See all Insights

IRS Releases Long-Awaited Spending Plan for $80 Billion in New Inflation Reduction Act Funding

Brownstein Client Alert, April 11, 2023

OVERVIEW

On Thursday, April 6, the Treasury Department and Internal Revenue Service (IRS) issued their long-term Strategic Operating Plan (SOP), outlining how the IRS intends to spend $79.4 billion in funding provided by the Inflation Reduction Act (IRA). The 160-page document focuses on the IRS’ five “transformation objectives,” which are intended to guide the allocations of IRA funding over the entire 10-year spending period. In addition to these objectives, the SOP reiterates the IRS’ commitment to implementing the green-energy tax incentives enacted in the IRA—designating this ongoing process under a new strategic objective of “energy security.”

Within each transformation objective, the SOP offers several broad initiatives and accompanying “key projects” designed to achieve these long-term goals. The document also provides some additional details on the IRS’ proposed budget and short-term hiring targets. However, most of the budgetary and employment estimates are limited to only the next two fiscal years of agency operations and were already disclosed last month in the IRS FY2024 Budget-in-Brief (BIB).

The SOP was created at the request of Treasury Secretary Janet Yellen, who initially assigned the task of developing it to former IRS Commissioner Charles Rettig in August 2022. In her letter to Rettig last year, Yellen mandated that the SOP be provided to the Treasury Department by Feb. 17, 2023—a deadline the IRS ultimately did not meet. Prior to Yellen’s directive, early versions of the IRA included a similar statutory requirement for the IRS to furnish the SOP to Congress within six months of the bill’s passage, but that mandate was later removed in the Byrd Bath process.

Transformation Objective	Objective Goals	Total Proposed Funding (FY 2022–2031)
Objective 1	Dramatically improve services to help taxpayers meet their obligations and receive the tax incentives for which they are eligible	$4.3 billion
Objective 2	Quickly resolve taxpayer issues when they arise	$3.2 billion
Objective 3	Focus expanded enforcement on taxpayers with complex tax filings and high-dollar noncompliance to address the tax gap	$47.4 billion
Objective 4	Deliver cutting-edge technology data and analytics to operate more effectively	$12.4 billion
Objective 5	Attract, retain and empower a highly skilled, diverse workforce and develop a culture that is better equipped to deliver results for taxpayers	$8.2 billion
Energy Security	Support the implementation of IRA energy-tax incentives and ensure taxpayers are informed of benefits for which they may qualify	$3.9 billion

KEY TAKEAWAYS

1. Focus remains on tax enforcement, but new details are sparse. Nearly 60% or just over $45 billion of IRA appropriations are reserved for tax-enforcement initiatives. While the Biden administration has frequently reiterated that this funding is not intended to increase the percentage of audits against taxpayers with less than $400,000 in annual income compared to “historical levels,” the IRS has yet to provide specifics regarding the actual audit rate that will constitute this “historical” baseline. The SOP does not address this question or most of the other outstanding mysteries regarding the proposed enforcement expansion. Instead, the plan offers vague goals to “achieve compliance coverage” in several areas through “audits and non-audit contacts.” However, providing some insight into the IRS’ general plans, chapter 3 of the SOP alludes to existing IRS definitions for five distinct areas of proposed audit targets:

- Large Corporations: Corporate taxpayers with over $250 million in assets.
- Complex Partnerships: Partnerships with $100 million or more in assets and 100 or more direct and indirect partners.
- High-Income/High-Wealth Individuals: Individual taxpayers with more than $1 million in annual income.
- Other Areas Where Audit Coverage Has Declined: Taxpayers engaged in perceived “lower-audited areas,” including estate, gift and employment taxation.
- Complex, High-Risk and Emerging Issues: Taxpayers engaged in rapidly changing or potentially abusive tax landscapes, including digital assets, listed transactions and certain international-tax issues.

While the SOP offers few additional details on enforcement beyond these broad categories, the BIB provides initial estimates on portions of the IRS’ proposed total audit capacity. In FY2024, the IRS intends to open approximately 4,830 new cases against high-income individuals, 5,253 cases against complex partnerships and 947 cases against large corporations. With increased audits against these groups, the SOP argues that the IRS will lower the deficit by significantly more than the initial Congressional Budget Office estimates of $180 billion over the next decade. Notably, neither the SOP nor the BIB discusses potential audits against individuals and small businesses (presumably the owners of passthrough businesses) with income below the $400,000 threshold, even though Treasury Department and IRS officials have confirmed that these taxpayers may experience increased audit rates compared to current levels.

2. IRS commits to expediting implementation of green-energy tax incentives. In addition to the statutorily provided $500 million for the administration of the IRA climate and energy-tax incentives, the SOP discusses the IRS’ intentions to spend an additional $3.4 billion over the next decade to support these objectives. The additional funding will be spent on dedicated, energy-focused staff and technology, and it is intended to be split between taxpayer services, increased enforcement and system modernization. As the SOP notes, the expanded cost estimate was developed in consultation with the Department of Energy and will likely be necessary to cover the costs of administering the approximately 20 new or revised energy-related tax incentives.

The document also notes that the IRS is focused on developing regulations to clarify requirements for increased credit amounts associated with domestic-content, labor, geographic-area or greenhouse-gas-emission-reduction standards. This effort has led to the creation of a dedicated office within the IRS to contend with the implementation complexities of the energy credits, including the transferability and refundability of many of the new incentives. In the immediate future, the SOP says the IRS expects to complete the dealership-transfer provisions associated with the section 30D clean-vehicle tax credit by Dec. 31, 2023. In addition, the IRS intends to release new mapping tools to help taxpayers identify eligibility for certain bonus credit amounts, as well as updated FAQs for the residential clean-energy and energy-efficient building tax incentives in the coming months.

3. Hiring estimates invoke uncertainty for long-term operations. Despite promising additional clarity regarding anticipated IRS hiring in the entire 10-year IRA budget window, the SOP provides only high-level staffing estimates for FY2023 and FY2024. Additional transparency on the expected number of new IRS employees supported by the IRA was a focal point for requests by Democratic and Republican lawmakers alike, following conflicting accounts on the number and role of these new hires. Addressing this potential criticism in a call with reporters last week, Deputy Treasury Secretary Wally Adeyemo said the SOP limited the budget to a two-year window to allow for more future flexibility in planning and to enable the IRS to avoid becoming “locked into numbers on a piece of paper.” Information on new hiring gleaned through the SOP is summarized in the chart below:

Proposed Full-Time Equivalent (FTE) Supported by IRA Funding

	Changes in FY2023	Changes in FY2024	Total Changes Through FY2024
Taxpayer Services	+7,394	-905	+6,489
Enforcement	+1,543	+5,696	+7,239
Operations Support	+727	+3,083	+3,810
Business Systems Modernization	+357	-160	+197
Energy Security	0	+1,810	+1,810
Total FTE	+10,021	+9,524	+19,545

The estimates above assume that certain hiring objectives will be supplemented by an additional $2.1 billion in FY2024 IRS funding, although the budget increase is unlikely to occur in a politically divided Congress. The estimates section of the SOP notes that if Congress does not provide the IRS additional funding, the agency will be required to use 100% of IRA taxpayer-services funds to maintain current programs and will be unable to pursue many of the taxpayer-assistance objectives outlined under Objectives 1 and 2 of the SOP. In that scenario, the IRS admits it may exhaust the entire IRA taxpayer-services budget within four years.

4. System modernization and digitalization among top agency priorities. While the IRA commits just $4.8 billion to the IRS’ business-system-modernization (BSM) account, the SOP diverts significant funding for additional technology improvements (Objective 4) through allocations from other business accounts. This includes a proposed $9.2 billion redistribution from the operations-support account, which is usually reserved for routine maintenance costs such as rent, facilities and security, as well as legacy telecommunications and information technology. The proposed modernization investment is marketed as an agencywide transformation to replace the IRS’ legacy systems with new “interconnected, data-driven decision-making” digital platforms.

The SOP further explains specific short-term project goals associated with these modernization initiatives, including:

Continued development of a modernized information-returns intake to provide a free online portal for businesses to file Form 1099-series returns [an initial version of this system was opened in January 2023 as the Information Returns Intake System (IRIS)];
Replacement of the Individual Master File, Business Master File and Generalized Mainline Framework legacy databases with a more flexible digital system;
Creation of a new cloud-based robotic process automation platform to automate myriad high-volume processes; and
Implementation of data-at-rest encryption on the entire portfolio of IRS critical systems.

To achieve the proposed modernization efforts outlined in the SOP, the IRS requests at least $290 million in additional annual discretionary funding for the BSM account. In the FY2023 appropriations bill, Congress entirely eliminated non-IRA funding for the BSM account to appease GOP requests to limit new IRS funding.

5. IRS offers vague success metrics, despite overwhelming calls for greater accountability. Lawmakers on both sides of the aisle have increasingly called for greater accountability in the IRS’ use of IRA funding. Last month, Sens. Chuck Grassley (R-IA) and John Thune (R-SD) introduced the IRS Funding Accountability Act that would require the IRS to provide Congress with an annual plan on how the agency intends to use IRA spending. Moreover, in her letter to Rettig last year, Yellen clarified that the SOP was intended to improve IRS accountability and should include “metrics for areas of focus and targets over the course of the coming years that the agency will strive to achieve.”

Despite ongoing calls for stronger accountability, the SOP is devoid of significant, quantifiable success metrics for IRA-funded efforts. While the document includes over 50 “project milestones” split between the five transformation objectives, they are overwhelmingly broad and are largely unmeasurable. For example, in reference to ongoing efforts to improve staffing at Taxpayer Assistance Centers, the SOP sets goals to provide “expanded hours” in FY2023 and “increased service availability” in FY2024, without additional quantitative milestones. The lack of precise goal setting was likely an effort to insulate the IRS from attacks in the case of potential failure and to provide the agency with additional flexibility to adapt the plan to changing circumstances. However, this strategy has garnered significant criticism from groups that view the deliberate ambiguity as further contributing to a growing lack of public trust in the agency.

6. Werfel takes center stage in oversight of the IRA and its implementation. Despite having served as head of the IRS for less than a month before the SOP’s publication, Commissioner Danny Werfel has taken on the leadership of the agency’s transformation efforts. The document begins with a letter from Werfel, in which the newly sworn-in commissioner acknowledges recent agency improvements, before subsequently summarizing his vision for the “future of federal tax administration.”

Werfel’s significant role in the prospective implementation of IRA funding is further exemplified in the announced Transformation and Strategy Office (TSO), which will coordinate the allocation of IRA resources. As the SOP explains, the effort will be led by a chief transformation and strategy officer (CTSO), who is yet to be named but will report directly to Werfel. Additionally, the CTSO will be responsible for developing a new advisory committee to assist Werfel in making decisions regarding “strategic alignment and problem-solving.” Werfel and the TSO will also coordinate an update of the SOP annually and will seek to provide frequent progress updates to external stakeholders—including the Office of Management and Budget, Congress and the public—through existing reporting and review processes, like the Annual Performance Plan and Report.

REACTIONS

Immediately following the SOP’s release, House Ways and Means Committee Chairman Jason Smith (R-MO) issued a statement critical of several elements of the plan. In particular, Smith emphasized the lack of detail regarding target audit rates as well as proposed hiring beyond FY2024. Smith also criticized the agency for requesting additional funding for taxpayer services on top of already appropriated amounts, despite providing no supplementary information regarding budget estimates beyond the end of the next fiscal year. In contrast to stark GOP opposition, Democratic lawmakers have remained muted in their public reactions to the document.

Also responding to the plan, National Taxpayer Advocate Erin Collins released a blog post commending the plan as a sign that “the tax administration stars seem to be aligning.” Notwithstanding her optimism, Collins cautioned that the IRS must not forget about its core mission, including the immediate challenges of eliminating the paper-return backlog and addressing ongoing telephone-service deficiencies.