National Taxpayer Advocate Nina Olson didn’t mince words in her recent annual report to Congress about the state of taxpayer interactions with the IRS and the agency’s future plans to handle its workload in the face of budget shortfalls.
In short, Olson, who heads the Taxpayer Advocate Service (TAS), an independent office within the IRS that helps taxpayers and protects taxpayer rights, said the United States is approaching a pay-to-play tax system that unless changes are made and soon, many taxpayers will find themselves in a black hole of wanting to comply and behaving themselves but getting screwed instead.
Taxpayers facing a problem in the future, she said, “will have to undertake ‘self-service’ or obtain ‘for-fee’ third-party assistance. This approach transforms our tax system into a pay-to-play system.”
Olson continued: “Those who are sophisticated enough to understand their tax problem or their tax needs and can navigate the self-help options well enough to protect their rights will be able to do so. Those who have the ability to pay a third party to navigate the IRS and protect their rights will do so. But for those who have neither the expertise, the time, nor the resources to navigate these options – they will be up a creek. They will make mistakes with self-help; they will agree to assessments and adjustments they never should; and they will forfeit significant due-process protections, like the right to go to the US Tax Court or have a collection due-process hearing – all because they can’t talk with an IRS employee about their situation or because they can’t afford to pay someone to help them. This creates a two-class tax system – those who can pay and those who can’t. It undermines the fundamental right to a fair and just tax system. When you add on the additional burden of paying ‘user fees’ for actions and services that are rightly considered core duties and responsibilities of tax administration officials, the financial burden and consequence of pay-to-play becomes even greater. Fundamental rights are now up for sale.”
And on that note, welcome to busy season, right?
Olson’s report breaks down the most serious problems that taxpayers face into 24 categories and offers her recommendations. Here are the highlights:
1. Taxpayer service. The IRS’s Future State plan that outlines how it will operate in five years includes what Olson says are positives that allow taxpayers to interact with the agency through online accounts. But, she notes, that means the IRS will “substantially reduce” phone and in-person service. Further, if taxpayers need help, the IRS is developing ways for third parties, like tax return preparers and tax software companies, to provide it. That, she says, will increase taxpayer compliance costs.
Recommendation: The IRS should publish its plan immediately and solicit public comment, and Congress should hold hearings soon on the future state of IRS operations during which groups representing individual taxpayers, sole proprietors and other small businesses, unenrolled tax return preparers, and Circular 230 practitioners can testify. Testimony should also address the plan’s compliance burdens on taxpayers and how it will affect overall voluntary compliance.
2. IRS user fees. Because of budget shortfalls, the IRS is considering increasing user fees. The IRS charges taxpayers a user fee for entering into installment agreements. Increasing the user fee could end up seeming “outrageous” to taxpayers who already face costs for typical taxpaying and from third-party tax preparers. If the costs discourage taxpayers from using IRS services, that can erode voluntary compliance and taxpayer rights.
“However, the Internal Revenue Manual does not require the IRS to consider these items,” Olson notes. “As a result, the IRS may increase user fees without fully considering the consequences.”
Recommendation: The IRS should update its manual to avoid fees that would negatively affect taxpayers, the IRS mission, voluntary compliance, or taxpayer rights. The agency should estimate the effects of proposed fees, publish that analysis and show the basis for it, and only impose fees after it revises the analysis to address stakeholders’ concerns.
3. Form 1023-EZ. The IRS’s Tax Exempt and Government Entities (TE/GE) division allows some organizations to use Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, which uses a checkbox allowing applicants to attest that they qualify as a tax-exempt entity. The form doesn’t require any information about the organization.
“With the adoption of Form 1023-EZ, the IRS effectively abdicated its responsibility to determine that an entity is actually exempt. TE/GE intends to address the noncompliance it helped create by shifting more resources to audits,” Olson’s report states.
Recommendation: The IRS should revise Form 1023-EZ to require applicants, other than corporations in states that make articles of incorporation publicly available online at no cost, to submit their organizing documents. Form 1023-EZ should require applicants to describe their actual or planned activities and financial information, such as revenues and expenses. The IRS should make a determination only after reviewing the application and supporting documents. A deficiency should require the applicant to provide a certified copy of reformed articles before exempt status is allowed.
4. Revenue protection. How the IRS screens refunds in the Pre-Refund Wage Verification Program (or “income wage verification”) harms taxpayers with legitimate returns, Olson reports. While false positives can be expected, the IRS doesn’t track them for this program. So, the agency can’t figure out which filters or screens are halting the legit returns. Plus, the IRS lacks adequate procedures to adjust its fraud-detection filters and models. And taxpayers with frozen refunds aren’t able to reach a real person to help them. So, for taxpayers with legitimate refunds, lengthy delays are the rule.
“As a result, taxpayers’ right to be informed, to quality service, to challenge the IRS’s position and be heard, to privacy, and to a fair and just tax system are jeopardized,” Olson states in her report.
Recommendation: Begin tracking income wage verification false-positive rates by model or filter during tax season, perform global reviews, and adapt filters and models based on confidence in them; determine target false-positive rates for each process and filter; work with the TAS to put in place the new legal requirement to file returns and statements of employee wage information and nonemployee pay on or before Jan. 31 of the year following the calendar year to which such returns relate; reinstate the Pre-Refund Program Executive Steering Committee to coordinate policy and other processes and business rules; include TAS in the steering committee as a charter voting member; create a subcommittee under the Business Rules and Requirements Management office to put in place modifications to screening for tax fraud, resolution, and prevention; and create a taxpayer call area in the Integrity and Verification Operation unit to include verification calls to taxpayers and answer direct taxpayer calls about refunds.
5. Taxpayer access to online account system. Yes, this is a good thing, Olson’s report states. But the IRS can’t ignore the fact that there are taxpayers without online access or who need more personal service – and not all issues can be resolved online.
“Any efforts to significantly reduce personal service options may ultimately impair voluntary compliance and undermine the taxpayers’ right to quality service, right to be informed, and right to pay no more than the correct amount of tax,” the report states.
Recommendation: Conduct a biennial nationwide survey of taxpayers to identify trends and determine the types of transactions taxpayers would want to do digitally with the IRS; research which taxpayers will use the online taxpayer account system and by what type of transaction, also focusing on reasons for not using the program; incorporate a plan to meet the needs of taxpayers unlikely to use online services; and research how taxpayers respond to online account cybersecurity and authentication measures.
6. Preparer access to online accounts. Despite the benefits to this system, Olson’s concerns focus on whether taxpayers will be harmed if the IRS doesn’t restrict preparer access to those who are subject to agency oversight under Circular 230.
Recommendation: Limit preparer access to taxpayers’ online accounts to those subject to IRS oversight under Circular 230, allow taxpayers strict control over preparer authorizations by checking boxes for each action allowed on behalf of the taxpayer, develop automatic alerts to the taxpayer of any preparer actions and how to report unauthorized access, and develop ways to track preparer access to taxpayers’ online accounts and verify that it was allowed by the taxpayer.
7. International taxpayer service. With the elimination of the last four international tax attachÃ© offices and the Electronic Tax Law Assistance (ETLA) Program, “the IRS has shut itself off from international taxpayers with no way of knowing whether it is providing the service taxpayers need,” Olson’s report states. That makes it more likely that taxpayers will misunderstand international tax rules.
Recommendation:Reopen the four international tax attachÃ© offices and provide funding for one local taxpayer advocate in each; determine the effects of additional offices on taxpayer service and compliance; re-establish the ETLA Program with timeframes for responses and create a way to use the information from ETLA inquiries in updates to IRS materials, including its website; fund more phone-service staff to accommodate the expanded international enforcement activities; create a task force to analyze and report within one year on the barriers to Voice-over Internet Protocol and partnering with the US Department of State to employ Virtual Service Delivery technology for taxpayers at US embassies and consulates; and reinstate the International Individual Taxpayer Assistance Team.
8. Appeals. The recently implemented Appeals Judicial Approach and Culture (AJAC) project was intended to improve “internal and external customer perceptions of a fair, impartial, and independent Office of Appeals,” the report states. But in reality, the project is “eroding the very perceptions of fairness and objectivity that it claims to bolster.” For example, AJAC is used to intimidate taxpayers and deny their right to an administrative appeal, the report states. And once in appeal, cases “bounce back and forth” between the Appeals and Compliance offices, and then a brief review by hearing officers.
Recommendation: Discontinue the Letter 5262 series and keep taxpayers’ rights to an appeal, even in cases where all requested information is not provided to Compliance; loosen AJAC restrictions to allow hearing officers more discretion in determining whether more factual review and analysis by Compliance would materially assist case resolution; give hearing officers revised guidance and more training, emphasizing quality substantive review rather than mere satisfaction of procedural requirements by expanding timeframes and retaining Appeals’ jurisdiction where appropriate, as the best means of providing taxpayers with the right to appeal an IRS decision in an independent forum; and develop and implement an outreach plan aimed at practitioners to help them understand what is needed for a successful appeal and to provide Appeals with information about the difficulties experienced by taxpayers and practitioners under AJAC.
9. Collection Appeals Program. The program provides benefits, such as expedited timeframes and the ability to challenge findings about installment agreements. But the program is “severely limited” in what it offers taxpayers, the report states. The program rejects substantive review and collection alternatives, which would balance collection proposals against a taxpayer’s concern about the collection’s intrusiveness. And if a taxpayer wants a hearing under the program, that can “inadvertently cause the loss of all substantive administrative and judicial review of a collection action,” the report states.
Recommendation: Revise the program to give more authority to hearing officers and more time to consider collection alternatives. Guidance should be issued indicating that taxpayers in the program are allowed an independent reconsideration through an appeal. After the program is improved, publicize it and make sure all IRS employees with taxpayer contact let taxpayers and their representatives know that hearings are available.
10. Levies on assets in retirement accounts. The IRS manual doesn’t define flagrant conduct, which is a prerequisite for the levy, and doesn’t adequately instruct how to analyze future retirement calculations. The IRS guidance explaining the steps to take before a retirement account can be levied is inadequate and “insufficient to protect taxpayer rights or enable taxpayers to meet basic living expenses in retirement,” the report states.
Recommendation: Revise the manual to define flagrant conduct as willful and voluntary, and as conduct that a reasonable person would consider a gross violation; include examples of extenuating circumstances; include a full financial analysis; identify calculators to determine how a levy would affect a taxpayer or create another calculator; and create a way to track levy cases.
11. Notices of federal tax lien. This puts the public and creditors on notice of a lien that establishes the government’s interest in a debtor’s property. But the notices can harm taxpayers and reduce their ability to comply with federal tax-filing obligations, the report states. The notices also are costly to the government. But the IRS files most notices based on an arbitrary dollar threshold of the unpaid taxes, and more than 21 percent are filed automatically “without human involvement. Current IRS lien policies can have a negative impact on taxpayers’ economic viability, ability to pay the past debt, and comply in the future,” the report states.
Recommendation: The IRS manual should be revised to require that agency employees make multiple attempts at personal contact with taxpayers instead of filing a notice of lien after just one attempt. The agency also should adopt an early-intervention policy, increase the 10-day timeframe for lien filing, mail monthly notices to taxpayers, develop lien pilot programs, analyze more thoroughly a taxpayer’s financial situation, and transfer complex cases to a manager.
12. Third-party contacts. The IRS doesn’t empower taxpayers to provide information making third-party contacts unnecessary. The agency also doesn’t tell taxpayers about third-party contacts it has made, as required by law, so that they can mitigate damage to their reputations.
Recommendation: A notice of third-party contact should include a request for information that would make the contact unnecessary. Taxpayers should be copied on “most” written requests for information sent to third parties. The IRS should give taxpayers post-contact reports periodically and with better directions on how to request them. The agency should improve its internal controls to ensure the accuracy of the reports.
13. Whistleblower Program. The Internal Revenue Code requires the IRS to award whistleblowers an amount between 15 and 30 percent of collected proceeds from unpaid tax liabilities. The US Tax Court is to review those award determinations. But subjects of whistleblower claims face risks if the claims are unsupported or not pursued. Taxpayers may not voluntarily comply if they think the IRS isn’t guarding their tax information. Current Internal Revenue Code provisos don’t address these issues.
Recommendation: The IRS and the US Treasury Department should revise Internal Revenue Code provisos to require that an administrative proceeding follows a whistleblower’s claim. Regulations also should be revised to provide penalties for redisclosures of returns or return information by a whistleblower who has signed off on a confidentiality agreement as part of an administrative hearing. Regulations should also safeguard requirements that apply to the whistleblower and should allow whistleblowers biannual updates to monitor claim status.
14. Affordable Care Act: Businesses. Beginning last year and going forward, large employers must offer minimum coverage to full-time employees under the healthcare law. If they don’t comply, they face an employer shared responsibility payment. Olson’s concern is that the Affordable Care Act requirements for the 2016 filing season may be a burden to employers and employees if certain issues aren’t addressed.
Recommendation: The IRS should provide additional guidance on how to calculate the number of full-time employees in order to meet the minimum-coverage requirements, publish regulations explaining how the Affordable Care Act excise tax could apply to some flexible spending accounts and health reimbursements, establish a rapid-response team to help with problems or questions from employers or tax practitioners, and give employees in the new Affordable Care Act Business Exam unit special training on aspects of the healthcare law that affect businesses.
15. Affordable Care Act: Individuals. The IRS did well overall in 2015, but “several developments will likely result in significant burden imposed on both taxpayers and the IRS in future years,” the report states. For one, the pre-refund Automated Questionable Credit (AQC) procedures for Premium Tax Credit (PTC) mismatches are the same and impose the same burden as post-refund PTC exams. But the IRS contends it can do both the AQC review and post-refund audit of another issue, “thereby undermining the important statutory protection against multiple audits,” according to the report.
Recommendation: The IRS must take steps to avoid overpayments of the individual shared responsibility payment in the future; issue guidance to field compliance workers to help them identify returns with a tax liability from the correction of Form 1095 errors and not pursuing collection, including blocking the accounts from refund offsets; work on revising letters 5591, 5591A, and 5596 for 2016 to include the exact date the taxpayer needs to file by to automatically re-enroll for the Advanced Premium Tax Credit (APTC); conduct outreach and education to inform taxpayers early this year about the consequences of filing for an extension if the taxpayer received an APTC; determine how to identify all issues relating to a return, as selected by the various filters in the filing season, and include all of the issues in one notice to the taxpayer to avoid multiple audits of the same return; conduct outreach on the consequences of receiving large lump-sum distributions to APTC recipients and organizations making such distributions; issue guidance to taxpayers and IRS employees about how both can use the look-up tool on Healthcare.gov to find the second-lowest-cost silver plan premium (SLCSP) amount; reform the rules for exchange reporting on Form 1095-A and require the Affordable Care Act marketplace to provide the SLCSP amounts on the form; expand the Taxpayer Identification Number Matching Program to include health insurers and self-insured employers that are required to file Form 1095-B.
16. Identity theft. At the end of September 2015, the IRS had more than 600,000 identity theft cases affecting taxpayers (excluding duplicates), an almost 150 percent increase over 2014. (Tax-related identity theft involves someone using another person’s personal identification to file a false tax return to get a refund.) The IRS’s reorganization last year of its identity theft victim assistance under one division is a good thing, Olson states, but she’s still not happy about victim assistance procedures. Problems include failure to assign one IRS person to handle victims with multiple tax issues and limited availability of Identity Protection Personal Identification Numbers (IP PINs).
Recommendation: Expand IP PIN availability nationwide, appoint one contact person and a direct phone line for identity theft victims with multiple issues, revamp account reviews so that all issues are resolved before a case is closed, and train employees.
17. Automated Substitute for Return Program. When a taxpayer who should file a tax return doesn’t, the IRS could prepare a Substitute for Return and assess the person’s tax liability based on information, such as W-2 and 1099 forms filed by employers, banks, and other third parties. But that doesn’t include itemized deductions or credits and allows only a filing status of single or married filing separately. The Automated Substitute for Return (ASFR) Program has poor collection results and a high abatement rate, indicating that selection criteria are inefficient, liabilities are inflated, and abatements follow.
Recommendation: The ASFR Program should be assessed and refined to determine where assessments have been most successful in getting taxpayers to file an original return, refine abatement reason codes to be more specific, and consider third-party documentation that includes exemptions, deductions, and credits before making assessments.
18. Individual Taxpayer Identification Numbers. People who have difficulty getting a Social Security number but owe taxes also have a hard time getting an Individual Taxpayer Identification Number (ITIN), and applications for the numbers have dropped sharply. IRS processes have contributed to this. While there are concerns about ITIN refund fraud, the IRS methods don’t adequately target the fraud or balance that concern against the taxpayer’s right to privacy and the least intrusive process. “As a result, the IRS burdens legitimate taxpayers and harms global commerce,” the report states.
Recommendation: The IRS should allow all ITIN applicants to apply without a tax return if they can provide other information or a legitimate reason for the number. Pay stubs or bank statements should be allowed as proof that they are required to file a return and need the number. Process all returns that can be considered valid and notify taxpayers if their returns won’t be processed. Certifying acceptance agents should certify documents for dependent applicants, and IRS Taxpayer Assistance Centers should certify identification for ITIN applications. The IRS and US State Department should partner to verify ITIN applications abroad. Clarify the ITIN deactivation policy to include timeframes for the deactivation, how to challenge that, and how to reactivate the number.
19. Practitioner services. The IRS has cut back its Practitioner Priority Service, which means practitioners wait longer on calls, have less chance of reaching a real person, and use the service less.
Recommendation: Increase staffing, allow practitioners to resolve up to five separate client account issues during one call, ask practitioners what’s most needed in the service, and use the service with any online program that may evolve.
20. IRS collection effectiveness. The IRS is inconsistent and inaccurate in using Designated Payment Codes (DPCs), which limit how the agency can assess its collection actions. Instead, the IRS “is blindly applying its broad collection powers and resources rather than analyzing accurate information to determine funding priorities,” the report states. The result is an intrusive approach that harms taxpayers and thwarts voluntary compliance.
Recommendation: Revamp guidelines to require DPCs on all balance-due payments, require verification of the right DPC on payments, provide specific instruction on when employees can use a miscellaneous DPC, and put in place systemic input of payment codes.
21. Exempt organizations. The way in which the IRS maintains its two public databases of tax-exempt organizations and delays in how the exempt status can be reinstated mean that an organization’s effort to restore its exempt status won’t be immediately indicated. So, the reinstated organizations could lose out on donations or grants they would have received if the databases indicated the organizations’ current status.
Recommendation: Update the databases weekly or update the Select Check database manually. Put in place an emergency process that allows a manual update within 24 hours of exemption being restored, even when there is weekly updating.
22. Earned Income Tax Credit: Education. Taxpayers who qualify for the Earned Income Tax Credit (EITC) may have difficulty understanding eligibility rules, and they get only “rudimentary help” from the IRS, the report states. Without a dedicated toll-free helpline, such as the one used in the United Kingdom, the specific needs of these taxpayers are disregarded and high noncompliance rates continue.
Recommendation: Determine how to best serve low-income taxpayers based on a study similar to the one used in the United Kingdom, and create a helpline specifically for EITC-eligible taxpayers.
23. Earned Income Tax Credit: Exams. Despite special challenges in dealing with EITC-eligible taxpayers, the IRS persists in using traditional audits as its main compliance tool.
Recommendation: The IRS should assign one employee to each EITC audit in correspondence examination; design a formula for workload selection; revise the agency’s manual to include additional documentation and to accept alternative documents; and require correspondence examiners to adjust accounts for childless worker credits.
24. Earned Income Tax Credit: Preparers. Despite a little more than half of returns claiming EITC in 2013 being done by paid preparers, there’s high noncompliance. The IRS’s strategy to improve compliance of preparers overlooks opportunities to reach unscrupulous preparers. The IRS also doesn’t educate taxpayers so they can avoid these preparers. And the IRS can’t measure its success, which means it can’t determine if the compliance strategy is effective.
Recommendation: Educate EITC taxpayers about avoiding unscrupulous preparers, make public the annual analysis of the EITC preparer strategy, evaluate the strategy’s effectiveness, and incorporate preparer referrals as a selection method.