Banks call IRS reporting plan a compliance and privacy nightmare. Is it?

WASHINGTON — The scuffle over a Biden administration proposal to use bank account data to combat tax evasion is focused on how much the plan will raise banks' compliance burden and threaten the privacy of their customers.

Banks and their advocates charge that the proposed measure — a key element of how the administration wants to pay for the $3.5 trillion reconciliation bill — could give the government a glimpse into customers' private transactions, while the expanded reporting would impose new processing costs on the industry.

"We believe that this program is costly for all parties, not fit for purpose, and loaded with potential for unintended and serious negative consequences," more than 40 trade associations, including banking industry groups, wrote in a letter Friday.

But backers of the plan to narrow the "tax gap" between owed and paid taxes — including the Treasury Department, former Internal Revenue Service officials and others — say banks are greatly exaggerating the potential fallout.

The suggestion that banks will report transaction-level data to the Internal Revenue Service "is an outright misstatement," said Charles O. Rossotti, a former IRS commissioner.

Rossotti said the plan would simply expand a reporting framework already in place by adding new data points. Banks already must provide 1099 forms on how much interest income a customer has accrued in an account.

"The proposal is adding two numbers to a 1099 form: total deposits, and total withdrawals,” said Rossotti. “There's no transaction data; there's no detail on individual transactions.”

The financial services industry has fought mightily since the spring to stop the proposal, but the measure to require the reporting on accounts with more than $600 of annual inflows or outflows is under active consideration in the Senate.

A companion bill advanced by the House Ways and Means Committee did not include the reporting proposal, but sources say a deal may be in the works to eventually pair the measure with the revival of the State and Local Tax deduction — a casualty of Trump-era tax changes that had largely benefited homeowners living in the country’s highest-cost areas.

On Wednesday, Treasury Secretary Janet Yellen wrote to the Ways and Means Committee Chairman Richard Neal, D-Mass., urging the House to include the measure in its version of the budget plan.

An op-ed published in American Banker by Sen. Mike Crapo, the top Republican on the Senate Finance Committee, argued that the proposal was "a huge violation of privacy” and “an egregious abuse of Americans’ right to due process by inferring that all U.S. taxpayers are guilty of evading taxes until proven otherwise.”

"This surveillance dragnet will capture every single American — from all income levels — with a bank, credit union, brokerage or financial account," Crapo wrote.

But progressives say banks and Republican opponents of the plan are engaging in fearmongering. They say the information provided by the banking industry would be valuable to the IRS to coordinate tax audits and ensure that high-net-worth taxpayers report their investment and business income.

“Once something is easily demagogued, it becomes an increasingly big thing as the process goes on,” said Seth Hanlon, a senior fellow at the Center for American Progress. “The proposal is requiring a tiny amount of noninvasive information on the front end to avoid pointless, but very intrusive, audits on the back end.”

The industry trade groups' letter addressed to House Speaker Nancy Pelosi and Minority Leader Kevin McCarthy urged Congress to reconsider the tax reporting requirements.

“While the stated goal of this vast data collection is to uncover tax dodging by the wealthy, this proposal is not remotely targeted to that purpose or that population,” the trade associations wrote, including the American Bankers Association, Independent Community Bankers of America, Consumer Bankers Association and Electronic Transactions Association.

"In addition to the significant privacy concerns, it would create tremendous liability for all affected parties by requiring the collection of financial information for nearly every American without proper explanation of how the IRS will store, protect, and use this enormous trove of personal financial information," the groups wrote.

Rossotti suggested that the industry's greatest fear — rather than compliance cost or privacy issues — may be that the proposal works as intended, putting banks in the awkward position of being an instrumental part of the government’s crackdown on tax avoidance.

“There are people that are not paying a substantial amount of tax regularly, every year, for many years. And now with this reporting, it's going to be very difficult to avoid that,” said Rossotti. “And it's bank reports that are going to be front and center of making that happen, right? They want to get out of the line of fire.”

The reporting plan first proposed by the administration in May as a means of closing the tax gap would require a “breakdown for physical cash, transactions with a foreign account, and transfers to and from another account with the same owner,” according to the Treasury Department.

The argument from the Biden administration is that a better-funded IRS with more robust tax data at its disposal would have a much easier time identifying systemic tax avoiders and cut down on unnecessary tax audits.

The nonprofit investigative newsroom ProPublica found that misplaced audits disproportionately targeted lower-income families in 2019. Meanwhile, the Treasury Department estimates that 28% of all unpaid taxes is owed by the top 1% of income earners.

According to IRS data analysis of tax-year cycles from 2011 through 2013, underreported income is the main culprit for the hundreds of billions of dollars of underpaid taxes, accounting for 38% of the gross tax gap.

But the proposal has been staunchly opposed by banks from the beginning. The ICBA has claimed on its website the proposal would require banks to “report virtually all their customers’ bank account information and activity to the IRS regardless of the customers’ consent.”

“The idea that now you're going to go after even more data from individuals, regardless of their tax liability or any suspicious activity, is really a dragnet, and I don't think members of Congress want to go there,” said Paul Merski, executive vice president of congressional relations and strategy at the ICBA.

Industry representatives also stress that the appearance of IRS surveillance of customer bank accounts may undercut efforts to expand access to the financial system, particularly for marginalized communities.

"Privacy concerns are cited as one of the top reasons why individuals choose not to open financial accounts and participate in the financial system," the trade groups' letter on Friday said. "This proposal would almost certainly undermine efforts to reach vulnerable populations and unbanked households."

But Hanlon said banks themselves are responsible for stoking that fear.

“If they’re concerned about that, they should stop grossly mischaracterizing the proposal,” Hanlon said. “So many transactions are already reported to the IRS. If people had the full context of what a tiny reform this is, it wouldn’t have any impact.”

Still, plenty of Americans simply don't trust the IRS in general. The agency is not particularly popular and has been dogged by poor funding, accusations of political pressure and high-profile data breaches for years.

“The IRS is absolutely incapable of handling or processing this massive amount of new data, and they would admit as much — that's why they're asking for an additional $80 billion in this budget,” Merski said.

Merski also suggested that the government may not stop at requesting basic outflow and inflow data. “The real fear is that they are going to ask the banks to then supply additional details on someone the IRS is profiling or has flagged [using the new bank reporting requirements], and then they'll say, 'Well, we want the specific transactions,' ” he said. “ It's not an innocent [proposal] just trying to close the tax gap. This would be an historic invasion of financial privacy like we've never seen before.”

In a statement, a spokesperson for the Treasury Department pushed back on claims that the Biden proposal had anything to do with individual transaction data.

“This proposal does not mandate reporting of individual transactions to the IRS. The President’s proposal requires that banks report the most basic, high level information on account inflows and outflows,” the Treasury spokesperson said. “This will help the IRS target its enforcement activities on those who are actually evading their tax obligations—decreasing costly and burdensome audits for the vast majority of taxpayers who pay what they owe.”

Still, some analysts maintain that the reporting requirements would represent a real cost burden, particularly for community banks. Jaret Seiberg, manager director at the Cowen Washington Research Group, wrote in a recent brief that the proposal was “the definition of an unfunded mandate.”

“It is one thing to require the reporting of transactions of at least $10,000. It is another to go as low as $600,” Seiberg wrote. “We suspect this leads to a one-time charge for banks as they revise customer account agreements. It also will increase administrative costs on an annual basis as banks report the required data.”

But supporters of the proposal say that the costs to banks would be marginal compared to the potential benefits of a more robust tax collection system.

“Should we continue the current system, where the quality of IRS audit selection is not even close to what it should be, or it could be, which means ordinary people are being unnecessarily audited?” Hanlon said. “It’s a choice between that or a small, common-sense reform.”