The Biden administration has proposed requiring all financial institutions, from Wall Street banks and brokerages to credit unions and private lenders, to report annually to the IRS all of a consumer’s transactions if they total at least $10,000. What would that mean for affluent investors and their financial advisors?

The level was $600 until the Treasury Department raised it to $10,000 early Tuesday afternoon, following an avalanche of criticism that the lower amount would have targeted low-income workers.

Treasury Secretary Janet Yellen said in a statement mid-Tuesday that “Today’s new proposal reflects the Administration’s strong belief that we should zero in on those at the top of the income scale who don’t pay the taxes they owe, while protecting American workers by setting the bank account threshold at $10,000.”

Still, few wealth planners seem aware of how the controversial proposal would work. Here’s what you need to know.

The original proposal, laid out last May in Treasury’s “Green Book” detailing spending and tax increases in President Biden’s proposed $6 trillion budget, calls for banks to report data on “gross inflows and outflows,” broken down by cash, transactions with a foreign account and transfers to and from another account with the same owner. That means your clients’ mortgage payments and retirement account withdrawals, but also transactions like cash deposits from real estate rentals and other business ventures, would get caught in this net.

Treasury's proposal is aimed at rooting out tax avoidance and evasion by individuals of all income groups.

Treasury’s proposal is aimed at rooting out tax avoidance and evasion by individuals of all income groups.

Bloomberg News

If approved, the requirement would apply to all business and personal accounts at financial institutions, including bank, loan and investment accounts. The IRS, which is overseen by Treasury, wouldn’t see individual transactions, only the total amount deposited and withdrawn annually with a given account.

Yellen’s statement said there would be an exception for “wage earners like firefighters and teachers,” but didn’t explain why or who else was included. A fact sheet released mid-Tuesday by Treasury detailed how the proposal would work, and said that audits rates wouldn’t rise for anybody making less than $400,000 a year.

While the measure isn’t included in the emerging tax bill making its way through Congress, administration officials have been talking it up extensively.

Last week, in an interview with CBS News about the proposal, Yellen said that “If somebody reports an income of $10,000 and they had $3 million go out of their checking account, that tells the IRS that’s an individual you might audit.”

Treasury Secretary Janet Yellen says the measure would help catch wealthy tax cheats.

Treasury Secretary Janet Yellen says the measure would help catch wealthy tax cheats.

Bloomberg News

The tax gap
The measure is aimed at shoring up what the Treasury Department estimates is $600 billion in taxes a year that go uncollected. The so-called “tax gap” is the difference between taxes owed and taxes actually collected. The shortfall, whose size is disputed by academics, reflects returns that aren’t filed; taxes that are underreported on returns; and taxes that are accurately reported but not paid in full. Treasury estimates that the cost of tax evasion among the top 1% of richest taxpayers exceeds $160 billion a year.

Critics had argued that the low $600 threshold would go after shadow economy workers like housekeepers and contractors, not wealthy Americans.

$600 was “a fine-mesh fishing net designed for minnows to catch whales,” argued Jerry Theodorou, the director of the finance, insurance and trade program at the R Street Institute, a nonprofit, free market think tank in Washington, D.C. “It is not clear how the plan will achieve the objective of combating ‘sophisticated evasion’ by collecting information, the vast majority of which is not directed at the plan’s target.”

But President Biden’s budget calls for boosting the IRS’s budget by $80 billion over 10 years to reduce the tax gap and catch cheats. So there’s speculation that the reporting rule would be used to generate data to go after the big fish.

Experts are not entirely convinced it would work.

‘Remains to be seen’
Daniel Hemel, a tax specialist and law professor at the University of Chicago Law School, said that “some allies of the administration have sold this as being about the top 1%.” He added that “Maybe bank account reporting can help the IRS better target audits of the bottom 99%, leaving more firepower for the top 1%. But that remains to be seen.” He was speaking in the context of the $600 limit. Hemel wasn’t immediately available for fresh comments.

The key element for high net worth investors is the “at least $10,000.” Any amounts higher would fall in the reporting crosshairs.

The measure has prompted howls that it would constitute intrusive government overreach, create data privacy concerns and spawn expensive, record-reporting hassles for banks and account owners. Hemel noted that “millions of Americans will have bank account inflows in excess of gross income — many for entirely legitimate reasons,” such as gifts or the sale of a used car. Likewise, someone who received life insurance death benefits from a deceased parent wouldn’t pay federal income tax on the payouts but would still show the money in their bank account.

Amid the backlash from financial institutions and some conservative pundits, Bloomberg News quoted the chair of the tax-writing House Ways and Means Committee as saying on Sept. 27 that staffers were considering raising the threshold to $10,000. That’s the same level at which anti-money laundering rules require banks to file reports with the IRS of cash transactions exceeding $10,000 a day.

Karen Altfest, the executive vice president and principal advisor at Altfest Personal Wealth Management, an independent advisory firm in New York, called the $600 threshold “a low bar” that would “become more meaningful” if raised — which it was on Tuesday.

Bigger fees for consumers?
Mike Palmer, a managing principal at Ark Royal Wealth Management, an independent advisory firm in Raleigh, North Carolina, said that the rule, if approved, “will be enormously onerous for institutions” Palmer, a CFP, added that banks would pass along to consumers the costs of complying. That could mean higher fees on their retirement and brokerage accounts.

Some $163 billion of the estimated $600 billion “tax gap” is attributable to the top 1% wealthiest Americans, a top Treasury tax official, Natasha Sarin, wrote on Sept. 7. “For opaque income sources that accrue disproportionately to higher earners — like partnership income, proprietorship income and rental income — noncompliance can reach 55 percent.” Around 71% of the gross tax gap comes from uncollected individual income tax and 18% from uncollected payroll tax, according to the Center for Budget and Policy Priorities. Only 11% comes from corporate taxes.

Fish of all sizes
With the dawn of Side Hustle Nation, as more workers moonlight outside their regular gigs or, like Uber drivers, cobble together projects as self-employed business owners, the IRS is concerned about people who don’t pay the 15.3% Self-Employed Contributions Act tax, or SECA, for Social Security, Medicare and unemployment benefits. But the agency is worried that some high earners in partnerships avoid SECA as well, an area of mounting scrutiny by the agency. Salaried workers pay its cousin, the Federal Insurance Contributions Act, or FICA, through deductions from their paychecks.

Palmer said he assumed the proposed rule “will also apply to Venmo – my adult kids routinely split bills with housemates that exceed this (as do all kids of that generation). Are all those transactions going to be flagged?”

The answer is yes, but not by this proposal. Come 2022, a separate rule requiring mobile payment apps, like Venmo, PayPal and Zelle, and their users to report information about their commercial transactions to the IRS will come into effect. That rule only applies to users who pay businesses, so it wouldn’t cover situations like your college kid paying her roommate back for pizza or selling his smelly sofa.

Also separately, the bipartisan $1 trillion infrastructure bill has a measure that would force brokers of digital assets like bitcoin to report on their transactions to the IRS, but its definition of “broker” is murky.

With the reporting threshold, opponents “have exaggerated the extent of the privacy intrusion,” Hemel said. “On the other hand, some proponents have exaggerated the utility of the information.”

This story has been updated to reflect an announcement by the Biden administration early Tuesday afternoon that the $600 threshold would rise to $10,000.