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October 10, 2013
IRS Shutdown Adds to Economic Headwinds for Businesses, Individuals
by William Hoffman

Full Text Published by Tax Analysts®

For a small but growing number of businesses and families across the United States, the week-old federal government shutdown has left a gaping -- and expanding -- IRS-sized hole in the economy.
Home loans are being delayed, with potentially higher interest rates for borrowers, because the IRS isn't available to verify their income to lenders. Mergers, acquisitions, and other major business transactions are being held up because the already slow process of issuing letter rulings has ground to a halt. Retailers and restaurateurs near major IRS offices are reporting revenue declines -- by as much as half at popular lunch spots in downtown Washington, according to The Washington Post.

"The accommodation of taxes in every business transaction doesn't work well when the IRS isn't working," said Christopher S. Rizek of Caplin & Drysdale. Taxpayers up against the October 15 filing and filing extension deadline will face delayed refunds and no IRS help resolving disputes over their assessments, he said. The U.S. treasury may lose untold sums in assessed taxes because the IRS doesn't have staff to meet statutory notice of deficiency deadlines, Rizek added.

Small businesses in trouble with the IRS because of problems traced back to the Great Recession cannot resolve collections and audit problems that in turn keep them from securing new lines of credit, said Lawrence Brown of Brown PC, a tax controversy and litigation firm based in Fort Worth, Texas.

"Long story short," Brown told Tax Analysts, "from where we sit, I think there's going to be this enormous tsunami-type impact" on the nation's economy if the IRS and government shutdown continues.

Furloughed Workers Can't Spend

The most immediate economic impact of the IRS shutdown was to put almost 90 percent of its 95,000 workers on unpaid furlough.

Moody's Analytics estimated that a three- to four-week government shutdown would cost the country $55 billion in lost or deferred economic activity. Moody's economist James Bohnaker said that estimate may be a bit high if a House-passed bill (H.R. 3223) approving back pay for the furloughed workers is enacted. "Certainly there still will be a significant impact, being that government workers aren't going to receive a paycheck . . . and that can weigh on some of the workers who are income-constrained," he said.

While the IRS continues to collect taxes and expects everyone to meet their filing and other deadlines, most other work has ceased. Every economic transaction that requires IRS guidance, interpretation, information, or other assistance will be altered or even stopped as a result of the IRS shutdown.

Most IRS contractors will not be paid until the shutdown ends, and perhaps not even then. Unlike with furloughed workers, Congress appears to have made no provision yet to make contractors and their workers whole.

Another immediate effect of the IRS shutdown is being felt in the recovering housing industry. According to an October 4 Washington Post article, thousands of buyers won't be able to get income verification for their lenders from the IRS, as well as identity verification paperwork from the Social Security Administration. (The American Bankers Association said it did not have a representative available for comment; the Mortgage Bankers Association did not return a call for comment.)

Homes for sale with tax liens attached won't be sold because the IRS officials who accept past-due tax payments and remove the liens are unavailable, Brown said.

The backlog of home loan paperwork may further clog the system for weeks or months after the shutdown ends.

Business Deals Delayed, Altered

Businesses large and small could be inconvenienced or worse by the continuing IRS shutdown.

Letter rulings -- the memoranda the IRS issues to businesses to clarify the tax treatment of mergers, acquisitions, and other transactions -- aren't being issued, Brown noted. "In the private sector [letter rulings] are something that's very common," he said. But those transactions won't always wait, he added; a seller waiting for a letter ruling may confront a buyer with multiple alternative options. "You're looking at transactions certainly being postponed potentially, and then maybe scuttled entirely," Brown said.

Even before the shutdown, the letter ruling program had reduced its output. In late June, the IRS announced (Rev. Proc. 2013-32, 2013-28 IRB 55) that it would limit its letter rulings on reorganizations to "significant issues." The effective date of the cutback was deferred for two months, until August 23, to give taxpayers time to finalize letter ruling requests already in the works. The deferred effective date likely led to a bunching of requests at the deadline, potentially lengthening the delay in issuing the rulings.

The looming October 15 deadline could also cause anxiety for taxpayers who filed for six-month extensions back in April, Rizek said. Those include high-net-worth individuals with many information returns, such as Schedules K-1, that must be paired with the appropriate forms W-2 and 1099 through the IRS's matching programs. Those filers can meet their filing and payment obligations by postmarking their returns as late as October 15, Rizek said, but the taxpayers won't get any refunds during the shutdown and can't resolve any controversies over their tax obligations until IRS employees return to work.

Further, because the October 15 returns are usually matched in November, the work backlog could push that process back, Rizek said. Thus, people with minor deficiencies or math error notices may not get those notices before interest is imputed. "A month or two's interest at 2 or 3 percent is not your biggest concern if you're facing a tax adjustment," Rizek said, "but cumulatively it could be a pretty [big] effect."

Tax-exempt organizations awaiting IRS approval of their status may lose grant money contingent on clearing their application with the Service, Mary Burke Baker of K&L Gates LLP said. "The IRS has an expedited process for those," she noted, "but no one is home."

Biggest Loser? Treasury, IRS

For now, the economic effects of the IRS shutdown for most people are dispersed and limited. Perhaps the biggest loser will be the Treasury Department, and specifically the IRS itself.

The IRS has statutory deadlines, explained Rizek. Some of them will be little more than a nuisance for taxpayers. Taxpayers have 90 days to respond to statutory notices of deficiency and 30 days to appeal collection due process notices. As long as taxpayers meet the deadlines, they are fine, he said. The IRS doesn't have to do anything, he noted, and for the time being, it's not.

However, missing deadlines could cost the government. "They also have notices of deficiency with hard and fast deadlines, frequently tied to the return date, so it may be tied to the October 15" filing deadline, Rizek said. "If they don't get the statutory notice of deficiency out or get the tax assessed, as the case may be, before October 15, they'll lose that revenue forever." He added, "It's my understanding that there are skeleton crews who are trying to keep that from happening, but I expect a certain amount of it to slip through the cracks."

Refunds delayed more than 45 days from the date of filing the return are entitled to interest, Rizek noted. While it's not clear how many October 15 filers were overwithheld on or otherwise entitled to a refund, "that could be a huge hit to the Treasury Department," he said.

Practitioners agree that most business and individual taxpayers aren't yet up in arms over the IRS shutdown. "The sense I'm getting from clients is that it is a small but growing problem," said Lori Shrout, an enrolled agent and manager at Gumbiner Savett Inc., a CPA and business advisory firm in Santa Monica, Calif. "I haven't seen any frustration yet. I think our clients are being cautious about approaching these things. It hasn't been very long. I think as time goes it'll matter more for them."

Brown agreed that the longer the shutdown, the more onerous the IRS's absence. "Two or three weeks from now and we're still as polarized and divided and no end in sight, I think there's certainly going to be a psychological impact . . . that, wow, this is new territory and the level of uncertainty can be problematic."

Former IRS Commissioner Mortimer Caplin of Caplin & Drysdale said, "If the IRS is blamed for this thing, it will hurt compliance more and more. They've been kicked around enormously for the last six months. But this is one of those intangibles in terms of whether people comply or not. And there are a lot of ingredients going into that. If compliance falls, that would hurt the bottom line a great deal."

Rizek added: "Even a small blip in compliance levels will have a much longer-term effect than whatever sort of short-term dislocations there are. . . . There are definitely those sorts of small dislocations, on a transaction-to-transaction basis, that cumulatively could add up to quite a bit. But in the long, long term -- beyond, you know, a year -- the bigger danger is that it hurts the IRS's compliance level one more time."

George White contributed to this article.

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