The Inflation Reduction Act’s Impact on Business Valuation

A shortage of personnel at the IRS may affect how you handle audits.

On Aug. 16, 2022 President Biden signed into law the Inflation Reduction Act (the Act).1 This law gives the Internal Revenue Service an additional $80 billion dollars and 87,000 employees over the next 10 years. Some of these goals are reflected in the IRS Strategic Plan for fiscal years (FY) 2022-2026 (Strategic Plan), which provides a roadmap to guide IRS operations. Here’s some background on the Strategic Plan, an analysis of what the Treasury department and Congressional leadership are focused on, the short-term impact on business valuation at the IRS and recommendations on how you may want to proceed going forward.2

Historical Perspective

The 2022-2026 Strategic Plan lists IRS accomplishments:

Processed 269 million tax returns in fiscal year (FY) 21;
Processed 492 million economic relief payments that were distributed (FY 20-21);
Collected $4.1 trillion in revenue in FY 21;
Collected $75 billion in enforcement revenue in FY 21;
Processed an average individual refund of $2,816 in FY 213

Key Elements of Strategic Plan

The Strategic Plan is dynamic in nature, reviewed quarterly and expands on detail with specific actions by various stakeholders with more current time frames. It’s not simply something that sits on the shelf.4

The Strategic Plan is broken down into four broad areas relating to service, enforcement, transformation and people.

Service. The major areas relating to service are to:

assist the 20% of U.S. residents who speak a language other than English at home;
deliver secure customer service;
address the needs of the underserved;
protect taxpayer data; and
conduct outreach and education.

So how did the IRS do? The IRS was behind some 21 million returns at the end of May in 20225 and only answered 11% of calls by consumers to the IRS.6 The IRS had lofty goals but wasn’t able to deliver the quality of service demanded by taxpayers.

Enforcement. Major elements include:

rising responsibilities with fewer resources (before $80 billion bill passed);
growing number of returns;
changing expectations (COVID-19 relief, for example);
modernization of compliance and taxpayer service; and
Criminal Investigation Division (CID) and fraud.

Enforcement has been declining with budget cuts. Since 2010 to 2022, the IRS budget has been cut 17%, and it has 13,000 fewer employees and nearly 12,000 fewer enforcement staff. The individual and business audit levels are the lowest they’ve been in over a decade.7

Transformation. The IRS wants to transform itself to become more resilient, agile and responsive to improve the taxpayer experience and narrow the tax gap. The IRS has had trouble transforming itself from what the agency wants to do to what the agency needs to do. It’s had to reorganize to optimize mission-critical functions while addressing the direction of the 535 members of the board of directors (435 in the House and 100 in the Senate) and various changing priorities such as the economic impact payments relating to Coronavirus Tax Relief and Economic Impact Statements.8

The major goals and challenges in this area are:

processing interactions efficiently. For example, the IRS processed 1.44 billion interactions costing $.13 on average in FY 21;
improving cybersecurity and data protection;
adapting to evolving technology and expectations;
redesigning and maximizing efficiencies and modernizing structure; and
managing risk.

People. The goal is to foster an inclusive, diverse and well-equipped workforce and to strengthen relationships with external partners. Unfortunately, the IRS anticipates losing 52,000 employees due to attrition in the next five years9 out of a current total workforce of 78,000.10 With the drop in personnel and funding, the previous IRS Commissioner, Charles Rettig, shared his accomplishments during his 4-year tenure.11 His emphasis on case closures and expanding penalties on taxpayers has a direct impact on how the IRS views its mission through its workforce. The IRS collects nearly $100 billion in penalties.12 More recently, the emphasis has been on appropriate penalty abatement or relief for taxpayers impacted by the COVID-19 pandemic.13 This will free up the employees’ time so they can spend more time on examinations rather than aggressively enforcing penalties.

The commentary presented here points out the overall challenges, goals and potential implications that the IRS will be addressing with additional funding in FY 2023 and beyond.

Given this incoming funding and the IRS strategic plan, the Treasury Secretary and Congress have expressed specific interests regarding the Act.

Priorities for IRS

After Commissioner Rettig retired on Nov. 12, 2022, the IRS appointed an acting commissioner, Doulas O’Donnell.14 President Biden has nominated Daniel Werfel15 to be the next commissioner. This nomination will take some time to work its way through the confirmation process. The leadership is in a state of transition. However, the Treasury secretary and chair of the Senate Finance Committee have clearly indicated their priorities.

Treasury Secretary Janet Yellen. Here are her top five priorities:16

Clear the backlog by the end of 2022. In August, the IRS Commissioner believed that it had 9.7 million returns as of July. At the same time, the IRS Taxpayer Advocate indicated that number at 21 million; as of December 2022, the Taxpayer Advocate indicated that 4 million returns are yet to be addressed.17 A report issued from the Treasury Inspector General for the Tax Administration has stated that the IRS won’t clear its tax return backlog before 2023.18

Improve customer service from answering 11% of calls in FY 2021 to a much higher percentage in the future. Explore additional applications for artificial intelligence (AI). Determine the optimal types and quantities of hire the IRS needs to obtain in the future.

Overhaul the agency’s technology systems. The current systems are decades out of date. The IRS has tried to update these systems many times over several years, but funding is never provided over the full cycle for updating. Secretary Yellen is referring to the Individual Master File and Business Master File systems and other systems at the IRS.

Replace 50,000 of 78,661 employees expected to retire within five years. This is no misprint. Of 78,000 employees, the IRS expects to lose 50,000 employees in the next five years.

Don’t increase audits on households with net incomes less than $400,000.

Senator Ron Wyden. By comparison, this is what Sen. Ron Wyden, the chair of the Senate Finance Committee, sees as priorities:19

Boost customer service with 6.2 million unprocessed returns as of Sept. 23, 2022.
Invest in technology with systems upgrades addressing classification, processing and enforcement.
Increase audits of the wealthy focusing on those making over $1 million a year and rebalance audit rates.
Pursue offshore tax evasion and encourage whistleblowers.
Rebuild the CID to 2010 levels from 2,000 to 3,000 and pursue major players.

As demonstrated in the commentary of Secretary Yellen and Sen. Wyden, the IRS needs clear guidance overall with where to go. Secretary Yellen told the IRS to produce a plan regarding the
$80 billion with detail for FY 2023 within six months. This means that Acting Comm’r O’Donnell needs to produce his plan about the same time as the article being published.

The IRS was planning to hire about 5,000 people in FY 23 and then about 12,000 per year through FY 27. That amounts to approximately 53,000.20 This number ties into Secretary Yellen’s estimate of 50,000 retirees in the next five years.

What are the challenges? Looking at the current job market, can the IRS hire quality employees to fill these roles? The hiring process for government jobs takes months rather than weeks, as is the case in the private sector. The IRS will need a strong permanent Commissioner to address these challenges and opportunities. This is a work in progress.

This unprecedented bump to the IRS from the current budget year of $13.1 billion by about $8 billion a year for the next 10 years remains to be seen. Given the budget process in Congress, will this be fully funded? Major announcements and lack of funding in later years by other Congresses have resulted in a lack of follow through on modernization. The IRS will develop a plan for the next 10 years. In essence Secretary Yellen has told the IRS “we are watching you.” Stay tuned.

Plans for Business Valuation

I was on a call with the director of the IRS Engineering Program for an hour on Sept. 16, 2022. The IRS Engineering Program is where the IRS has business valuers, real property appraisers, engineers trained in business valuation and other specialists. The IRS Engineering Program has about 250 employees. In September and October 2021, the IRS trained 79 new hires in business valuation through the National Association of Certified Valuers and Analysts. Currently, the IRS is trying to hire 120 more. What are the implications if the goals on hiring can be met?

There will be approximately 200 employees with less than three years of experience.
There will be approximately 115 experienced technical employees.
There are about 30 managers and territory managers.

Having been an IRS territory manager and heading up business valuation for the IRS for 11 years,21 here are my personal thoughts going forward:

In FY 2023, the Engineering Program will be operating at about 50% efficiency with new hires, training and on-the-job instructors.
In FY 2024, this is likely to increase to about 75% efficiency.
In FY 2025, this is likely to increase to 90% efficiency.

It takes time to learn the culture and the job and to gain experience to be proficient as a valuer. It will take time before these employees really begin to understand their roll and learn to work efficiently.

Considerations for Business Valuer

Having written Business Valuations and the IRS: Five Books in One22 and The Collaboration Effect,23I see the plans outlined above as a real opportunity for both you and your expert business valuer when your clients need to supply an appraisal to the IRS during an audit. It’s likely the IRS personnel wouldn’t have developed a full skill set in the short term. Business valuers will need to be there to help explain in detail how they developed their values. It takes years to become a competent business valuer, and when the IRS hires experienced business valuers, they come with their own perceptions of their role. Often, the experienced business valuers that the IRS hires from the private sector come with a strong orientation towards enforcing their perspective, and the IRS needs to train them to operate with integrity and fairness and to accept work that’s reasonable. The IRS isn’t interested in making the maximum money for the Treasury; rather, the IRS is interested in applying the tax laws with integrity and fairness.

When filing the return with an appraisal, take the time to read the preliminary appraisal from your business valuer and make sure you can understand it. Would an IRS auditor (IRS estate and gift tax attorney) with no experience in valuation be able to understand everything in the report? If not, hire someone to assist you with this process who understands valuation and how the IRS looks at business valuations. This ensures that the IRS agent won’t have questions regarding the valuation, and so hopefully, the auditor will accept the report without bringing an IRS business auditor on board.

If the appraisal is audited by the IRS, your expert should be there to help the IRS auditor conduct their audit. Your business valuer shouldn’t respond to questions related to their report with a statement like “it’s in my report.” Rather, any response should point out the answer in the report specifically, and your business valuer should be able not only to explain but also to elaborate further. For example, the business valuer shouldn’t simply indicate the source book or data set used but actually provide the relevant pages in the source book and run through what filters were applied to the data set used to reach the conclusion in the report. Literally walk the IRS auditor through what your valuer did and why.

You have a real opportunity on an audit to connect with the IRS auditors. Collaborate24 with this individual who’s new to you.25 Learn all you can about them online with Facebook, LinkedIn, Google and other sources. Use your own network to learn what you can. Try to find ways to relate to them based on geography, education, marital status, children, pets, hobbies, vacations and other personal elements. Build a connecting relationship.26 Take the time up front to build trust.

Listen27 to the IRS auditor without making judgments and offering refutable commentary. Instead, listen actively by paraphrasing, asking open-ended questions, summarizing and being empathetic. Put yourself in the auditor’s shoes and consider what it is they don’t know. When someone has been listened to, they’re more apt to listen to you.

Educate28 the IRS auditor the way they want to be educated. After you develop an authentic connecting relationship29 and listen to them, you’ll be able to address their concerns and interests. This takes patience and understanding. Avoid the natural tendency to become confrontational. Stay above the line. Remain professional.

This builds bridges and allows you to negotiate closure. Isn’t that what you and your client want? You may be surprised. On the other hand, you may need to elevate this in management to the Estate and Gift Tax Manager, or if the case can’t be resolved, you may have to go to Appeals. What have you got to lose? With so many new IRS employees who need to be trained, it will pay for you to go out of your way to help the IRS understand what was done and why.

Endnotes

1. https://tax.thomsonreuters.com/news/the-federal-inflation-reduction-act-p-l-117-169-and-state-taxes/.

2. https://sub.bvresources.com/TrainingEvent.asp?WebinarID=1760.

3. https://www.irs.gov/pub/irs-pdf/p3744.pdf,at p. 6.

4. www.irs.gov/about-irs/irs-strategic-plan.

5. www.irs.gov/newsroom/national-taxpayer-advocate-issues-midyear-report-to-congress-expresses-concern-about-continued-refund-delays-and-poor-taxpayer-service#:~:text=At%20the%20end%20of%20May,it%20succeeds%2C%22%20Collins%20wrote.

6. www.forbes.com/advisor/taxes/how-to-contact-the-irs/#:~:text=Collins%2C%20%E2%80%9Cwas%20horrendous.%E2%80%9D,independent%20office%20within%20the%20IRS.

7. www.cbpp.org/research/federal-tax/irs-funding-cuts-compromise-taxpayer-service-and-weaken-enforcement.

8. www.irs.gov/coronavirus-tax-relief-and-economic-impact-payments.

9. This author having discussions with Internal Revenue Service insiders.

10.www.irs.gov/statistics/irs-budget-and-workforce.

11. www.irs.gov/newsroom/irs-statement-irs-commissioner-charles-rettigs-final-message.