August 16, 2022, the Inflation Reduction Act (IRA) was signed into law by President Joe Biden (P.L. 117-169). It provided a special allocation of $80 billion to the IRS for enhanced enforcement, modernization, and customer service improvements. The Congressional Budget Office (CBO) estimated that over a 10-year period the special allocation of resources would translate into new revenues to the federal government of $200 billion.
The $80 billion special allocation came under political fire from the start and is still being attacked by Republicans as an assault on taxpayers' rights and one that will inevitably lead to armed IRS agents aggressively enforcing the tax law on low- and moderate-income persons. Republicans began to chip away at the IRS budget. First, in fiscal year (FY) 2023, Congress stripped $275 million from the IRS's annual funding. Next, in FY 2024, Congress clawed back a total of $21.6 billion of the $80 billion special allocation.
Why does the public pension community care about this? After all, state and local governmental retirement systems are not taxpayers. They are tax-exempt entities. However, they must be qualified under the federal tax code in order to be eligible for their tax-advantaged status. And, as you likely know, from that qualification flows significant tax advantages, including that employer contributions on behalf of employees are not taxable income to those employees, and also that the earnings of the trust are not earned income to the plan or to the plan's participants.
On February 13 of this year the House Ways and Means Committee held a hearing to further explore the IRS's special allocation. Republicans used the hearing to cast doubt on CBO's initial scoring estimates and the IRS's progress to date. It was stated that the estimate of the new revenue windfall through enforcement was already down 56 percent from CBO's initial estimates. Further, it was claimed that the IRS was continuing to struggle with customer service.
The stage is set for a near-complete claw back of the remainder of the IRS's special allocation. This could happen in the budget reconciliation bill later this year. Add to this the decision by Elon Musk's Department of Government Efficiency (DOGE) to fire 7,000 newly hired IRS personnel and the recent retirement of Acting IRS Commissioner Doug O'Donnell. Now, we begin to see a picture of an IRS starved of resources and personnel.
A growing concern for the public pension community is that the lack of resources and personnel will bleed over into areas of our direct interest, principally the continuing need for guidance on the new tax law changes contained in the SECURE Act and the SECURE Act 2.0. The original SECURE Act contained over 20 new provisions of tax law, and the SECURE Act 2.0 contained over 90 new provisions. Time will tell what damage is being done to the IRS's ability to provide timely guidance to taxpayers while also enforcing the laws against age-old fraud. Already the Trump Administration has reinstated a process whereby final tax regulations must be reviewed by the Office of Management & Budget in addition to the IRS and Treasury Department. Of course, this will slow down pieces of taxpayer guidance.
In addition, there may be a direct downstream effect on state governments. Most states simply adopt the fundamental figure of federal taxable income to begin their analysis of taxpayers' state income tax obligations, said John Valentine, Utah's Commissioner of Revenue. They deploy more than 90 percent of their audit and collection resources to factors below that line. Any disruption at the IRS in calculations and compliance processes could filter down to the states, he said. “It is conceivable that reductions in force at the federal level could affect the revenues flowing to the states,” said Valentine, also a past president of the Federation of Tax Administrators. “It could affect it in enforcement. It could affect it in compliance.”
As the changes take root at the IRS and other federal agencies, NCPERS will keep its members apprised of any significant developments.
Tony Roda is a partner at the Washington, D.C. law and lobbying firm Williams & Jensen, where he specializes in legislative, regulatory, and fiduciary matters affecting state and local pension plans. He represents the National Conference on Public Employee Retirement Systems and state-wide, county, and municipal pension plans in California, Colorado, Georgia, Kentucky, Nebraska, Ohio, Tennessee, and Texas. Tony has an undergraduate degree in government and politics from the University of Maryland, J.D. from the Catholic University of America, and LL.M (tax law) from the Georgetown University Law Center.
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