IRS Key Updates: ERC, EITC, And Government Shutdown Plans

Robert Kerr, formerly with the IRS and now with Kerr Consulting, discusses latest developments from the IRS, including the tax agency’s plans for a government shutdown and its handling of the employee retention credit.

This transcript has been edited for length and clarity.

David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: navigating choppy seas.

All eyes have been on the IRS lately as Commissioner [Daniel] Werfel works to improve the agency, while Congress debates taking back some or all of its $80 billion funding from the Inflation Reduction Act. Add to that a looming government shutdown, and the IRS has a lot on its plate.

So what kind of changes have happened recently, and what’s coming next?

Here to talk more about this is Tax Notes senior reporter Jonathan Curry. Jonathan, welcome back to the podcast.

Jonathan Curry: Hi, Dave. It’s good to be back.

David D. Stewart: Now, I understand you recently talked with someone about this. Could you tell us about your guest?

Jonathan Curry: Yeah, I had the pleasure of talking with Bob Kerr. He has his own consulting company, Kerr Consulting. He also spent a long time with the National Association of Enrolled Agents before that.

And I’ve always appreciated talking with Bob about matters about the IRS, what’s going on in Congress, [and] tax administration in general. He has a good outside-the-box perspective that doesn’t always fit neatly into one camp or the other, and he always brings a lot of candor to our conversations.

David D. Stewart: And what sort of things did you get into?

Jonathan Curry: Yeah, so today we talked about all things IRS, and there’s been a lot going on. So we spotlighted some key events in the past few months. Just to run you through the high-level stuff, we talked about the employee retention credit announcement the IRS made, that they were putting a stop to processing the new claims.

The IRS has also announced that they’re going to be going after partnerships and big corporations and wealthy taxpayers for audits, and they were hiring a whole bunch of new revenue agents to do that. And so we talked about some of the practical challenges of getting something like that off the ground.

So we covered quite a few topics today. There’s some more there that you’ll get to hear about, and it was an intriguing conversation.

David D. Stewart: All right, let’s go to that interview.

Jonathan Curry: Welcome back to the podcast, Bob. It’s good to have you back.

Robert Kerr: Thank you. It’s good to be here.

Jonathan Curry: So we’re here today to talk about the IRS, and there’s been a lot of news coming out of 1111 Constitution Avenue these days, hasn’t there?

Robert Kerr: There has. The Big House has been busy.

Jonathan Curry: Big House has been busy. So for this episode, we’re going to be spotlighting some of those key developments that have been happening this season. I’d like to start with the employee retention credit. That one’s gotten a lot of attention lately.

And just to recap where we are, the IRS has been hinting for quite a while now that they’re not exactly keen about the new employee retention credit claims that are coming in. I’ll call that ERC for short.

There have been announcements, press releases, [and] speeches from IRS officials over the past few months, all saying that this is an area of concern. They’re looking at it closely.

And then about two weeks ago, they kind of dropped the hammer, didn’t they? They said that they were going to stop processing all new ERC claims that were coming in, and they were going to stop that for at least three months. It’s like a temporary moratorium.

They’d also be processing the existing claims that they do have, but they’ll be doing it at a much slower pace. IRS officials say they’re looking at a tsunami of fraud. So Bob, how did we get here?

Robert Kerr: Well, I think we have to jump into the “Wayback Machine” and turn the dial to 2020.

So we’re at the beginning of a pandemic, and Washington decision-makers, policymakers are running around with their hair on fire. And out of that, you get the PPP. You get the ERC as well.

Jonathan Curry: Yeah, the Paycheck Protection Program.

Robert Kerr: Exactly. I’m sorry. And you get these relief programs because these are extraordinary times. But even, I’d have to suggest to you, Jonathan, that even at the time, what I said at the time is that this ends in tears.

It’s an unbelievable amount of money pushed out very quickly during a pandemic with the guidance that was catch as catch can. And the agency was under tremendous pressure to get out the money.

So I don’t think that anyone should be surprised. The Casablanca, “I’m shocked that there’s gambling,” and “I’m shocked that there’s a tremendous amount of fraud.” Well, no, I’m not. It’s unfortunate and it’s truly problematic, but it’s not shocking.

Jonathan Curry: And the IRS was a bit in a kind of a damned if you do, damned if you don’t position. If they made it too stringent to qualify for it, then they would be — lawmakers would be shouting at them for making it hard to get the relief that these companies need to stay afloat. They make it too easy, now we’re kind of in a situation we’re in now, where now the people are mad that there’s so much fraud going on, and there’s way more billions of dollars flowing through this than what was initially envisioned.

Robert Kerr: No, it’s absolutely — the agency, I agree, was in a no-win situation, and the urgency of the moment then was to get out this money. And even, you’ll recall during the past several years, the agency has still been under a lot of pressure to process these ERC claims.

And so, the time that it took for IRS to process the claims was significant in many cases. What I understand is that as we got deeper and deeper in, went down the calendar, the proportion of good to bad claims became truly out of kilter.

Jonathan Curry: Yeah. The IRS at this point is saying, I’ve heard them say, some officials say they believe that as many as 95 percent of new claims coming in may be either fraudulent or just ineligible, people being sort of duped by these ERC mills. Can you explain a little bit about what these ERC mills and these promoters, what’s in it for them and why are they jump-starting this?

Robert Kerr: There are firms out there who market the ERC, and the lead on this is everyone qualifies for $26,000 an employee. So it’s a lot of money. These firms suggest that it’s easy and everyone qualifies. They work on a contingency basis. And so, I don’t know precisely what those numbers are, but let’s approximate it at 30 percent. And so, the contingency folks grab 30 percent and they’re gone. So it’s profoundly lucrative for the firms that are doing this, and it will leave those who actually didn’t qualify holding the bag.

Jonathan Curry: So how does this decision — the IRS is saying they’re going to stop processing. What is the IRS hoping to accomplish from doing this?

Robert Kerr: I believe it’s probably trying to do two things, the first of which is make the strongest statement possible that these are problematic.

The second of which is, I suspect, that the agency is trying to cobble together something more holistic.

I would expect to see the agency come out with something akin to the offshore voluntary compliance program. So OVDI, if you’ll recall from, I don’t know, 10, 12 years [ago]. It could be even longer. When Kevin Brown was at the helm at IRS and the agency gave folks with offshore accounts — they gave them a window in which they could come in and self-report.

I believe what the agency is going to do, and probably should do, is create the same kind of programs, and it actually should have that program, plus create a window to allow people to withdraw. “Oops. Mulligan. Let me pull that claim back. I didn’t really mean it.” Which will also sort of clear up inventory.

The voluntary disclosure program helps the agency call back money, because it doesn’t have the bandwidth to go after everybody anyways. And so, this is unfortunate, but it’s a case largely or likely in which pigs get fat and hogs get slaughtered.

Jonathan Curry: OK, so what’s next then? So we have the next few months, the IRS saying they’re going to be rolling out these new programs. I’ve also heard the IRS and Treasury say that they’re looking to Congress for help, right?

They’ve talked about trying to get authority from Congress to regulate paid preparers. Commissioner Werfel has also said that they’re considering getting Congress to change the law to end the period early for people to amend their returns and claim the credit, and essentially close the window before when it would normally close. I think in 2024. So do you think that those measures could help?

Robert Kerr: Theoretically, I think both of those measures could help. The return preparer piece, the return preparer standards, this is not a new idea at all. It’s been kicking around for at least 20 years.

The issue I have — and I’m on the record in favor of it — I would hate to see this be the end. This is the answer to problems. All problems will be answered by the regulation of return preparers. I think it’s part of a solution. I don’t think it’s the entire solution, either with ERC or anywhere else, anywhere else where we see problems in the code.

Jonathan Curry: So moving on to another big issue with the IRS. The IRS — we’ll talk about their collections operation post-pandemic here. The IRS, they basically hit pause on a large swath of their enforcement activities during the pandemic. It was part of their People First Initiative.

They were wanting to go easy on taxpayers while we were in this shared national emergency. And part of that may been driven by the IRS just feeling charitable. They wanted to be kind, to do taxpayers a favor.

But there definitely was a big part that was practical too. There was this huge — most people will be aware of this by now — the IRS had a huge backlog of unprocessed tax returns, mail correspondence. So when the IRS automated system was sending out notices to taxpayers saying, “Hey, you missed the deadline to file or pay your taxes,” many taxpayers had already filed or paid their taxes, but they just hadn’t been processed yet. And then when they would respond, the IRS wouldn’t process their response.

There was this constant disconnect, and it was just creating a lot of confusion, so the IRS basically just hit pause. And it’s now end of September 2023, and a lot of this enforcement activity is still paused. So what’s going on here? Why not just restart the notices and get back into action?

Robert Kerr: That’s a great question. It is one that I’ve been asking quite a bit as well. IRS begins the pandemic, as you suggested, with this People First Initiative.

I mean, all is well in the sense of, I don’t think that any serious observer thought that IRS shouldn’t have made that decision at the onset. We are now some three and a half years into post-pandemic, or after the beginning of the pandemic, and IRS still hasn’t turned on the notice stream, hasn’t turned on ACS (Automated Collection System). So what we have is, by the time, and I’ve heard through, I think, credible sources that IRS hasn’t planned on doing anything there until after the beginning of the year.

So if that’s in fact the case, then it’ll be going on four years that IRS hasn’t had a functioning ACS. It’ll be four years in which IRS has throttled down on notices, on liens, on levies, and it’ll be four years of statutes that have, they’ve been blown. You have a 10-year statute and it’ll be four years in, so every single thing that, if we could back up to May, I’m sorry, March of 2020, that’s four years. Four years of statute that have fallen off. And you have four years of new that have come on and haven’t been touched.

And so, every single week that IRS waits to come online to do something is another week worth of problem.

Jonathan Curry: Yeah, yeah. And it’s been interesting to watch this. When I remember, not this May, last May 2022, at the American Bar Association meeting, I heard one of the high ranking IRS officials say that the IRS was looking at restarting these notices. And then the following year, this May, same official saying, “We’re still looking at restarting those notices.” And then I heard later it was going to be later this summer, early this fall, and now it looks like it might not be until early 2024 at the earliest.

Robert Kerr: Well, IRS said that it had caught up on its backlog. The backlog was back to normal, and the former commissioner committed at the beginning of last year in congressional testimony that IRS would be back to normal by the end of the year.

So IRS says it’s back to normal. Then that raises the question of why are we waiting so long from back to normal on the backlog, if that’s indeed what drove the decision in the first place?

And in the meantime, it sends this message, I believe, to taxpayers and would-be taxpayers that filing your returns or paying what you owe, it’s not a priority for IRS, and so why should it be a priority for me as a taxpayer?

Jonathan Curry: IRS data has shown that the numbers of balance-due filers and the number of filers requesting an extension has also spiked upwards recently. Why do you think that is, and why do you think that might matter?

Robert Kerr: I think that that would be a great research paper for somebody in perhaps the taxpayer advocate’s office or a research division.

I can make some guesses here, one of which is that on balance-due returns, we had to change the W-4 several years ago, which made it very difficult for people to get their withholding right. We also had programs recently that were designed to give more money to taxpayers, enhanced child tax credit, for instance.

And people don’t adjust from those changes very well, so when they get larger refunds, that’s what they expect to get. So when the program underlying it changes, then we see this change in returns moving from a refund to a balance due.

One of the problems with it, though, is that a refund return says to IRS, “I don’t have a collection problem.” A balance-due return to IRS says, “I have a potential collection problem.”

And the more of those that you have, whatever percentage of them come home, you’re working with a larger base. And I’m just going to make this up. If 60 percent of those balance-due returns actually pay, that means 40 percent aren’t, but if you double the amount of, or number of returns that are becoming balance due, then you’re doubling the number of returns that aren’t paying.

Jonathan Curry: All right, so Bob, the IRS has also been making a lot of announcements recently about how they’re tackling the rich, how they’re going after wealthy taxpayers, especially complicated partnerships, big corporations, and the such.

Recently, they’ve announced that they’ve created what I’ll call a “Super Squad” or something, the A-team of auditors that they’re trying to hire. They wanted to bring in 3,700 experienced auditors to come help with this crackdown on the higher income levels.

So is hiring that many auditors realistic for the agency at this point? And how long do you think it might take for them to actually fulfill that goal?

Robert Kerr: I believe, Jonathan, that the answer to every interesting question in tax is the same, and it was an interesting question, so the answer is, it depends.

Is it reasonable for IRS to hire 3,700? Sure, depending on over what time frame are we bringing on folks. And are they going to be direct hire? Are they going to be hired through the standard federal process?

And for folks who are listening who have never gone through the standard federal process, I have to say, it’s misery-inducing. It is unpleasant, and I think the process itself is the punishment, and I think it dissuades a lot of people from applying.

So you’ll have that, and I don’t know whether they’re using their direct-hire authority for this. If they are, they’ll have — I think, it’ll be faster and they’ll have better luck at it. So, maybe. Maybe they can. I think it’s a heavy lift.

And you haven’t asked this yet. I also think it’s the right — if you’re looking at an IRS that wants to readjust how it faces the world, it seems that going after these complex partnerships and high-net-worth individuals is, that’s a crowd-pleaser.

Jonathan Curry: Speaking of crowd-pleasers, is there sort of a political side to this as well? Like, “Hey, we’re doing something.” They’re hiring these people with the extra Inflation Reduction Act money. Now they’re publicizing, “Look what we’re doing with this money.” Is that a critical aspect here?

Robert Kerr: Oh, I think so. If you go back to the beginning of the Inflation Reduction Act, and there was a tremendous push from Treasury that this money, the Inflation Reduction Act money, wouldn’t be used for people who weren’t wealthy. And I always get a little wrapped around the axle on this because I’m a corn-fed Midwesterner, and so when we come to D.C. and we define rich at $400,000, I struggle a little bit with that. But that’s the mark. That’s what we’ve called it.

So the Treasury comes out and says, “Well, we’re not going to pick on middle class, that is, people under $400,000.” So that’s a huge line in the sand, and I think this is a natural extension of it. As I said, I think it plays well. I think it also is, it’s smart.

The amount of mischief going on in these partnerships and closely held C corps, it’s significant, and it’s going to be difficult to find, and it’s going to require highly trained IRS staff to do it. I think it’s a win.

Jonathan Curry: Now, I have heard that it does oftentimes take a long time for IRS agents to get up to speed. It can take oftentimes two to three years before they’re really experienced enough to know what to look for, how to spot signs of misdoings by a taxpayer.

These would be experienced agents that they’re looking to hire, but they’d be typically experienced from the private sector, and now they’d be playing on the other side of the table, working for the government. How long do you expect to see an impact?

Robert Kerr: There’s going to be a lead time. There’s going to be some sort of learning curve, and it will depend on the skill set of the folks that they bring on.

In a perfect world, you’re bringing on, at least theoretically, you’re bringing on precisely the right people. You’re bringing on people who understand how that sector works.

So it’s not IRS training people from scratch; it’s IRS training people who understand what they’re looking for, and the training, I would imagine, would simply be on how do we do that here? What’s the IRM (Internal Revenue Manual)? How do we follow the procedures? And what does the end look like? How do we wrap up an audit?

I would imagine, and this is just me staring at the ceiling tiles, that that’s a much lighter lift than creating a revenue agent from scratch.

Jonathan Curry: Now we’ve been talking about the IRS’s enforcement actions on the high end. Now let’s talk about it on the low end here. The IRS announced recently that they’re going to be scaling back earned income tax credit (EITC) audits. Most of these audits are what’s called correspondence audits that are done by mail. They’re usually also limited to the earned income tax credit claim itself, so it’s not an audit of the entire taxpayer situation. And the IRS does a large number of these, I think somewhere in the realm of around 300,000 or so each year, which if you look at their numbers, it makes it so that they are auditing a large share of low-income taxpayers.

The IRS, in response to a study from Stanford University that found that Black taxpayers were being audited at higher rates compared to non-minority taxpayers, said it would look into this. The Stanford study didn’t have access to IRS data. It was imputing race onto public data. And the IRS said that its own internal data does validate, at least to some extent, what Stanford, what their conclusions were.

So the IRS in response to that said that they’re going to be essentially redirecting resources. They’re not going to be doing as many of these audits. They are messing around with their algorithm to try to change how it selects audits, or selects returns for audits. And so, do you see wisdom in this? Is it the IRS caving to pressure, or do you think that there’s some wisdom here?

Robert Kerr: I think it could be a little bit of both, actually. The agency, not withstanding these $80 billion or $60 billion or however many billion the Inflation Reduction Act funding happens to be when the dust settles, it sits here right now with a distinct staffing disadvantage.

It hasn’t hired revenue agents and revenue officers and TCOs (tax compliance officers) and so on and so forth for 10 years in any serious fashion. So there just isn’t enough. There isn’t. The tablecloth is too short, Jonathan.

And so, when we’re going to cover, we can choose to cover one end or the other, but we can’t choose to cover both. If the agency wants to pivot to higher income, higher-net-worth taxpayers, the resources have to come from somewhere, is one way that you can sort of make a narrative of this.

The other, and the one that I question, and frankly I don’t know, is how exchangeable is the staff, the office? Because it’s not going to be a revenue agent typically, I don’t believe, that’s out there doing an EITC audit. That’s just a correspondence audit.

So if you’re going to draw back on the number of EITC audits, where do you put those staff? Because I don’t think you’d take them and you lift them from there and drop them into 100-person partnerships.

So I don’t know how, if you’re framing it as a staffing or a resource issue, I’m not sure how that works. If we’re framing it as the agency wants to have a more balanced approach to its compliance activities, well, I think that dog hunts.

Jonathan Curry: That’s interesting to think about the context of the EITC. The IRS is essentially pulling back from enforcement action on an area that is generally understood to be an area with a high improper payment rate.

Now, there is a lot of debate over how precise that improper rate is. There’s a lot of academic research saying, suggesting that people aren’t necessarily, might not be ineligible for it, but when they get the notice from the IRS saying, “Hey, do you actually qualify for this? Prove your eligibility,” they get intimidated and they back out and say — and that gets added to the improper payment rate as, well, that person wasn’t eligible because they didn’t contest it. But the IRS, if they’re pulling back from an area of low-income enforcement, or even just pulling back from enforcement in certain areas, does this create a vacuum, in a sense?

Robert Kerr: Well, I have to suggest that I don’t know how it couldn’t. Let’s look at collection for a minute, and let’s look at the number of nonfilers, for instance, which I read a profoundly interesting article recently from a tremendously reputable source, and he suggested within this study that some 11.2 million taxpayers are nonfilers. And then I hit the Google machine pretty hard on this to try to find out, how do I put this in context?

And if we list the states by adult population and created a new state with 11.2 million adults in it, it would be the fifth-largest state in this country, somewhere between New York and Pennsylvania. And I have to ask myself, if this new state, or if Pennsylvania entirely stopped filing tax returns, I would think we would do something about that.

But if you have 11.2 million known nonfilers that IRS is not doing anything about, what narrative, what trend is IRS permitting? What message is IRS sending there? And I can’t help but think it’s not a good one.

Jonathan Curry: So now let’s talk about something that’s a little, definitely very current this week: the IRS shutdown. Just a little brief recap of where we are. About two to three weeks ago, there was reporting that the IRS was going to stay fully open. They were just going to reprise their plan from last year, which was, “Hey, we’ve got billions of dollars of Inflation Reduction Act money stashed in a vault somewhere. Why don’t we just pull from that and keep, stay afloat for however long we need?”

And then last week, we found out some things changed. The National Treasury Employees Union said that the IRS has communicated to them that they should prepare their employees, which are largely IRS, to prepare for a partial shutdown. So what’s going on here? Why would there be a partial shutdown this year, when the IRS still has access to all that cash?

Robert Kerr: I was surprised, Jonathan, because I was of the opinion as well that IRS would simply dust off — I think every agency has to put together this contingency plan, a contingency shutdown plan, and IRS’s has historically has been a fairly lengthy document and breaks down by W&I [wage and investment division] and SB [small business/self-employed division] and so forth of who’s in and who gets to stay home.

Which, by the way, creates a certain amount of agita within the agency, because there are people who are going to be deemed essential and people then that are going to be nonessential, which is, that’s sometimes cuts a little deep. But that’s, for this point, neither here nor there.

IRS last year, as you said, because it has this — the Inflation Reduction Act money is no-year money, so it can spend it, to some extent, at its will. My gut says that IRS wanted to reprise last year’s plan, but two things came in the way of it, the first of which is, I think, that the optics are bad. The Hill optics are bad.

When you have a non-trivial portion of the right flank, at least, saying that IRS shouldn’t have had $80 billion, shouldn’t have $60 billion, shouldn’t even have $6 billion, probably.

So it looks bad when they’re pushing to shut down the government and IRS says, “We’ll take a pass,” or, “Yes, no thank you, not for us.” And I suspect Treasury also weighed in and said, even if IRS had a thought that it was going to do it that way, I think Treasury probably said, “Let’s not and say we did.”

Jonathan Curry: To your point about the IRS shutdown plan, it usually is about 120-, 130-page document. Last year when they had their—

Robert Kerr: It was like, four.

Jonathan Curry: It was about four pages, and one of them was a title page, and one was a “This page intentionally left blank.” So really it was, nothing to see here.

Robert Kerr: “We’re all going to be here. Yeah, we’re all going to be here, and don’t panic, anybody. Things will be precisely as functional as they were before.”

Jonathan Curry: That’s right. So why would it matter, though, if the IRS was shutting down? And also, I’ll add to that, do you see a difference between a three-to-five-day shutdown and a 30-day shutdown?

Robert Kerr: Why does it matter? It matters because the process of turning on and turning off is time-consuming and wasteful.

So whatever machinations the agency has to go through for a shutdown and reverse for starting back up, that’s wasted time, wasted effort. That did not accomplish anything for taxpayers. That did not accomplish anything for tax administration.

So we also at this point have a filing season to prepare. We have work to do, frankly, on compliance, on pulling together notices to put out on the collection notice stream, and arguably, none of those are going to happen. I am not sure about filing season. They might be considered essential. It’s deeply disruptive.

And the longer this goes on, the more, of course, just the more disruptive it is. And it’s terrible for employee morale as well, because while these folks will, with almost 100 percent certainty, get paid, they won’t get paid during the shutdown, and for some, that’s a real hardship.

Jonathan Curry: Yeah. I recall during the last shutdown plan, when the IRS didn’t have the Inflation Reduction Act money to pull from, that was in what they would call fiscal year 2022, that plan actually distinguished between the filing season and the nonfiling season.

So a certain number of employees would be furloughed during the nonfiling season before January 1 of the following year, and then if the shutdown continued, they’d have a different plan for certain employees who would be deemed essential.

Now, a lot of those might be customer service representatives that would handle the phone call influx that would be coming. But it does seem like the filing season is a big topic weighing on the IRS’s mind leading up to and going into the next year.

Robert Kerr: Well, it always is, and the issue then becomes, which shutdown is going to be of concern? Will there be a beginning of fiscal year shutdown? Or there’s other patterns. We’ve seen CRs, continuing resolutions, and then we see, how about a January shutdown? How’s that going to be for you, IRS? Oh, yeah, that’s going to be really not great for IRS. None of it’s good. None of it’s good for IRS.

Jonathan Curry: Well, Bob, thank you so much for joining us today. It’s been a pleasure having you. Thank you for weighing in on all these topics. And I’ll just note that all of these are ongoing storylines. None of them have conclusively ended, and we’ll see how they play out.

Robert Kerr: Absolutely, and it’s a pleasure to be here. Thanks for inviting me out.