Decades of underfunding and hiring freezes have thoroughly depleted the operations of the Internal Revenue Service, adversely impacting virtually every internal and external function. Recent and forthcoming reductions to the IRS have so severely hampered its ability to enforce tax laws to the point that the IRS and taxpayers must reevaluate long-standing norms about how tax compliance works. This scenario should present new, meaningful opportunities for both the IRS and taxpayers to resolve existing tax disputes and should be a consideration in the writing of future tax laws.
The IRS has never been equipped to audit all suspected noncompliance, but not that long ago it at least had the resources to pursue identified, noncompliant behavior effectively. This was most evident in the tax shelters that the IRS termed “listed transactions” in the late 1990s and early 2000s. The IRS listed thirty transactions from 1999 to 2008 and, to our knowledge, audited 100 percent of the known participants with open statutes of limitation.
The IRS listed far fewer transactions after 2008. Two, to be exact (although it has proposed listing others and has identified some as “transactions of interest”). The IRS is not naive. It knows that aggressive tax planning continues. In fact, it is easier to find than ever, given that some promoters brazenly advertise their wares across the internet and social media. Rather, the IRS simply lacks the resources to do much about it.
Even when the IRS does go all in to attack specific noncompliance, resource constraints now greatly limit its options. Although recently enhanced IRS technology and sophisticated data scientists can now better identify noncompliance, resolving significant issues still requires highly specialized IRS examiners and related resources to conduct examinations, determine deficiencies, and defend the IRS’ position in administrative appeals and possible litigation. Once resolved, teams of IRS employees need to promptly assess (and collect) the relevant liabilities.
In recent years, the IRS has offered taxpayer-favorable settlements it would not have considered just a decade ago. Although these settlements typically have involved individual taxpayers or small businesses, corporate taxpayers should take note. For example, the IRS offered a voluntary disclosure program (VDP) to claimants of the employee retention credit which, at the time, the IRS claimed was rife with fraud. The VDP allowed claimants to keep approximately forty percent of the value of the possibly fraudulent credit, with few questions asked. Or consider syndicated conservation easements (SCE), one of the two recent listed transactions and a repeat visitor on the IRS Dirty Dozen list of tax schemes. In 2020, the IRS offered to settle many SCE cases on terms that would allow taxpayers to deduct their costs (in lieu of the often-inflated deductions at issue) and pay a ten percent penalty. That offer paralleled historic IRS settlement offers for other tax shelter transactions. Only a few years later, the IRS sweetened the deal. In 2024, the IRS allowed taxpayers a deduction for their initial investment, a five percent penalty, and calculated the tax due at a twenty-one percent rate. Notably, the rate differential significantly rewarded those who completed the biggest, most aggressive transactions.
The 2024 SCE settlement offer also broke a long-standing unwritten rule of tax administration: that IRS settlement offers don’t get better over time. (The rationale is that the IRS does not want taxpayers to wait for a better offer or encourage taxpayers to attempt to overwhelm the IRS with volume and litigation to force a better offer.) These and other examples demonstrate that resource constraints have displaced other factors (for example, hazards of litigation, effect on future tax administration) as the IRS’ paramount concern in resolving perceived noncompliance.
Tax administration is best served when the IRS touches as many taxpayers as possible. A prompt resolution preserves critical, limited IRS resources and allows the agency to focus on a broader base of tax noncompliance rather than applying scarce resources to fewer cases and completely ignoring others. A broad, visible enforcement presence deters future noncompliance.
What does this mean in the current environment? For the IRS, it means that resource issues (revenue agents, lawyers, engineers, etc.) will primarily determine which cases it fights and how hard. This condition makes resolving noncompliance with fewer resources particularly appealing. For taxpayers, it likely means that there will be greater opportunities to resolve existing tax disputes and to avoid future ones.
For decades, Exam teams resolved cases on a binary basis: the taxpayer either complied or did not comply with the tax law. Whereas IRS Appeals and Chief Counsel would also account for the hazards of litigation in resolving cases, new factors have entered the mix. The effort and resources the IRS will expend to pursue certain tax reporting (and the return on that investment) will be among the top settlement considerations and highly relevant points (or at least considerations) in every IRS conversation. Where the IRS has already determined to pursue a position, taxpayers can help themselves (and the IRS) by moving the case through the tax dispute cycle in the least resource-intensive way possible.
This is particularly true when the IRS perceives a reporting position to be problematic. Indeed, we recall when coalitions of taxpayers would work together (through counsel joint defense or common interest groups) to resolve widespread reporting issues that the IRS disputed. Recently, taxpayers have opted for a go-it-alone strategy, but taxpayers should reconsider this approach, since the opportunity to resolve masses of cases (and significant overall liabilities) will appeal to the IRS. In that vein, the IRS can be reluctant to resolve single cases without knowing how that resolution might affect other similar cases.
Finally, Congress must consider limited IRS resources going forward. Although Congress often considers “administrability,” IRS resource constraints must be a primary concern in the writing of new laws. The IRS simply lacks the resources to police fact-intensive issues. That lack of resources also presents taxpayers the opportunity to engage with Congress and the IRS as new laws and regulations are crafted. Simplicity must have added import in this new age.
Tom Cullinan and John W. Hackney are shareholders in the Atlanta office of the law firm Chamberlain Hrdlicka. Cullinan works in the firm’s tax controversy group, focusing on tax, tax controversy, and litigation. Before joining the firm, he served as the counselor to the IRS commissioner and then as the acting IRS chief of staff. Hackney, as a member of the firm’s tax controversy and litigation practice, specializes in federal and state tax controversy and tax litigation. Charles P. Rettig was the commissioner of the IRS from 2018 to 2022. He currently practices tax law with Chamberlain Hrdlicka, working in the firm’s tax controversy group, focusing on tax, tax controversy, and litigation nationwide.
