Taxpayer Advocate Service Cites Tax Code Complexity in Report to Congress

But most importantly, She has taught me how to live With grace in the face of adversity.

Honorable Members of Congress:

I respectfully submit for your consideration the National Taxpayer Advocate's 2012 Annual Report to Congress. Section 7803(c)(2)(B)(ii) of the Internal Revenue Code requires the National Taxpayer Advocate to submit this report each year and in it, among other things, to identify at least 20 of the most serious problems encountered by taxpayers and to make administrative and legislative recommendations to mitigate those problems.

As this report goes to press, it appears an agreement has been reached to patch the Alternative Minimum Tax. For taxpayers and the IRS, that is extremely good news. The IRS systems that process tax returns cannot generally be programmed to accommodate alternative scenarios. As the IRS Commissioner has said, the IRS made a risk-based decision to program its systems on the assumption that an AMT patch would be passed, and if a patch was not enacted, the start of the filing season would have been delayed from January to late March or possibly later for the significant majority of taxpayers. That would have brought about the most chaotic filing season in memory. I am hopeful and relieved that that near-crisis seems to have been averted.

Since the election, the dominant issue before Congress has been the so-called "fiscal cliff." While that term seems to mean different things to different people, it encompasses three critical issues from a tax administration perspective -- tax complexity, the Alternative Minimum Tax, and the risk that sequestration or alternative budget cuts will further weaken the IRS's ability to serve taxpayers and collect the revenue upon which the rest of government depends.

Consider the following:

• Tax Complexity. An analysis of IRS data by the Office of the Taxpayer Advocate shows it takes U.S. taxpayers (both individuals and businesses) more than 6.1 billion hours to complete filings required by a tax code that contains almost four million words and that, on average, has more than one new provision added to it daily. Indeed, few taxpayers complete their returns without assistance. Nearly 60 percent of taxpayers hire paid preparers and another 30 percent rely on commercial software to prepare their returns. To inspire confidence and trust, the tax laws should be comprehensible and the computations of tax should be transparent and relatively simple, yet few taxpayers today can confidently say they understand the tax code or even that they have correctly computed their tax liabilities.¹ In this report, we identify tax complexity as the #1 most serious problem facing taxpayers, and we recommend (as we have in prior reports) that Congress vastly simplify the tax code to make tax compliance easier. We offer both conceptual and specific suggestions for Congress to consider as it moves forward.

• Alternative Minimum Tax. Taxpayers spent about 18 million hours for the 2000 tax year (the most recent year for which we found data) completing and filling out AMT tax forms and determining whether they owed the tax. The AMT was originally enacted to ensure that the wealthiest U.S. taxpayers pay at least some tax each year by adding back into income certain tax benefits known as "tax preferences." Yet in 2008, 87 percent of all tax preferences that gave rise to AMT liabilities was attributable to the disallowance of personal exemptions and the deduction for state and local taxes. Only under the unique logic of the AMT are the acts of having a large family and living in a high-tax state viewed as a tax dodge. As we document in this report, the AMT does not seem to achieve its intended purpose. Many middle and upper-middle class taxpayers pay the AMT, while most wealthy taxpayers do not, and thousands of millionaires pay no income tax at all. At the same time, the AMT adds significant complexity to tax computations, requiring millions of taxpayers essentially to compute their tax liabilities twice -- once under the regular tax rules and again under the AMT rules -- and then to pay the higher of the two tax amounts. Because the AMT largely fails to achieve its objective and because it adds considerable complexity for so many taxpayers, including millions who don't even end up owing it, we identify the AMT as the #2 most serious problem facing taxpayers, and we reiterate our longstanding recommendation that the AMT be repealed.

• IRS Funding. In fiscal year (FY) 2012, the IRS received around 125 million calls. The IRS answered only about two out of three calls from taxpayers trying to reach a live person, and those taxpayers had to wait, on average, about 17 minutes to get through. Meanwhile, at fiscal year end, the IRS had a backlog of more than one million pieces of correspondence (up 188 percent from FY 2004), and almost half of that backlog was overage (up 316 percent from FY 2004). Is it any wonder that some taxpayers give up and stop responding to the IRS?² At the same time that the IRS is not meeting taxpayer needs, it is struggling to close a "tax gap" estimated at nearly $400 billion a year. In this report, we designate the significant and persistent underfunding of the IRS as the #3 most serious problem facing taxpayers.

Yet this is precisely what we are doing with the IRS budget. Last year, the IRS brought in federal revenue of about $2.52 trillion on a budget of $11.8 billion, for a return-on-investment (ROI) of 214:1. If we cut IRS funding, the IRS Commissioner recently estimated in a letter to Congress that we can expect lower tax collections in an amount seven times as much as the budget cuts. That means fewer dollars to put toward deficit reduction, fewer dollars for military funding, fewer dollars for disaster recovery, fewer dollars for our intelligence services and embassy protection, fewer dollars for an economic safety net, fewer dollars for disaster recovery, fewer dollars for infrastructure renewal, fewer dollars for medical research -- in short, fewer dollars for all the things we believe as a nation we should provide for our citizens. It means real harm to real people.

Since FY 2010, the IRS budget has been declining each year, and absent congressional action, it is likely to be reduced more in the coming years, perhaps significantly so, by sequestration or other budget cuts that replace the sequestration mechanism. More than 90 percent of the IRS's taxpayer service and enforcement budget goes for personnel costs, so budget cuts mean that fewer employees will be available to answer phone calls from taxpayers needing assistance.³ Budget cuts mean that there will be long delays when taxpayers call or write to say there is a mistake on their IRS bill and they don't owe these taxes.⁴ Budget cuts mean that victims of identity theft will have to wait longer than six months to get resolution of their cases and receive their refunds.⁵ Budget cuts mean that because taxpayers couldn't get the assistance they needed when they needed it, they will do things incorrectly. Budget cuts mean that, because of these avoidable problems, taxpayers will face IRS enforcement actions -- liens, levies, seizures, audits -- that will be automated and initiated without so much as a phone call to the actual taxpayer.⁶ And budget cuts mean that the IRS will not have the trained personnel or technology required to administer the laws properly to close the tax gap.

None of this bodes well for taxpayers. But the harm from budget brinksmanship and last-minute tax law changes goes beyond the immediate impacts I've outlined above. As we report in our Volume Two study, Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results, the factors that are most highly correlated with noncompliance among sole proprietors -- the single largest component of the tax gap -- are distrust of government, distrust of the IRS, and disbelief in the fairness of our tax system. The fiscal cliff drama reinforces taxpayers' belief that government and the tax system are not helping them.

Under our system of government, it may be inevitable that important decisions about tax policy and federal budgeting are sometimes deferred until the last minute. But the extent of the resulting uncertainty about tax rates, people's take-home pay, the AMT, and the prospect of a delay in the delivery of tax refunds resulting from a delay in the start of the filing season produces disappointment, dismay, and cynicism among taxpayers. The IRS budget cuts likely to come about with sequestration (or replacement cuts), and the virtual freeze on hiring and training that has already occurred because of successive years of continuing resolutions and inadequate funding, erode what little taxpayer service remains in IRS operations and all but ensure that IRS technology will remain in the 20^th century, hampering its ability to effectively collect tax and assist taxpayers who are trying to comply. Meanwhile, the complexity creep of the tax code and the menacing shadow of the AMT confirm taxpayers' suspicions that the tax laws are designed to entrap them and obscure what is and is not being taxed.

The fiscal cliff also deflects attention from other priority issues in tax administration, including the 20 other most serious problems we identify in this report. At its most basic level, insufficient funding drives the IRS to reduce its meaningful interaction with taxpayers and replace it with automated enforcement mechanisms. This approach can erode fundamental taxpayer rights and protections. We see evidence of this erosion in the IRS's failure to provide adequate assistance to victims of identity theft or return preparer fraud;⁷ its insistence on draconian penalties against taxpayers with overseas accounts, irrespective of their benign purpose;⁸ its inadequate use of installment agreements and offers in compromise for taxpayers, particularly with respect to business taxpayers and taxpayers experiencing economic hardship;⁹ and its abandonment of an education and compliance presence in local communities.¹⁰ All of these are problems for which solutions exist and about which my office has made practical recommendations.

Yet throughout this report, the IRS responses to our analysis and recommendations often seem to miss the basic point or are otherwise unpersuasive. What underlies these responses is the understandable IRS concern that it does not have the resources to make the improvements that are so obviously needed, so it is better to rationalize the status quo or commit to only those improvements it can afford currently, rather than try to make the case for more funding or for reallocating current funding. The current budget crisis and recurring continuing resolutions exacerbate this IRS tendency.

This is no way to run a tax system. What the IRS -- and its taxpayers -- need is a stable funding mechanism for the IRS that allows it to educate its taxpayers about their tax obligations, provide assistance to taxpayers when they need it, work with taxpayers who are trying to comply but aren't in compliance for one reason or another (including economic hardship), enforce the tax laws against those who seek to evade reporting their taxable income or paying their tax liabilities, and generally seek to increase the amount of taxes paid voluntarily.

What the IRS -- and its taxpayers -- have now is an unstable funding mechanism that treats the IRS like any other government spending program instead of the revenue center or accounts receivable function that it is. The IRS must compete for funding with the rest of the government agencies that rely on IRS collections to accomplish their missions. The plain truth is that the IRS's mission trumps all other agencies' missions -- because without an effective revenue collector you can't fund those other agencies. Certainly, Members of Congress may disagree about the appropriate level of taxation. But whatever level is written into law, there can be little disagreement that taxpayers should receive the assistance they need to comply, and the laws should be enforced so that everyone pays their fair share of tax and we have a level playing field. Without an effective tax collector, honest taxpayers end up paying more to subsidize noncompliance by others, and we don't raise the funds our government requires. And that state of affairs is not sustainable.

In this and previous reports, we have proposed a solution to the problem of IRS funding.¹¹ It is really very simple in concept: fence off -- or "sequester," if you will -- IRS funding from the rest of the federal budget. Determine what level of revenue the IRS needs to collect for the government to do what we want it to do, and then determine what the IRS needs to collect that revenue -- in a way that maximizes (voluntary) compliance, protects taxpayer rights, and minimizes taxpayer burden. The return on investment in the IRS should be guaranteed to be greater than 1 to 1. And if we simultaneously set goals for the IRS in terms of taxpayer service, victim assistance, online services, and voluntary compliance while funding research, development, and innovation, we may well exceed our ROI expectations. We might actually end up with the 21^st century tax administration we deserve rather than the heroically struggling, overwhelmed one that we have.

Looking forward, the year 2013 is shaping up to be an active one from the standpoint of tax policy. As Congress moves forward on these fronts, I urge you to keep in mind the impact of various legislative proposals on the taxpayer and on the IRS's ability to administer the proposals effectively and fairly. As the National Taxpayer Advocate, I hope 2013 brings about fundamental tax simplification, repeal of the Alternative Minimum Tax, and a new approach toward funding the IRS that ensures the agency can do a better job of meeting taxpayer needs and collecting the revenue that funds virtually all other government operations. I also hope the IRS makes progress in addressing the growing problem of tax-related identity theft and particularly improves its performance in providing timely and effective assistance to identity-theft victims and preparer fraud victims as well as taxpayers who are struggling to comply with their tax obligations.

I respectfully submit this report to Congress for your consideration and action, and I stand ready to assist you in any way that I can.

Sincerely,

Nina E. Olson

²See Most Serious Problem: The IRS is Significantly Underfunded to Serve Taxpayers and Collect Tax, infra.

³See Most Serious Problem: The IRS Telephone and Correspondence Services Have Deteriorated Over the Last Decade and Must Improve to Meet Taxpayer Needs, infra.

⁴See Most Serious Problem: The Automated Collection System Must Emphasize Taxpayer Service Initiatives to Resolve Collection Workload More Effectively, infra.

⁵See Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, infra.

⁶See Introduction: The IRS "Fresh Start" Initiative Has Produced Significant Improvements in Some Collection Policies; However, Significantly More Emphasis on Service Delivery Is Necessary to Realize the Full Benefits of These Important Changes, infra; Most Serious Problem: The Diminishing Role of the Revenue Officer Has Been Detrimental To The Overall Effectiveness Of IRS Collection Operations, infra; Most Serious Problem: The Automated Collection System Must Emphasize Taxpayer Service Initiatives to Resolve Collection Workload More Effectively, infra; Most Serious Problem: Although the IRS "Fresh Start" Initiative Has Reduced The Number Of Lien Notices Filed, the IRS Has Failed To Determine Whether Its Lien Policies Are Clearly Supported by Either Increased Taxpayer Compliance or Revenue, infra; Most Serious Problem: Early Intervention, Offers in Compromise, and Proactive Outreach Can Help Victims of Failed Payroll Service Providers and Increase Employment Tax Compliance, infra; Study: Study of Tax Court Cases In Which the IRS Conceded the Taxpayer Was Entitled to the Earned Income Tax Credit (EITC), infra; and Study: Investigating the Impact of Liens on Taxpayer Liabilities and Payment Behavior, infra.

⁷See Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, infra; Most Serious Problem: The IRS Harms Victims of Return Preparer Misconduct by Failing to Resolve Their Accounts Fully, infra.

⁸See Most Serious Problem: The IRS's Offshore Voluntary Disclosure Programs Discourage Voluntary Compliance by Those Who Inadvertently Failed to Report Foreign Accounts, infra.

⁹See Introduction: The IRS "Fresh Start" Initiative Has Produced Significant Improvements in Some Collection Policies; However, Significantly More Emphasis on Service Delivery Is Necessary to Realize the Full Benefits of These Important Changes, infra; Most Serious Problem: The Diminishing Role of the Revenue Officer Has Been Detrimental To The Overall Effectiveness Of IRS Collection Operations, infra; Most Serious Problem: Early Intervention, Offers in Compromise, and Proactive Outreach Can Help Victims of Failed Payroll Service Providers and Increase Employment Tax Compliance, infra.

¹⁰See Most Serious Problem: The IRS Is Substantially Reducing Both the Amount and Scope of Its Direct Education and Outreach to Taxpayers and Does Not Measure the Effectiveness of Its Remaining Outreach Activities, Thereby Risking Increased Noncompliance, infra.

¹¹See Most Serious Problem: The IRS Is Significantly Underfunded to Serve Taxpayers and Collect Tax, infra; see also National Taxpayer Advocate 2006 Annual Report to Congress 442-457 (Legislative Recommendation: Revising Congressional Budget Procedures to Improve IRS Funding Decisions).

As in earlier years, this report discusses at least 20 of the most serious problems encountered by taxpayers -- but not necessarily the top 20 most serious problems. That is by design. Since there is no objective way to select the 20 most serious problems, we consider a variety of factors when making this determination. Moreover, while we carefully rank each year's problems under the same methodology (described immediately below), the list remains inherently subjective in many respects.

To simply report on the top 20 problems would pose many difficulties. First, in doing so, it would require us to repeat much of the same data and propose many of the same solutions year to year. Thus, the statute allows the National Taxpayer Advocate to be flexible in selecting both the subject matter and the number of topics to be discussed and to use the report to put forth actionable and specific solutions instead of mere criticism and complaints.

METHODOLOGY OF THE MOST SERIOUS PROBLEM LIST

The National Taxpayer Advocate considers a number of factors in identifying, evaluating, and ranking the most serious problems encountered by taxpayers. The 23 issues and the six status updates in this section of the Annual Report were ranked according to the following criteria:

• Impact on taxpayer rights;

• Number of taxpayers affected;

• Interest, sensitivity, and visibility to the National Taxpayer Advocate, Congress, and other external stakeholders;

• Barriers these problems present to tax law compliance, including cost, time, and burden;

• The revenue impact of noncompliance; and

• Taxpayer Advocate Management Information System (TAMIS) and Systemic Advocacy Management System (SAMS) data.

TAXPAYER ADVOCATE MANAGEMENT INFORMATION SYSTEM LIST

The identification of the most serious problems reflects not only the mandates of Congress and the IRC, but TAS's integrated approach to advocacy -- using individual cases as a means for detecting trends and identifying systemic problems in IRS policy and procedures or the Code. TAS tracks individual taxpayer cases on TAMIS. The top 25 case issues, listed in Appendix 1, reflect TAMIS receipts based on taxpayer contacts in fiscal year 2012, a period spanning October 1, 2011, through September 30, 2012.

IRS RESPONSES

TAS provides the IRS's respective operating divisions and functional units with the opportunity to comment on and respond to the problems described in each year's report. For each most serious problem, these responses appear unedited (with the exception of correcting typographical or clerical errors), under the heading "IRS Comments," followed by the National Taxpayer Advocate's own comments on the IRS response and her final recommendations.

USE OF EXAMPLES

The examples presented in this report illustrate issues raised in cases handled by TAS. To comply with IRC § 6103, which generally requires the IRS to keep taxpayers' returns and return information confidential, the details of the fact patterns have been changed. In some instances, the taxpayer has provided a written waiver to the National Taxpayer Advocate to use facts specific to that taxpayer's case. These exceptions are noted in footnotes to the examples.

The most serious problem facing taxpayers -- and the IRS -- is the complexity of the Internal Revenue Code (the "tax code"). Among other things, the tax code:

• Makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns;

• Requires the significant majority of taxpayers to bear monetary costs to comply, as most taxpayers hire preparers and many other taxpayers purchase tax preparation software;

• Obscures comprehension, leaving many taxpayers unaware how their taxes are computed and what rate of tax they pay;

• Facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and by providing criminals with opportunities to commit tax fraud;

• Undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply; and

• Generates tens of millions of telephone calls to the IRS each year, overburdening the agency and compromising its ability to provide high-quality taxpayer service.

To alleviate taxpayer burden and enhance public confidence in the integrity of the tax system, the National Taxpayer Advocate urges Congress to vastly simplify the tax code. In general, this means paring back the number of income exclusions, exemptions, deductions, and credits (generally known as "tax expenditures"). For fiscal year (FY) 2013, the Joint Committee on Taxation has projected that tax expenditures will come to about $1.09 trillion,³ while individual income tax revenue is projected to be about $1.36 trillion.⁴ This suggests that if Congress were to eliminate all tax expenditures, it could cut individual income tax rates by about 44 percent and still generate about the same amount of revenue.⁵ The Treasury Department also makes annual tax expenditure estimates, and for FY 2013, it projects tax expenditures of $1.02 trillion, which would allow for a 43 percent reduction in tax rates under similar assumptions.⁶

As this report goes to press, we are well aware that the subject of tax reform is figuring prominently in the political dialogue over ways to reduce the federal budget deficit. The National Taxpayer Advocate does not take a position regarding optimal revenue levels, tax rates, or the distribution of tax liabilities. As the statutory voice of the taxpayer, the National Taxpayer Advocate is recommending tax reform for the purpose of reducing taxpayer burden. As discussed below, the existing tax code inflicts significant, even unconscionable, burden on taxpayers, and Congress could alleviate much of that burden by vastly simplifying the tax code. Thus, our advocacy for tax reform is longstanding and wholly unrelated to deficit reduction.

In 1986, the last time Congress enacted fundamental tax reform, the legislation proceeded on a revenue-neutral basis. That approach had the virtue of allowing policymakers to assure taxpayers that, at least on average, their tax bills would not rise. If tax reform is undertaken now as part of an effort to raise revenue, that assurance cannot be given. But the same structural tradeoffs will apply. Once Congress sets its revenue targets, it can hit its targets by enacting relatively high tax rates that continue to be offset by a bewildering array of exclusions, exemptions, deductions, and credits, or it can hit its targets by enacting relatively low tax rates and minimizing the number of tax breaks it permits.

From the standpoint of reducing taxpayer burden, simpler is better. As we have suggested in the past, we recommend that Congress employ a "zero-based budgeting" approach to tax reform. The starting point for discussion would be a tax code without any exclusions or reductions in income or tax. A tax break or IRS-administered social program would be added only if lawmakers decide, on balance, that the public policy benefits of running the provision or program through the tax code outweigh the tax complexity burden that the provision creates for taxpayers and the IRS. At the end of the exercise, tax rates can be set at whatever level is required to raise the amount of revenue that Congress determines is appropriate.

ANALYSIS OF PROBLEM

The National Taxpayer Advocate on numerous occasions has identified the complexity of the tax code as the most serious problem facing taxpayers and urged Congress to simplify it. In this section, we quantify the burden the tax code imposes, summarize the largest tax expenditures to make clear that fundamental tax reform will require difficult tradeoffs, share select comments on tax reform from taxpayers, make the case for a "zero-based budgeting" approach, summarize our office's prior tax simplification recommendations in key areas, and propose several recommendations for Congressional consideration.

A. Why is Tax Reform Needed?

1. The Current Tax Code Imposes Huge Compliance Burdens on Individual Taxpayers and Businesses.

Consider the following:

• According to a TAS analysis of IRS data, individuals and businesses spend about 6.1 billion hours a year complying with the filing requirements of the Internal Revenue Code.⁷ And that figure does not include the millions of additional hours that taxpayers must spend when they are required to respond to IRS notices or audits.

• If tax compliance were an industry, it would be one of the largest in the United States. To consume 6.1 billion hours, the "tax industry" requires the equivalent of more than three million full-time workers.⁸

• Compliance costs are huge both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and corporate income tax requirements for 2010 amounted to $168 billion -- or a staggering 15 percent of aggregate income tax receipts.⁹

• According to a tally compiled by a leading publisher of tax information, there have been approximately 4,680 changes to the tax code since 2001, an average of more than one a day.¹⁰

• The tax code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted using the "word count" feature in Microsoft Word turned up nearly four million words.¹¹

• Individual taxpayers find return preparation so overwhelming that about 59 percent now pay preparers to do it for them.¹² Among unincorporated business taxpayers, the figure rises to about 71 percent.¹³ An additional 30 percent of individual taxpayers use tax software to help them prepare their returns,¹⁴ with leading software packages costing $50 or more. For 2007, IRS researchers estimated that the monetary compliance burden of the median individual taxpayer (as measured by income) was $258.¹⁵

IRS data show that when taxpayers have a choice about reporting their income, tax compliance rates are remarkably low. Workers who are classified as employees have little opportunity to underreport their earned income because it is subject to tax withholding. Employees thus report about 99 percent of their earned income. But among workers whose income is not subject to tax withholding, compliance rates plummet. An IRS study found that nonfarm sole proprietors report only 43 percent of their business income and unincorporated farming businesses report only 28 percent.¹⁶

Noncompliance cheats honest taxpayers, who indirectly pay more to make up the difference. According to the IRS's most recent comprehensive estimate, the net tax gap stood at $385 billion in 2006,¹⁷ when there were 116 million households in the United States.¹⁸ This means that each household was effectively paying a "surtax" of some $3,300 to subsidize noncompliance by others.

This raises an important question: Why is it that few Americans would steal from their neighbor or a local charity, yet a high percentage of taxpayers who have a choice about paying taxes appear to have no compunctions about cheating their fellow citizens?

The Taxpayer Advocate Service has conducted some research into the causes of noncompliance, including a major study published in volume 2 of this report,¹⁹ and plans to conduct additional studies. While we do not have definitive answers, we can suggest at least two hypotheses.

• First, no one wants to feel like a "tax chump" -- paying more while suspecting that others are taking advantage of loopholes to pay less. In a TAS survey of taxpayers conducted this year, 73 percent said "[t]he wealthy have ways of minimizing their Federal taxes that are not available to the average taxpayer" and only 12 percent said, "everyone pays their fair share of taxes."²⁰ Taxpayers who believe they are unfairly paying more than others inevitably will feel more justified in "fudging" to right the perceived wrong. Transparency is a critical feature of a successful tax system and is essential if the system is to build taxpayer confidence and maintain high rates of tax compliance. Simplifying the tax code so tax policy choices and computations are more transparent would go a long way toward reassuring taxpayers that the system is not rigged against them.

• Second, most people feel a sense of affinity and unity with local organizations, while in relative terms, they feel disconnected from the federal government. This may be because members of a community generally understand the services that local organizations provide and the benefits they personally derive, while many Americans do not understand how their tax dollars are spent or how they benefit. It may also be because they know the leaders of local community groups personally, while the federal government is faceless. Either way, stealing from a local charity may feel to many like stealing from family and friends, while cheating on one's taxes feels more like a victimless offense.²¹

3. The Tax Code Is So Complex That the IRS Has Difficulty Administering It.

The IRS employs some 90,000 full-time workers²⁵ and performs many of its tasks very well, but it faces daunting challenges in administering the tax code. This report catalogs many of them. Two key indicators of taxpayer service are the IRS's ability to answer taxpayer telephone calls and the IRS's ability to respond to taxpayer correspondence. Despite the fact that about 90 percent of individual taxpayers rely on preparers or tax software packages, the IRS received more than 115 million calls in each of the last two fiscal years.²⁶ That is a staggering volume of calls, and not surprisingly, the IRS has had trouble answering them. In fact, the problem is growing worse. From FY 2004 to FY 2012, the number of calls the IRS received from taxpayers on its Accounts Management phone lines increased from 71 million to 108 million, yet the number of calls answered by telephone assistors declined from 36 million to 31 million.²⁷ The IRS has increased its ability to handle taxpayer calls using automation, but even so, the percentage of calls from taxpayers seeking to speak with a telephone assistor that the IRS answered dropped from 87 percent to 68 percent over the period.²⁸ And among the callers who got through, the average time they spent waiting on hold increased from just over 2 1/2 minutes in FY 2004 to nearly 17 minutes in FY 2012.²⁹

Over the same FY 2004 through FY 2012 period, the IRS's ability to timely process taxpayer correspondence also declined. The IRS receives more than ten million letters from taxpayers each year responding to IRS adjustment notices.³⁰ Comparing the final week of FY 2004 with the final week of FY 20102, the backlog of taxpayer correspondence in the tax adjustments inventory increased by 188 percent (from 357,151 to 1,028,539 pieces), and the percentage of taxpayer correspondence classified as "overage" jumped by 316 percent (from 11.5 percent to 47.8 percent).³¹

As discussed throughout this report, the IRS also struggles to enforce the tax laws, and often burdens taxpayers unnecessarily in attempting to do so.

Simply put, tax code complexity strains the IRS's ability to serve taxpayers, while a simpler code would make the job of the tax administrator much easier -- something that would benefit taxpayers and the government alike.

B. Tax Simplification Requires Trade-Offs.

There is a widespread belief that the influence of "special interests" is the biggest roadblock to comprehensive tax reform. There is no doubt that many provisions in the tax code benefit narrow groups of taxpayers. But the largest special interests are us -- the vast majority of U.S. taxpayers. Virtually all of us benefit from tax breaks that are technically defined as "tax expenditures" -- special reductions in tax revenue attributable to an exclusion, exemption, or deduction from gross income or a credit, preferential tax rate, or deferral of tax.³²

As a preliminary note, we use the term "tax expenditure" rather than "tax loophole" because, in our view, the term "loophole" has taken on a meaning that distorts discussion. In general, taxpayers and policymakers use the term "loophole" to describe a tax expenditure that they do not agree with (or do not benefit from) and use terms like "incentives" or "sound government policy" to describe tax expenditures that they like. To promote a constructive dialogue, we should keep in mind that every provision in the tax code had enough support to pass the House and Senate and be signed into law by the President, and while some provisions benefit broader taxpayer segments than others, every tax break has a constituency. One taxpayer's loophole may be another taxpayer's lifeline, and vice versa. Notably, the significant majority of tax expenditures benefits the masses.

For FY 2013, the Joint Committee on Taxation has estimated that total individual income tax expenditures will come to $1.09 trillion,³³ and the Treasury Department has estimated the total as $1.02 trillion.³⁴ The following tax expenditures account for 80 percent of this total:³⁵

• The exclusion of employer contributions for medical insurance premiums and medical care ($180.6 billion).

• The exclusion for retirement plan contributions and earnings ($165.4 billion).³⁶

• The mortgage interest deduction for owner-occupied housing ($100.9 billion).

• The reduced rates of tax on long-term capital gains and qualified dividends ($83.9 billion).³⁷

• The deduction for nonbusiness state and local taxes ($68.6 billion).

• The exclusion of net imputed rental income ($51.1 billion).

• The deduction for charitable contributions ($46.3 billion).

• The exclusion of Social Security and veterans' benefits ($44.9 billion).³⁸

• The exclusion of interest on state and local government bonds ($25.7 billion).

• The exclusion of capital gains at death ($23.9 billion).

• The exclusion of interest on life insurance savings ($22.5 billion).

Another perspective: As noted above, the Treasury Department estimates that individual income tax expenditures will total about $1.02 trillion in 2013.³⁹ As compared with about 140 million individual tax returns,⁴⁰ that amounts to an average reduction in tax of more than $7,000 per return.

Because tax is computed as a percentage of income, the total amount of exclusions or deductions that would generate a $7,000 tax reduction is a multiple of the tax reduction. Assume for purposes of illustration that a taxpayer pays a flat tax rate of 25 percent and does not qualify for any tax credits. At a 25-percent tax rate, the average tax reduction of $7,000 would translate to deductions or exclusions from income worth $28,000.

Example:

Despite these concerns, the National Taxpayer Advocate believes that fundamental tax reform is essential and urgent. We believe that taxpayers will support tax reform by wide margins if they better understand the trade-offs involved and can be part of an informed dialogue. If tax reform is enacted on a revenue-neutral basis, the average taxpayer's bill will not go up, and taxpayers will be much happier to have a simpler and more transparent system.⁴⁴ They will understand how much tax they are paying, they will understand how their tax is computed, and many will save time and money because they no longer will have to pay fees to a preparer to do the job for them.

It is important, however, to lay the groundwork for tax reform. Whenever proposals to reduce tax expenditures are made, affected groups and industries often mobilize quickly and seek to build public opposition. Therefore, the taxpaying public must understand that tax reform requires trade-offs between tax rates and tax breaks. An uninformed taxpayer who hears he may lose a tax break will instinctively want to keep it to prevent his tax bill from rising. An informed taxpayer often will have a very different reaction because she understands she will be losing a tax break but probably will not pay more (or at least not much more) because rates will be lowered.⁴⁵ The Tax Reform Act of 1986 was the last major revision of the tax code, and despite considerable initial concerns, taxpayers and Members of Congress came around. On the final votes, the Act was supported by significant bipartisan majorities in the House and the Senate.⁴⁶

C. TAS Has Been Receiving Taxpayer Suggestions Through Its Tax Reform Web Page.

To help promote a public dialogue about tax reform, the Office of the Taxpayer Advocate established a web page in January 2011 at www.taxpayeradvocate.irs.gov to solicit taxpayer suggestions. We promised to track and post comments periodically. We asked taxpayers to offer their thoughts on tax reform generally and to consider which tax breaks they would be willing to give up in exchange for simplification of the tax code. To date, we have received more than 3,000 comments. While the comments present a wide range of perspectives and address a variety of issues, most taxpayers seem to understand and support the need for trade-offs.

Here is a sampling of some of the comments:

D. Zero-Based Budgeting Approach Could Assist Congress in Deciding Which Tax Breaks and IRS-Administered Social Programs to Retain and Which to Eliminate.

As discussed above, we are well aware that tax reform has become part of the ongoing discussion about ways to reduce the federal budget deficit. However, our longstanding advocacy for fundamental tax reform is aimed at reducing taxpayer burden by simplifying tax compliance and making compliance requirements transparent to taxpayers. For that reason, we recommend that Congress approach tax reform in a manner similar to zero-based budgeting. Under that approach, the starting point would be a tax code without any exclusions or reductions in income or tax. As discussions proceed, tax breaks and IRS-administered social programs would be added only if lawmakers decide on balance that the public policy benefits of running the provision or program through the tax code outweigh the tax complexity challenges that doing so creates for taxpayers and the IRS. Some tax provisions and programs will meet this test, while others will not. Factors to consider in making this assessment include whether the government continues to place a priority on encouraging the activity for which the tax incentive is provided, whether the incentive is accomplishing its intended purpose, and whether a tax expenditure is more effective than a direct expenditure for achieving that purpose.⁴⁸ At the end of the process, most taxpayers should be able to complete their returns without the need for a tax preparer, and taxpayers should be able to see clearly how their tax liabilities are derived.

The immediate elimination of certain tax benefits could cause hardships for individuals or businesses where established pricing or conduct is based on those provisions. For example, persons who own homes paid a purchase price that took into account the federal subsidy provided through the mortgage interest deduction. Sudden elimination of that deduction could cause the value of existing homes to drop substantially. If Congress decides to eliminate tax incentives in situations like this, transitional relief should be provided.

In our 2010 Annual Report to Congress, we recommended adoption of a process to evaluate whether a tax expenditure presents an administrative challenge to the IRS or taxpayers and the extent to which it achieves its intended purpose.⁴⁹ In our 2009 report, we proposed an analytic framework for evaluating whether specific social benefit programs -- whether for individuals or for businesses -- should be run through the tax system.⁵⁰

If, in the context of structural tax reform, Congress applies this rigorous analytical framework to all proposed tax expenditures, it will incorporate solely those provisions that fulfill a compelling public policy purpose, that the IRS can effectively administer without undue burden to taxpayers, and that are designed to capture information to evaluate whether the benefit achieves its intended public policy outcome. Importantly, taxpayers and policymakers will understand why such provisions are included in the tax code and will be able to ascertain their effectiveness.

We are not so naïve as to suggest that all tax expenditures will be eliminated, even in the most robust tax reform effort. In fact, there are excellent public policy or administrative reasons for including some programs in the tax code -- whether they benefit individuals, small businesses, or entire industries.⁵¹ And we believe that given adequate lead time, proper design, and sufficient resources, the IRS can successfully administer many of these programs without unduly burdening taxpayers or itself.⁵² But the tax system will run much more smoothly if only tax benefits and social programs that withstand this analysis are included in the tax code.

E. Prior National Taxpayer Advocate Recommendations to Simplify Portions of the Tax Code Should Be Considered.

Over the past decade, the Office of the Taxpayer Advocate has made numerous proposals to simplify various sections or areas of the tax code. While these proposals were not written with the goal of structural tax reform in mind, they should be considered as part of an overall tax reform process.

Repeal the Alternative Minimum Tax (AMT) for Individuals.⁵³ Few people think of having children or living in a high-tax state as a tax-avoidance maneuver, but under the unique logic of the AMT, that is essentially how those actions are treated. The AMT effectively requires taxpayers to compute their taxes twice -- once under the regular tax rules and again under the AMT rules -- and then to pay the higher of the two amounts. The regular rules allow taxpayers to claim tax deductions for each dependent (recognizing the costs of maintaining a household and raising a family) and for taxes paid to state and local governments (reducing "double taxation" at the federal and state levels), but the AMT rules disallow those deductions. Disallowance of the deductions for state and local taxes and for personal exemptions accounted for about 87 percent of all AMT revenue generated by preference items in 2008.⁵⁴ The AMT computations are also extremely burdensome. The National Taxpayer Advocate has recommended that the AMT be repealed. Moreover, we note that if tax expenditures are substantially reduced, the AMT would be rendered largely irrelevant.⁵⁵

Consolidate the Family Status Provisions. Notwithstanding the improvements brought about by enactment of a Uniform Definition of a Child in 2004, the tax code's family status provisions continue to ensnare taxpayers and make tax administration difficult simply because of the number of such provisions and their structural interaction. These provisions include filing status, personal and dependency exemptions, the child tax credit, the EITC, the child and dependent care credit, and the separated spouse rule under IRC § 7703(b). Many of the eligibility requirements -- such as support or maintenance costs of the home -- are difficult for the IRS to verify without conducting audits into taxpayers' personal and private lives. The National Taxpayer Advocate has recommended that, as part of a comprehensive reform of the tax code's tax treatment of families, Congress consolidate the numerous existing family status-related provisions into two categories: (1) a Family Credit and (2) a Worker Credit. The refundable Family Credit would reflect the costs of maintaining a household and raising a family, while the refundable Worker Credit would provide an incentive and subsidy for low income individuals to work.⁵⁶

Improve Other Provisions Relating to Taxation of the Family Unit. The tax code currently imposes "joint and several liability" on married persons who file a joint federal income tax return. This concept dates back to the early years of the income tax when a husband was typically the sole wage earner for the family unit. Today, husbands and wives often have separate assets and incomes that they do not equally control. Recognizing that it is inequitable to hold one spouse liable for tax on the other spouse's income, at least in cases where he or she does not know about the income of the other spouse and does not significantly benefit from it, Congress has enacted relief rules. However, these relief rules are complex, do not always produce the right result, and impose a large burden on the "innocent spouse" to prove his or her case. The National Taxpayer Advocate has recommended several steps to improve equity and simplify the rules, including eliminating joint and several liability for joint filers.⁵⁷

The "kiddie tax" rules are another family-related area of taxation that create significant burden for some taxpayers. The tax code currently taxes a minor child's unearned income above a certain threshold at the parent's tax rate. The parent must decide whether to file a separate return for the child or include the child's income on the parent's own return. The calculations required to determine which option is preferable in a particular case are complex. Moreover, if the child's parents are separated, additional complications arise. If a custodial parent has been designated, the child's income must be included on that parent's return. If no custodial parent has been designated, the law requires the tax to be computed by reference to the return of the parent with the greater taxable income. During a divorce proceeding, however, spouses sometimes conceal their assets or income from the other spouse, making compliance with these rules impractical. The National Taxpayer Advocate has recommended that the unearned income of minor children above a specified threshold be taxed at a higher rate and that the link between the computation of the child's tax liability and the parent's tax return be severed.⁵⁸

Consolidate Education Savings Tax Incentives. The tax code contains at least 11 separate incentives to encourage taxpayers to save for and spend on education. The eligibility requirements, definitions of common terms, income-level thresholds, phase-out ranges, and inflation adjustments vary from provision to provision. The point of a tax incentive, almost by definition, is to encourage certain types of economic behavior. However, taxpayers will only respond to incentives if they know they exist and understand them. Few, if any, taxpayers are aware of each of the education tax incentives and familiar enough with the particulars to make wise choices. The National Taxpayer Advocate has recommended that Congress consolidate incentives and harmonize definitions and other terms to the extent possible.⁵⁹

Consolidate Retirement Savings Tax Incentives. The tax code contains at least 16 separate incentives to encourage taxpayers to save for retirement. These incentives are subject to different sets of rules governing eligibility, contribution limits, taxation of contributions and distributions, withdrawals, availability of loans, and portability. Similar to education savings incentives, the large number of retirement savings options and the lack of common definitions and terms can preclude taxpayers from making wise choices or understanding how each incentive works. The National Taxpayer Advocate has recommended that Congress consolidate existing retirement incentives, particularly where the differences in plan attributes are minor. For instance, Congress should consider establishing one retirement savings option for individual taxpayers, one for plans offered by small businesses, and one suitable for large businesses and governmental entities (eliminating plans that are limited to governmental entities). At a minimum, Congress should establish uniform rules regarding hardship withdrawals, plan loans, and portability.⁶⁰

Simplify Worker Classification Determinations to Minimize Employee-versus-Independent Contractor Disputes. The complexity and ambiguities in the existing worker classification rules create uncertainty for businesses and workers and lead to noncompliance. In general, businesses are required to pay and withhold employment tax, withhold income tax, and provide benefits only with respect to employees. Consequently, businesses have an incentive to classify workers as independent contractors to reduce their costs. Some workers seeking to avoid their tax obligations may also prefer to be classified as contractors if the business does not withhold taxes or report the payments to the IRS. Whether a worker should be classified as an employee or an independent contractor depends on a variety of factors that reflect the nature of the relationship between the worker and the business. The National Taxpayer Advocate has recommended that Congress:

Eliminate (or Simplify) Phase-Outs. Roughly half of all individual income tax returns filed each year are affected by the phase-out of certain tax benefits as a taxpayer's income increases. There are, in fact, legitimate policy reasons for using phase-outs in certain circumstances. Like tax sunsets, however, phase-outs are largely used to reduce the cost of tax provisions for budget-scoring purposes. Moreover, phase-outs are burdensome for taxpayers, reduce the effectiveness of tax incentives, and make it more difficult for taxpayers to estimate their tax liabilities and pay the correct amount of withholding or estimated taxes, possibly reducing tax compliance. Phase-outs also create marginal "rate bubbles" -- income ranges within which an additional dollar of income earned by a relatively low income taxpayer is taxed at a higher rate than an additional dollar of income earned by a relatively high income taxpayer. Because Congress could achieve a similar distribution of the tax burden based on income level by adjusting marginal rates, phase-outs introduce unnecessary complexity to the Code. The National Taxpayer Advocate has recommended that Congress repeal phase-outs or at least reassess them individually to ensure that they are necessary to accomplish their intended objective.⁶⁵

Streamline the Penalty Regime. The number of civil tax penalties has increased from about 14 in 1954 to more than 130 today. The last comprehensive reform of the tax code's penalty provisions was enacted in 1989, after careful study by Congress, the IRS, and others. Since then, legislative and administrative changes to the penalty regime have proceeded piecemeal, but without the kind of careful analysis conducted in 1989. The National Taxpayer Advocate has recommended that Congress direct the IRS to (1) collect and analyze more detailed penalty data on a regular basis and (2) conduct an empirical study to quantify the effect of each penalty on voluntary compliance. Congress should appropriate additional funds for this research, as necessary. In the meantime, based on penalty reform principles identified in 1989, the National Taxpayer Advocate has recommended 11 steps that could be taken immediately.⁶⁶

F. While Corporate Tax Reform Is Needed, Individual Income Tax Reform Should Be Given Priority.

The tax reform recommendations in this report focus on the individual income tax regime. This is for two reasons. First, there are vastly more taxpayers who file individual income tax returns. Second, even among businesses, most conduct their operations as sole proprietors or through "pass-through" entities and ultimately report their business income on their individual income tax returns.

Specifically, there were over 140 million individual tax returns filed in FY 2011.⁶⁷ There were also more than 32 million pass-through businesses, including at least 22.3 million sole proprietors that filed Schedules C,⁶⁸ at least 1.9 million farmers that filed Schedules F,⁶⁹ 4.5 million S corporations that filed Forms 1120-S,⁷⁰ and 3.6 million partnerships that filed Forms 1065.⁷¹ By contrast, only 2.3 million C corporations are taxed at the entity level and would derive most of the direct benefits of corporate tax reform.⁷² This is not to minimize the need for corporate tax reform, and the rationale for curtailing tax benefits in exchange for lower rates applies in that context as well. We are simply saying that corporate tax reform will not eliminate any of the complexity or burden that the vast majority of U.S. taxpayers experience today.

CONCLUSION

For all the reasons described above, we believe that fundamental reform must be made a priority. A simpler, more transparent tax code will substantially reduce the estimated 6.1 billion hours and $168 billion that taxpayers spend on return preparation; reduce the likelihood that sophisticated taxpayers can exploit arcane provisions to avoid paying their fair share of tax; enable taxpayers to understand how their tax liabilities are computed and prepare their own returns; improve taxpayer morale and tax compliance -- including the level of connection that taxpayers feel with the government; and enable the IRS to administer the tax system more effectively and better meet taxpayer needs.

Based on all the comments we receive every year in the Taxpayer Advocate Service and our experience in handling hundreds of thousands of taxpayer cases a year, we believe that lowering rates in exchange for broadening the tax base would be an excellent bargain. We are confident that in the end, public support for a simpler code will be strong and deep.

Recommendations

The National Taxpayer Advocate recommends that Members of Congress take the following steps:

²Id.

³See Staff of the Joint Committee on Taxation, 112th Cong., Estimates of Federal Tax Expenditures for Fiscal Years 2011-2015 (Joint Comm. Print 2012), at https://www.jct.gov/publications.html?func=select&id=5.

⁴See Office of Management and Budget, Budget of the United States Government, Fiscal Year 2013, Historical Tables, Table 2.1, at http://www.whitehouse.gov/omb/budget/Historicals.

⁵ We cite this figure as a ballpark estimate. There are at least two important effects that could cause this percentage to be higher or lower in practice. First, if all tax expenditures were eliminated, each taxpayer's taxable income would increase substantially (e.g., by 44 percent), and as taxable income rises, taxpayers move into higher marginal tax-rate brackets. Therefore, the additional taxable income would fall into the higher bracket levels, causing taxpayers to pay more in tax. This mechanical effect suggests Congress could cut tax rates by more than 44 percent and still raise the same amount of revenue. Second, tax expenditures have certain interactive effects that tend to push in the opposite direction. Thus, if all tax expenditures were eliminated simultaneously, the interactive effects would probably cause the additional tax revenue to be somewhat less than the sum of the tax expenditures eliminated. TAS does not have a revenue-estimation capacity, so we cannot determine whether the combination of these effects would, on balance, produce more revenue or less revenue. Nevertheless, the aggregate total provides a rough approximation of the increase in revenue that would result from the elimination of all tax expenditures, and we use it in this report for that purpose. See Leonard Burman, Eric Toder & Christopher Geissler, How Big Are Total Individual Income Tax Expenditures, and Who Benefits from Them? Discussion Paper 31, Amer. Soc. Sci. Assoc'n (New Orleans, La., Jan. 5, 2008) 3, at http://taxpolicycenter.org/UploadedPDF/1001234_tax_expenditures.pdf; shorter version published in 98 Amer. Econ. Rev. 79 (2008) (stating that despite interaction effects, "commentators have added up tax expenditures to make general statements about their magnitude").

⁶See Office of Management and Budget, Budget of the United States Government, Fiscal Year 2013, Supplemental Materials, Tax Expenditures Spreadsheet, Table 17-2, at http://www.whitehouse.gov/omb/budget/Supplemental.

⁷ The TAS Research function arrived at this estimate by multiplying the number of copies of each form filed for tax year 2010 by the average amount of time the IRS estimated it took to complete the form. While the IRS's estimates are the most authoritative available, the amount of time the average taxpayer spends completing a form is difficult to measure with precision. This TAS estimate may be low because it does not take into account all forms and, as noted in the text, it does not include the amount of time taxpayers spend responding to post-filing notices, examinations, or collection actions. Conversely, the TAS estimate may be high because IRS time estimates have not necessarily kept pace fully with technology improvements that allow a wider range of processing activities to be completed via automation.

⁸ This calculation assumes each employee works 2,000 hours per year (i.e., 50 weeks, with two weeks off for vacation, at 40 hours per week).

⁹ The IRS and several outside analysts have attempted to quantify the costs of tax compliance. For an overview of previous studies, see Government Accountability Office, Tax Policy: Summary of Estimates of the Costs of the Federal Tax System, GAO-05-878 (Aug. 2005). There is no clearly correct methodology, and the results of these studies vary. All monetize the amount of time that taxpayers and their preparers spend complying with the tax code. TAS estimated the cost of complying with personal and business income tax requirements (and thus excluding the time spent complying with employment, estate and gift, excise, and exempt organization tax requirements) by multiplying the total number of such hours (5.648 billion) by the average hourly cost of a civilian employee ($29.72), as reported by the Bureau of Labor Statistics. See Bureau of Labor Statistics, U.S. Department of Labor, Employer Costs for Employee Compensation -- December 2010, USDL: 11-0304 (Mar. 9, 2011) (including wages and benefits), at http://www.bls.gov/news.release/archives/ecec_03092011.pdf. TAS estimated compliance costs as a percentage of total income tax receipts for 2010 by dividing the income tax compliance cost as computed above ($168 billion) by total 2010 income tax receipts ($1.09 trillion). See Office of Management and Budget, Budget of the United States Government -- Fiscal Year 2013, Historical Tables, Table 2-1, at http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/hist.pdf. TAS's estimate that compliance costs amount to about 15 percent of aggregate income tax receipts falls within the range of some previous estimates. For example, Professor Joel Slemrod computed that compliance costs constitute about 13 percent of receipts, while the Tax Foundation computed that compliance costs constitute about 22 percent of income tax receipts. See Public Meeting of the President's Advisory Panel on Federal Tax Reform (Mar. 3, 2005) (statement of Joel Slemrod, Paul W. McCracken Collegiate Professor of Business Economics and Public Policy, University of Michigan Stephen M. Ross School of Business); Scott Moody, Wendy P. Warcholik & Scott A. Hodge, Special Report: The Rising Cost of Complying with the Federal Income Tax (Tax Foundation, Dec. 2005), at http://www.taxfoundation.org/research/show/1281.html.

¹⁰ Unpublished Commerce Clearing House (CCH) data provided to TAS (Dec. 12, 2012). This count does not include changes made after Dec. 28, 2012, if any, as they would have been enacted after our publishing deadline. CCH advised us that its count of tax-law changes is somewhat understated, because multiple changes to a section might be grouped together and counted as a single entry on its finding lists of tax-law changes.

¹¹ To determine the number of words in the Internal Revenue Code, TAS downloaded a zipped file of Title 26 of the U.S. Code (i.e., the Internal Revenue Code) from the website of the U.S. House of Representatives at http://uscode.house.gov/download/title_26.shtml. We unzipped the file, copied it into Microsoft Word, and used the "word count" feature to compute the number of words. The version of Title 26 we used was dated Jan. 3, 2012, so the count does not reflect legislation enacted during the second session of the 112th Congress. In Word, the document ran 9,191 single-spaced pages. The printed code contains certain information that does not have the effect of law, such as a description of amendments that have been adopted, effective dates, cross references, and captions. The word count feature also counts page numbers, the table of contents, and the like. Therefore, our count somewhat overstates the number of words that are officially considered a part of the tax code, although as a practical matter, a person seeking to determine the law will likely have to read and consider many of these additional words, including effective dates, cross references, and captions. Other attempts to determine the length of the Code may have excluded some or all of these components, but there is no clearly correct methodology to use, and we found no easy way to selectively delete information from a document of this length.

¹² IRS Compliance Data Warehouse, Individual Returns Transaction File (Tax Year 2010).

¹³Id.

¹⁴Id.

¹⁵ George Contos, John Guyton, Patrick Langetieg & Melissa Vigil, Individual Taxpayer Compliance Burden: The Role of Assisted Methods in Taxpayer Response to Increasing Complexity 26 (presented at IRS Research Conference, June 2010).

¹⁶See IRS News Release, IRS Updates Tax Gap Estimates, IR-2006-28 (Feb. 14, 2006), at http://www.irs.gov/uac/IRS-Updates-Tax-Gap-Estimates (accompanying charts at http://www.irs.gov/pub/irs-news/tax_gap_figures.pdf). As low as these rates are, they would be even lower if not for the fact that some of this income is reported to the IRS by third parties. In January 2012, the IRS updated its estimate of the tax gap, but the updated study does not contain a breakout of compliance rates for sole proprietors or unincorporated farming businesses. Thus, the compliance rates cited in the text remain the most recent estimates available.

¹⁷See IRS News Release, IRS Releases New Tax Gap Estimates; Compliance Rates Remain Statistically Unchanged From Previous Study, IR-2012-4 (Jan. 6, 2012), at http://www.irs.gov/uac/IRS-Releases-New-Tax-Gap-Estimates;-Compliance-Rates-Remain-Statistically-Unchanged-From-Previous-Study. The "net" tax gap reflects the amount by which tax liabilities exceed tax collection after accounting for late payments and enforced collections. The "gross" tax gap -- the amount of tax due but not paid timely and before enforced collections -- was estimated to be $450 billion.

¹⁸ U.S. Census Bureau, Table H-1, Income Limits for Each Fifth and Top 5 Percent of All Householders: 1967 to 2011, at http://www.census.gov/hhes/www/income/data/historical/household/index.html.

¹⁹See Research Study: Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results, vol. 2, infra.

²⁰ Russell Research, Inc., Factors Influencing Compliance: Topline Summary (May 2012). Russell Research conducted this survey for TAS among a statistically representative sample of sole proprietors. A detailed presentation and analysis of the survey results is published in Volume 2 of this report. See Research Study: Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results, vol. 2, infra.

²¹See generally National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, at 147-150 (Research Study: Normative and Cognitive Aspects of Tax Compliance: Literature Review and Recommendations for the IRS Regarding Individual Taxpayers) (discussing the effect of social norms on tax compliance).

²²See National Taxpayer Advocate 2010 Annual Report to Congress 368 (Legislative Recommendation: Enact Tax Reform Now).

²³ IRC § 7523 requires the IRS to include pie-shaped graphs showing the relative sizes of major outlay categories and major income categories in its instructions for Forms 1040, 1040A, and 1040EZ; see IRS Form 1040 Instructions (2011), at 97.

²⁴ In April 2011, the White House website launched a calculator titled "Your Federal Taxpayer Receipt" that allows taxpayers to enter the actual or estimated amounts of their Social Security, Medicare, and income tax payments and to see a breakdown showing how their payments are being applied to major categories of federal spending, including Social Security, Medicare, national defense, health care, job and family security programs, interest on the national debt, Veterans benefits, and education. While we view the availability of this calculator as a positive development, most taxpayers will not take the time to visit this website. We therefore believe a taxpayer receipt should be provided in connection with the filing of a return.

²⁵ According to the 2011 IRS Data Book, the IRS ended FY 2011 with about 91,380 full-time equivalent employees -- about 3,000 fewer employees than at the end of FY 2010. IRS Data Book, 2011, Table 30, at http://www.irs.gov/pub/irs-soi/11databk.pdf. In FY 2012, the IRS budget was reduced by 2.5 percent, which has led to a further reduction in the number of employees. See Department of the Treasury, FY 2013 Budget in Brief, at http://www.treasury.gov/about/budget-performance/budget-in-brief/Documents/11.%20IRS_508%20-%20passed.pdf (showing a decline in enacted appropriations levels from FY 2011 to FY 2012).

²⁶ IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (weeks ending Sept. 30, 2011 and Sept. 30, 2012).

²⁷Compare IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (week ending Sept. 30, 2012) with IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (week ending Sept. 30, 2004). The Accounts Management phones lines (previously known as the Customer Account Services phone lines) receive the significant majority of taxpayer calls. However, taxpayer calls to compliance phone lines and certain other categories of calls are excluded from this total.

²⁸Id.

²⁹Id. See Most Serious Problem: The IRS Must Confront Challenges to Delivering Quality Taxpayer Service in the Twenty-First Century, infra.

³⁰See, e.g., IRS, Joint Operations Center, CAS Accounts Management Paper Inventory Reports: FY12 July-September Fiscal Year Comparison.

³¹Compare IRS, Joint Operations Center, Weekly Enterprise Adjustments Inventory Report (week ending Sept. 29, 2012) with IRS, Joint Operations Center, Weekly Enterprise Adjustments Inventory Report (week ending Sept. 25, 2004).

³² Congressional Budget and Impoundment Control Act, Pub. L. No. 93-344, § 3(3) (1974). When Congress wishes to spend money, it may do so in either of two ways. It can make expenditures directly via cash outlays, or it can make expenditures by providing tax breaks through the tax code. As a practical matter, a tax expenditure has the same impact as a government spending program. To illustrate, assume that an individual facing a 25 percent tax rate pays $10,000 in mortgage interest and that the government wants to provide a subsidy for home ownership. It could accomplish this objective in two ways: (1) it could allow the taxpayer to deduct the $10,000 of mortgage interest from his gross income, which would produce a tax reduction of $2,500, or (2) it could make a direct payment of $2,500 to the taxpayer in lieu of the tax deduction. The taxpayer ends up in the same economic position either way. For a detailed discussion of tax expenditures, see National Taxpayer Advocate 2010 Annual Report to Congress, vol. 2, at 101-119 (Evaluate the Administration of Tax Expenditures).

³³ Staff of the Joint Committee on Taxation, 112th Cong., Estimates of Federal Tax Expenditures for Fiscal Years 2011-2015 (Joint Comm. Print 2012), at https://www.jct.gov/publications.html?func=select&id=5

³⁴ Office of Management and Budget, Budget of the United States Government, Fiscal Year 2013, Supplemental Materials, Tax Expenditures Spreadsheet, Table 17-2, at http://www.whitehouse.gov/omb/budget/Supplemental.

³⁵ This list reflects the Treasury Department's estimates. The Joint Committee on Taxation also publishes a list of tax expenditures. While the aggregate totals are similar, some estimates of specific tax expenditures vary considerably due to differences in methodology.

³⁶ This total represents the sum of Section 401(k)-type plans ($72.7 billion), employer plans ($52.3 billion), Individual Retirement Accounts ($19.7 billion), self-employed plans (sometimes known as "Keogh" plans) ($19.6 billion), and the low and moderate income savers credit ($1.1 billion).

³⁷ Of this amount, $62.0 billion is attributable to the reduced rates of tax on capital gains and $21.9 billion is attributable to the reduced rates of tax on qualified dividends.

³⁸ Of this amount, $37.7 billion is attributable to the exclusion of Social Security benefits from income and $7.2 billion is attributable to the exclusion of veterans' benefits from income.

³⁹See Office of Management and Budget, Budget of the United States Government, Fiscal Year 2013, Supplemental Materials, Tax Expenditures Spreadsheet, Table 17-2, at http://www.whitehouse.gov/omb/budget/Supplemental.

⁴⁰ The number of individual income tax returns filed was about 141 million in FY 2010 and about 144 million in FY 2011. See IRS Data Book, 2011, Table 2, at http://www.irs.gov/pub/irs-soi/11databk.pdf. Complete data for FY 2012 was not available at press time.

⁴¹ Personal exemptions and the standard deduction are not considered to be tax expenditures because they "defin[e] the zero-rate bracket that is a part of normal tax law." See Staff of the Joint Committee on Taxation, 112th Cong., Estimates of Federal Tax Expenditures for Fiscal Years 2011-2015, at 5 (Joint Comm. Print 2012). However, they have the effect of reducing taxable income further. If the value of personal exemptions and the standard deduction were considered to be tax expenditures, the Treasury Department's and Joint Committee on Taxation's annual estimates of tax expenditures would be considerably larger.

⁴² Because tax rates rise with income, these taxpayers pay tax at 10 percent on their first $17,400 of taxable income, at 15 percent on taxable income between $17,400 and $70,700, and at 25 percent on their additional taxable income (under the tax rate tables for 2012).

⁴³ The bipartisan fiscal commission appointed by President Obama in 2010 made recommendations along these lines. See National Commission on Fiscal Responsibility and Reform, A Moment of Truth, at 15, 28-34 (Dec. 2010) at http://www.fiscalcommission.gov/news/moment-truth-report-national-commission-fiscal-responsibility-and-reform.

⁴⁴ In the current environment, we understand that Congress may decide to raise revenue in the course of reforming the tax code rather than keep the system revenue-neutral. However, if the choice is between raising a given amount of revenue through increasing tax rates or eliminating tax expenditures, the same structural considerations apply. As discussed in the text above, we advocate tax simplification for the purpose of reducing taxpayer burden. We take no position regarding the broader economic effects of raising or lowering marginal tax rates.

⁴⁵ In the current environment, we understand that Congress may decide to raise revenue in the course of reforming the tax code rather than keep the system revenue-neutral. However, if the choice is between raising a given amount of revenue through increasing tax rates or eliminating tax expenditures, the same structural considerations apply. As discussed in the text above, we advocate tax simplification for the purpose of reducing taxpayer burden. We take no position regarding the broader economic effects of raising or lowering marginal tax rates.

⁴⁶ The vote to approve the conference report was 292-136 in the House and 74-23 in the Senate. See Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 at 4 (1987).

⁴⁷ Additional comments are posted at http://www.taxpayeradvocate.irs.gov//userfiles/file/Tax-Reform-Selected-Comments(1).pdf.

⁴⁸See National Taxpayer Advocate 2010 Annual Report to Congress, vol. 2, at 101-119 (Evaluate the Administration of Tax Expenditures).

⁴⁹See National Taxpayer Advocate 2010 Annual Report to Congress, vol. 2, at 101-119 (Evaluate the Administration of Tax Expenditures).

⁵⁰ National Taxpayer Advocate 2009 Annual Report to Congress, vol. 2, at 75-104 (Running Social Programs Through the Tax System). Among other factors, we suggested that Congress consider the IRS's existing relationship with and access to the targeted population as well as the additional burden imposed on that population, the IRS's ability to deliver the benefit in a timely manner and at the appropriate time, the IRS's access to information necessary to make eligibility determinations, and the IRS's suitability to be the administrator of the provision in light of its enforcement culture. We have also suggested that Congress consider whether the U.S. tax system should remain income-based or should add elements of a consumption tax. See National Taxpayer Advocate 2009 Annual Report to Congress, vol. 2, at 35-73 (An Analysis of Tax Administration Issues Raised by a Consumption Tax, Such as a National Sales Tax or Value Added Tax). In this analysis, we outlined tax administration challenges that we encourage policymakers to consider if a detailed consumption tax proposal is ultimately developed.

⁵¹ For example, the IRS in some cases already has access to all the financial or other data required to determine eligibility for a benefit. If another agency were tasked with administering the benefit, the beneficiary would be required to submit the information twice (once to the IRS and once to another agency) or the IRS would be directed to share confidential tax return information, which would impose administrative burden on two agencies and could undermine future tax compliance.

⁵² In our 2010 Annual Report to Congress, we recommended that the IRS revise its mission statement to explicitly acknowledge and describe its dual mission of collecting taxes and delivering social benefits. We believe that recognition of the IRS's dual role will help ensure that the IRS is adequately funded to deliver all of its programs and cause it to shift its emphasis from primarily enforcement to providing better service and assistance to its taxpayers and beneficiaries as well. See National Taxpayer Advocate 2010 Annual Report to Congress 15-27 (Most Serious Problem: The IRS Mission Statement Does Not Reflect the Agency's Increasing Responsibilities for Administering Social Benefits Programs).

⁵³ The AMT is discussed in more detail later in this report. See Most Serious Problem: The Alternative Minimum Tax Corrodes Both the Tax System and the Democratic Process, infra.

⁵⁴See Tax Policy Center, AMT Preference Items 2002, 2004-2008 (Dec. 21, 2010), at http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=468&Topic2id=30=36.

⁵⁵ The National Taxpayer Advocate has repeatedly identified the AMT as a serious problem for taxpayers and has recommended its repeal in prior reports and congressional testimony since 2001. See National Taxpayer Advocate 2008 Annual Report to Congress 356-362 (Legislative Recommendation: Repeal the Alternative Minimum Tax for Individuals); National Taxpayer Advocate 2006 Annual Report to Congress 3-5 (Most Serious Problem: Alternative Minimum Tax for Individuals); National Taxpayer Advocate 2004 Annual Report to Congress 383-385 (Legislative Recommendation: Alternative Minimum Tax); National Taxpayer Advocate 2003 Annual Report to Congress 5-19 (Most Serious Problem: Alternative Minimum Tax for Individuals); National Taxpayer Advocate 2001 Annual Report to Congress 166-177 (Legislative Recommendation: Alternative Minimum Tax for Individuals); see also Alternative Minimum Tax: Hearing Before the Subcomm. on Select Revenue Measures of the House Comm. on Ways & Means (March 7, 2007) (statement of Nina E. Olson, National Taxpayer Advocate); Blowing the Cover on the Stealth Tax: Exposing the Individual AMT: Hearing Before the Subcomm. on Taxation and IRS Oversight of the Senate Comm. on Finance (May 23, 2005) (statement of Nina E. Olson, National Taxpayer Advocate).

⁵⁶See Legislative Recommendation: Simplify the National Status and Related Requirements for Qualifying Children, infra, and Legislative Recommendation: Amend IRC § 7703(b) to Remove the Household Maintenance Requirement and to Permit Taxpayers Living Apart on the Last Day of the Tax Year Who Have Legally Binding Separation Agreements to Be Considered "Not Married," infra; see also National Taxpayer Advocate 2008 Annual Report to Congress 363-369 (Legislative Recommendation: Simplify the Family Status Provisions); National Taxpayer Advocate 2005 Annual Report to Congress 397-406 (Legislative Recommendation: Tax Reform for Families: A Common Sense Approach).

⁵⁷See National Taxpayer Advocate 2005 Annual Report to Congress 407-432 (Legislative Recommendation: Another Marriage Penalty: Taxing the Wrong Spouse); see also National Taxpayer Advocate 2001 Annual Report to Congress 128-165 (Legislative Recommendation: Joint and Several Liability).

⁵⁸See National Taxpayer Advocate 2002 Annual Report to Congress 231-242 (Legislative Recommendation: Children's Income).

⁵⁹See National Taxpayer Advocate 2008 Annual Report to Congress 370-372 (Legislative Recommendation: Simplify and Streamline Education Tax Incentives); National Taxpayer Advocate 2004 Annual Report to Congress 403-422 (Legislative Recommendation: Simplification of Provisions to Encourage Education).

⁶⁰See National Taxpayer Advocate 2008 Annual Report to Congress 373-374 (Legislative Recommendation: Simplify and Streamline Retirement Savings Tax Incentives); National Taxpayer Advocate 2004 Annual Report to Congress 423-432 (Legislative Recommendation: Simplification of Provisions to Encourage Retirement Savings).

⁶¹ Our initial recommendation was simply to require that the Secretary issue guidance. Based on subsequent discussions with small business groups, we revised our recommendation to suggest that Congress first direct the IRS to hold a series of consultations with affected industries and report back to the tax-writing committees on its findings.

⁶²See National Taxpayer Advocate 2008 Annual Report to Congress 375-390 (Legislative Recommendation: Worker Classification).

⁶³See Joint Committee on Taxation, List of Expiring Federal Tax Provisions 2011-2022, JCX-1-12 (Jan. 6, 2012), at https://www.jct.gov/publications.html?func=startdown&id=4383.

⁶⁴See National Taxpayer Advocate 2008 Annual Report to Congress 397-409 (Legislative Recommendation: Eliminate (or Reduce) Procedural Incentives for Lawmakers to Enact Tax Sunsets).

⁶⁵See id. at 410-413 (Legislative Recommendation: Eliminate (or Simplify) Phase-outs).

⁶⁶See id. at 414-418 (Legislative Recommendation: Reforming the Penalty Regime), and vol. 2, Research Study: A Framework for Reforming the Penalty Regime.

⁶⁷See IRS Data Book, 2011, Table 2, at http://www.irs.gov/pub/irs-soi/11databk.pdf.

⁶⁸ IRS Compliance Data Warehouse, Individual Returns Transaction File (Fiscal Year 2011). This figure reflects the number of Form 1040-series returns that contained at least one Schedule C. Some returns contained more than one Schedule C, so the total number of sole proprietorships was somewhat greater than 22.3 million.

⁶⁹Id. This figure reflects the number of Form 1040-series returns that contained at least one Schedule F. Some returns contained more than one Schedule F, so the total number of unincorporated farming businesses was somewhat greater than 1.9 million.

⁷⁰ IRS Data Book, 2011, Table 2, at http://www.irs.gov/pub/irs-soi/11databk.pdf.

⁷¹Id.

⁷²Id.

The individual Alternative Minimum Tax (AMT) was originally enacted to ensure wealthy persons paid at least some tax.¹ Because the AMT is not indexed for inflation, limited to high income taxpayers, or focused on tax loopholes, however, it increasingly penalizes middle income taxpayers for having children, getting married, or paying state and local taxes while allowing thousands of millionaires to pay no tax at all.²

The AMT is complicated and burdensome, even for those who are not subject to it. Many taxpayers must fill out the lengthy AMT form only to find they owe little or no AMT after all. Others must complete the form just to claim certain tax credits. The AMT requires taxpayers to compute their taxes twice -- once under the regular tax rules and again under the AMT rules. If the "tentative minimum tax" (or tentative AMT) liability exceeds the regular tax liability, the taxpayer pays the difference as AMT. Thus, the AMT reduces the transparency of the tax system, making it more difficult for nearly everyone to predict what they will owe.

As if the AMT were not complicated enough, Congress regularly passes so-called AMT "patches" to temporarily protect middle-class taxpayers and popular tax benefits, typically at the last minute or on a retroactive basis.³ Last-minute patches sometimes delay urgently needed tax refunds because with every change in law the IRS has to update its systems before processing returns. Because IRS systems assume a patch will be enacted in 2012, if Congress does not enact a patch, as expected, return processing will be delayed for 80 to 100 million taxpayers -- more than half of all filers -- and about 33 million taxpayers could pay AMT.⁴ Many taxpayers will also face estimated tax shortfalls and underpayment penalties.

The AMT is difficult to repeal because it is projected to raise a large amount of revenue. However, AMT patches have always prevented the AMT from raising these projected amounts. What we have, in essence, is one law that grants popular tax benefits (the regular tax code), another law that eliminates the benefits (the AMT), and then yet a third law that undoes the elimination of benefits (the patches), usually at the last minute -- a legislative Rube Goldberg contraption of unnecessary complexity.

In addition, the AMT reduces the transparency of the tax reform debate. For example, anyone proposing a tax cut has to determine whether the AMT will recapture the cut, and if so, whether to allow the cut to appear deceptively inexpensive because the AMT claws it back or to propose additional and costly changes to mitigate the AMT. Further, any revenue estimate for a tax reform proposal will have to be compared to the illusory revenue that supposedly will be collected after expiration of the AMT patch under current law -- even though no one believes Congress will let the patch expire. In this way, the AMT corrodes both the tax system and the democratic process.

ANALYSIS OF PROBLEM

The AMT does not achieve its original goal.

Congress enacted a minimum tax (the predecessor of today's Alternative Minimum Tax or "AMT") after hearing testimony that 155 taxpayers with adjusted gross incomes (AGI) above $200,000 (about $1,427,882 in 2012 dollars)⁵ paid no federal income tax for the 1966 tax year, due to tax preferences or loopholes.⁶ Remarkably, the AMT today does not achieve its original goal of ensuring that all wealthy persons pay income tax. In 2009 (the most recent year for which complete data is available), nearly 21,000 taxpayers with adjusted gross incomes (AGI) of more than $200,000 paid no income tax at all -- over 35,000 taxpayers if you use a more expanded definition of income than AGI.⁷

Perhaps more remarkably, the AMT will soon hit a much higher percentage of middle income and upper-middle income taxpayers than wealthy taxpayers. In 2013, absent another patch, the AMT is projected to affect an estimated 33 percent of taxpayers with incomes between $75,000 and $100,000 and 44 percent of taxpayers with incomes between $100,000 and $200,000 -- yet only 14 percent of taxpayers with incomes above $1 million.⁸

The AMT hits middle-income taxpayers for getting married, having children, and paying state and local taxes.

Because the AMT exemption amount is not indexed for inflation, and the AMT is not limited to high income taxpayers, or focused on loopholes, it increasingly hits taxpayers who have not done any tax planning. This is largely because the AMT eliminates the tax "benefit" of children (dependency exemptions are lost under the AMT) and marriage (the AMT contains marriage penalties), and does not allow a deduction for state and local taxes.⁹ As a result, 84 percent of married couples with two or more children and adjusted gross income between $75,000 and $100,000 will be hit by the AMT in 2012, up from 0.2 percent in 2011, unless Congress enacts retroactive legislation.¹⁰ While it is hard to imagine that the drafters of the original AMT provision would view incurring expenses to raise a family or living in a high-tax state as a tax-avoidance loophole, that is essentially the way those expenses are viewed under today's AMT.

More than 35,000 taxpayers with incomes above $200,000 pay no income tax despite the AMT.

More than 35,000 taxpayers with incomes of more than $200,000 paid no income tax in 2009, and one projection estimated that about 7,000 millionaires reportedly paid no income tax in 2011.¹¹ One reason for this is the exclusion of interest on certain tax-exempt bonds (and certain miscellaneous itemized deductions) under both regular tax and the AMT.¹² For example, wealthy individuals who invest in certain tax exempt municipal bonds generally pay no federal income tax on the interest they receive.

High income investors face lower marginal rates than moderate income wage earners despite the AMT because the AMT applies preferentially low rates to investment income.

High income taxpayers can pay lower rates than moderate income taxpayers because preferential low rates apply to investment income under both the regular tax system and the AMT. In general, the AMT regime taxes upper-income taxpayers at a flat rate of 28 percent.¹³ Before 1997, capital gains were considered a preference item and taxed at the same flat rate as other AMT income.¹⁴ Under current law, however, long-term capital gains and qualified dividend income are subject to a special low rate, which is generally 15 percent, under both the regular tax and the AMT.¹⁵ Therefore, taxpayers who have sufficient resources to live off investment income pay tax at 15 percent (or perhaps less if they have tax-exempt bond income) -- less than the 25 percent marginal rate applicable to a single person who earns just $34,501 in taxable income from wages.¹⁶

The AMT is complicated and burdensome.

Although the IRS has not measured the compliance costs arising from the AMT, it has estimated that taxpayers spent over 18 million hours in 2000 completing and filing AMT tax forms or determining whether they needed to do so -- more than 12 hours for each person who actually paid the AMT.¹⁷ By comparison, the IRS estimates that it takes 22 hours, on average, to fill out the entire Form 1040, U.S. Individual Income Tax Return.¹⁸

Tax software and preparers can reduce but not eliminate the burden of the AMT.

While computer software and tax preparers can reduce the complexity of computing the AMT, significant burdens remain. For example, the amount of state and local tax refunds included in income depends on the extent to which the AMT limited the state and local tax deductions in the prior year. That amount often needs to be calculated manually because it requires the taxpayer to recalculate his or her prior-year income tax liability.

One study found that between 62 and 67 percent of the Forms 6251, Alternative Minimum Tax -- Individuals, received by the IRS in TY 2000 were unnecessary.¹⁹ Given the prevalent use of tax preparation software and tax preparers, this data suggests that such preparation aids do not always ease the complexity and burden of the AMT, even for taxpayers who are not subject to it. Moreover, this burden is growing as increasing numbers of taxpayers fall under the AMT regime -- or at least believe they do.

The AMT hides the true cost of tax cuts, as estimates of AMT revenue have proven illusory.

The AMT replaces personal exemptions and some deductions (including the standard deduction and the deduction for state and local taxes)²⁰ with an AMT exemption, and then applies its own rate schedule, which contains a marriage penalty. It may also limit the use of personal credits.²¹

In this way, the AMT reclaims tax cuts and preferences enacted under the regular tax system, stealthily reducing their apparent cost. As a result, the AMT is projected to raise an enormous amount of revenue -- about $1.2 trillion from 2011-2022 ($2.3 trillion if the 2001-2003 tax cuts are extended) according to one estimate, at least on paper.²²

In reality, the AMT is projected to have raised only about $33 billion in each of the last two years (2010 and 2011), which is the most it has ever raised.²³ It does not meet revenue projections because Congress has repeatedly enacted short-term "patches" -- eight since 2001 -- to increase the AMT exemption amounts, sometimes on a retroactive basis.²⁴

 

FIGURE 1.2.1, Projections of AMT Revenues and Taxpayers Affected

 

by AMT with and without an AMT Patch²⁵

 

 

 

Temporary AMT patches prompt late-year and retroactive tax law changes.

AMT patches are necessary to keep middle class taxpayers from being hit by the AMT. In 2012, if Congress does not enact another retroactive patch, 46 percent of all tax filers with income between $75,000 and $100,000 will pay the AMT, as will 97 percent of those with income between $200,000 and $500,000.²⁷ Yet, only 37 percent of millionaires will pay the AMT, as shown in the following chart.²⁸

 

FIGURE 1.2.2, Percentage of Taxpayers Projected to Pay AMT in 2012

 

by Income with and without an AMT Patch²⁹

 

 

 

The AMT causes estimated tax underpayments, reducing tax compliance and increasing taxpayer burden.

Frequent AMT patches combine with the inherent complexity of the AMT to make it nearly impossible for taxpayers to estimate their tax liabilities in advance. The AMT is so complicated that the IRS's wage withholding calculator does not even consider the AMT in determining how much taxpayers should withhold.³⁴ Many taxpayers first learn they are subject to the AMT only after preparing their returns, when it is too late to increase their withholding or estimated tax payments. Taxpayers who did not withhold or pay enough estimated tax are subject to penalties. While we cannot determine how many taxpayers were subject to estimated tax penalties solely because of the AMT, IRS data shows that for tax year 2011, about 17 percent of those subject to the AMT were liable for estimated tax penalties, as compared to 4 percent of individual taxpayers overall.³⁵ Some taxpayers will not be able to afford to pay their tax (or penalties) in one lump sum at the end of the year. Thus, the unpredictability of the AMT likely reduces voluntary compliance.³⁶

The AMT hinders informed debate about tax reform options.

The constantly-shifting AMT rules make it more difficult for the government to estimate its revenues and the actual cost of changes to the regular tax system. For example, extending the 2001-2010 individual income tax cuts may appear less costly because the AMT is projected to recoup nearly one quarter of those cuts.³⁷ At the same time, the cost of repealing the AMT may be exaggerated if estimators assume temporary tax cuts will be extended and that the AMT will generate revenue by negating those cuts. Notably, ten-year estimates of AMT revenue double (from $1.05 trillion to $2.19 trillion) if expiring tax cuts are extended.³⁸ As a result, the AMT makes it more difficult for the public to understand the true costs of fundamental tax reform.

Temporary AMT patches compound these difficulties. The bipartisan 2005 Tax Reform Panel observed, "a tax reform proposal that does not repeal the AMT effectively results in a hidden, but real, future tax hike."³⁹ They may have been referring to the AMT patches, which are always scheduled to expire, essentially triggering a future tax hike. As noted above, the largest components of that tax hike involve eliminating the standard deduction and the deduction for state and local taxes, and imposing marriage penalties.⁴⁰ If Congress wanted to raise taxes in this manner, it could do so under the regular tax system. The merits of such a tax hike could easily be compared to alternative proposals for reform.

As the system is now structured, however, proponents of serious tax reform have to compare the cost of their proposals to current law, which includes a hidden tax increase because the AMT patch is always scheduled to expire. Alternative proposals that repeal the AMT may seem unduly expensive by comparison, even if the public would not accept and Congress would not adopt the hidden AMT tax increase that exists under the current law system of patches. As a result, it may be more difficult for the public to evaluate the true merit of realistic tax reform alternatives.

CONCLUSION

The National Taxpayer Advocate first recommended repeal of the AMT in the Annual Report to Congress for 2001 and has advocated for its repeal consistently over the past decade.⁴¹ We reiterate this recommendation.

In 1999, Congress voted to repeal the individual AMT, but the legislation was vetoed.⁴² The American Bar Association Section of Taxation, the American Institute of Certified Public Accountants Tax Division, and the Tax Executives Institute have jointly called for the repeal of the AMT.⁴³ The National Association of Enrolled Agents also advocated outright repeal or substantial restructuring of the AMT for individuals.⁴⁴ Similarly, both the 2005 Tax Reform Panel and the 2010 National Commission on Fiscal Responsibility and Reform (the Simpson-Bowles Commission) recommended repealing the AMT.⁴⁵ Leaders of both parties in both the House and Senate have also recently proposed repealing it.⁴⁶ For all of the reasons stated above, the National Taxpayer Advocate continues to recommend permanent repeal of the individual AMT.

² TPC, T12-0171, Characteristics of AMT Taxpayers With and Without AMT Patch, 2011-2013, 2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3514;TPC, T11-0175, Distribution of Tax Units that Pay No Individual Income Tax by Cash Income Level, Current Law, 2011 (July 13, 2011), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3056 (number of millionaires). The National Taxpayer Advocate has repeatedly identified the AMT as a serious problem for taxpayers and has recommended its repeal in prior reports and congressional testimony. See, e.g., National Taxpayer Advocate 2001 Annual Report to Congress 56-58; National Taxpayer Advocate 2001 Annual Report to Congress 166-177; National Taxpayer Advocate 2003 Annual Report to Congress 5-19; National Taxpayer Advocate 2004 Annual Report to Congress 383-385; Blowing the Cover on the Stealth Tax: Exposing the Individual AMT: Hearing Before the Subcomm. on Taxation and IRS Oversight of the Senate Comm. on Finance (May 23, 2005) (statement of Nina E. Olson, National Taxpayer Advocate); National Taxpayer Advocate 2006 Annual Report to Congress 3-5; Alternative Minimum Tax: Hearing Before the Subcomm. on Select Revenue Measures of the House Comm. on Ways & Means (Mar. 7, 2007) (statement of Nina E. Olson, National Taxpayer Advocate); National Taxpayer Advocate 2008 Annual Report to Congress 356-362.

³ In 2012, if Congress does not enact another retroactive patch, by one estimate 31 million taxpayers will pay $118 billion in AMT. See Joint Committee on Taxation (JCT), JCX-18-12, Overview of the Federal Tax System as in Effect for 2012 29-30, fig. A-5 and fig. A-6 (Feb. 24, 2012), https://www.jct.gov/publications.html?func=startdown&id=4400. This projection is similar to the TPC projections that we cite throughout this report. TPC estimates 34.9 million taxpayers will pay $119.8 billion. TPC, T12-0169, Baseline AMT Projections, Aggregate AMT Projections, 2011-2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3512. The IRS estimates that about 33 million taxpayers could pay AMT. See Letter from Acting IRS Commissioner to Ranking Member, House Committee on Ways and Means (Nov. 13, 2012), http://democrats.waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/Final_Response_Levin_37392.pdf.

⁴See id; Letter from Acting IRS Commissioner to Chairman, House Committee on Ways and Means (Dec. 19, 2012), http://waysandmeans.house.gov/uploadedfiles/camp_12_19_12.pdf.

⁵See Bureau of Labor Statistics, CPI Inflation Calculator, available at http://www.bls.gov/data/inflation_calculator.htm (last visited Nov. 29, 2012).

⁶ The 1969 Economic Report of the President: Hearings before the Joint Economic Comm., 91st Cong., pt. 1, p. 46 (1969) (statement of Joseph W. Barr, Secretary of the Treasury).

⁷ Justin Bryan, High-Income Tax Returns for 2009, 31 SOI Bulletin 6, 11 fig. C (Spring 2012), http://www.irs.gov/pub/irs-soi/12soisprbul.pdf.

⁸ TPC, T12-0171, Characteristics of AMT Taxpayers With and Without AMT Patch, 2011-2013, 2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3514 (2012 current law).

⁹ Disallowance of the deduction for state and local taxes accounted for about 68 percent of all of the AMT revenue generated by preference items in 2008. See TPC, AMT Preference Items 2002, 2004-2008 (Dec. 21, 2010), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=468&Topic2id=30opic3id=36.

¹⁰ TPC, T12-0171, Characteristics of AMT Taxpayers With and Without AMT Patch, 2011-2013, 2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3514.

¹¹ Justin Bryan, High-Income Tax Returns for 2009, 31 SOI Bulletin 6, 14 (Spring 2012), http://www.irs.gov/pub/irs-soi/12soisprbul.pdf ("20,752 returns with no U.S. income tax had an AGI of $200,000 or more; 35,061 returns with no U.S. income tax had an expanded income of $200,000 or more; and 16,465 returns with no U.S. income tax had both AGI and expanded income of $200,000 or more"); TPC, T11-0175, Distribution of Tax Units that Pay No Individual Income Tax by Cash Income Level, Current Law, 2011 (July 13, 2011), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3056 (number of millionaires). Of course, more taxpayers would pay no tax without the AMT -- at least 7,600 high income filers by one 2005 estimate. See Leonard E. Burman, William G. Gale and Jeffrey Rohaly, The Expanding Reach of the Individual Alternative Minimum Tax 7 (May 2005), http://www.taxpolicycenter.org/publications/url.cfm?ID=411194.

¹² Justin Bryan, High-Income Tax Returns for 2009, 31 SOI Bulletin 6, 15-17 (Spring 2012), http://www.irs.gov/pub/irs-soi/12soisprbul.pdf ("nontaxable returns under the expanded income concept, were much more likely to have tax-exempt interest than were taxable returns. . . . Similarly, nontaxable returns were much less likely to have any income from salaries and wages. . . . Because they do not generate AMT adjustments or preferences, tax-exempt bond interest, itemized deductions for interest expense, miscellaneous itemized deductions not subject to the 2-percent-of-AGI floor, casualty or theft losses, and medical expenses (exceeding 10 percent of AGI) could, by themselves, produce nontaxability."); Derek Thompson, Buffett Rule Rorschach: 7,000 Millionaires Paid No Income Taxes in 2011, The Atlantic (Sept. 21, 2011), http://www.theatlantic.com/business/archive/2011/09/buffett-rule-rorschach-7-000-millionaires-paid-no-income-taxes-in-2011/245469/ (indicating that items such as tax exempt bonds and casualty losses account for the zero liability returns, citing Roberton Williams of the TPC).

¹³ The 28 percent rate applies after a phase-out of the exemption amount and a 26 percent rate that applies to the first $175,000 of income. See generally IRC § 55.

¹⁴ Taxpayer Relief Act of 1997, Pub. L. 105-34, § 311(b), 111 Stat. 788 (1997) (reducing the rate applicable to long-term capital gains under both the regular tax system and the AMT).

¹⁵ Middle-income taxpayers who benefit from the AMT exemption face a higher marginal tax rate on long-term capital gains and dividend income because it decreases the value of the AMT exemption. See, e.g., Benjamin H. Harris and Christopher Geissler, Tax Rates on Capital Gains and Dividends Under the AMT, 118 Tax Notes 1031 (Mar. 3, 2008). An IRS analysis of the 400 taxpayers reporting the highest income found that between year 2000 and 2009, 46 to 72 percent of the income they reported was from capital gains. See IRS, SOI, The 400 Individual Income Tax Returns Reporting the Largest Adjusted Gross Incomes Each Year, 1992-2009 (2009), http://www.irs.gov/pub/irs-soi/09intop400.pdf.

¹⁶ IRC § 1; Instructions for IRS Form 1040, U.S. Individual Income Tax Return 98 (2011).

¹⁷ Allen H. Lerman and Peter S. Lee, Evaluating the Ability of the Individual Taxpayer Burden Model To Measure Components of Taxpayer Burden: The Alternative Minimum Tax as a Case Study, 2004 IRS Research Conference 140, 151, 166 (Feb. 2005), http://www.irs.gov/uac/SOI-Tax-Stats---Papers---2004-IRS-Research-Conference (estimating the AMT added 18.4 million hours in burden (including burden for those who did not owe AMT), and that between 1.4 and 1.5 million taxpayers actually paid AMT or had a reduced credit in tax year (TY) 2000).

¹⁸ Instructions for Form 1040, U.S. Individual Income Tax Return 95 (2011).

¹⁹See Allen Lerman and Peter Lee, Evaluating the Ability of the Individual Taxpayer Burden Model to Measure Components of Taxpayer Burden: The Alternative Minimum Tax as a Case Study, 2004 IRS Research Conference 140, 151 fig. 5 (Feb. 2005), http://www.irs.gov/pub/irs-soi/04lerman.pdf (showing three different estimates for TY 2000 filings: 3.786 million/5.657 million (or 67 percent), 3.104 million/5.034 million (or 62 percent), and 2.923 million/4.724 million (or 62 percent)). A study of TY 2000 returns indicated that 3.8 million taxpayers spent $331.8 million to file Form 6251 when it was not needed. Id. at 155 fig. 6, 162 fig.11.

²⁰ The disallowance of these items accounted for 87 percent of all AMT revenue in 2008. TPC, AMT Preference Items 2002, 2004-2008 (Dec. 21, 2010), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=468&Topic2id=30=36.

²¹ For taxable years after 1999, nonrefundable personal credits generally may not offset the AMT. IRC § 26(a)(1). However, for taxable years beginning in 2000 through 2011, nonrefundable personal credits are allowed to offset both regular tax liability and AMT liability. IRC § 26(a)(2). Thus, the AMT could limit personal credits if they are not addressed in subsequent legislation.

²² TPC, T12-0169, Baseline AMT Projections; Current Law and Current Policy, 2011-2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3512.

²³ TPC, T12-0168, Aggregate AMT Projections and Recent History, 1970-2022, (June 3, 2011), http://www.taxpolicycenter.org/numbers/displayatab.cfm?Docid=3511&DocTypeID=7.

²⁴ For a list of AMT patches, see, e.g., TPC, Historical AMT Legislation, (Jan. 31, 2011), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=195&Topic2id=30=36.

²⁵ TPC, Aggregate AMT Projections and Recent History, 1970-2022, (June 3, 2011), http://www.taxpolicycenter.org/numbers/displayatab.cfm?Docid=3511&DocTypeID=7. The revenue estimates include revenue from direct AMT liability on Form 6251, lost credits, and reduced deductions. Id. The estimates of the number of taxpayers affected by the AMT include those affected by each of these items. Id. They assume that if an AMT patch is enacted for 2012, all the temporary provisions in place for calendar year 2011 are also extended, with the exception of the payroll tax cut. They also assume the AMT patch sets exemption levels to those specified in Senate bill S.3413 for 2012 and 2013, indexes the 2013 levels in later years, and allows non-refundable personal credits against AMT liability. Senate bill S. 3413 sets the AMT exemption amount for 2012 at $50,600 for individuals and $78,750 for married taxpayers filing jointly and for 2013 at $51,150 for individuals and $79,850 for married taxpayers filing jointly. S. 3413, 112th Cong. (2012).

²⁶ TPC, Aggregate AMT Projections and Recent History, 1970-2022 (June 3, 2011). JCT recently estimated that it would cost about $855 billion over 10 years to enact the President's proposal to make the 2011 exemption amounts permanent, index them for inflation, index the 28 percent AMT bracket, and remove certain personal credits from the AMT. Congressional Budget Office (CBO), An Analysis of the President's 2013 Budget 7 (Mar. 2012), http://www.cbo.gov/publication/43083 (citing a JCT estimate). A recent proposal to extend the AMT patch for 2010 and 2011 was estimated to cost about $136.7 billion if the Bush-era tax cuts were also extended. See JCT, JCX-54-10, Estimated Budget Effects of the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010," Scheduled for Consideration by the United States Senate (Dec. 10, 2010), http://www.jct.gov/publications.html?func=startdown&id=3715.

²⁷ TPC, T12-0171, Characteristics of AMT Taxpayers with and without AMT Fix, 2011-2013, 2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3514.

²⁸ TPC, T12-0171, Characteristics of AMT Taxpayers with and without AMT Fix, 2011-2013, 2022 (Sept. 13, 2012).

²⁹Id. Dependents are excluded from the analysis. Taxpayers are defined as returns with positive income tax liability net of refundable credits. We use the term "paying" AMT to include paying AMT liability on Form 6251, as well as any reduction of credits or deductions. The TPC's estimates are based on a broad measure of income called "cash income," defined as adjusted gross income minus taxable state and local tax refunds, plus total deductions from AGI, non-taxable pension income, tax-exempt interest, non-taxable social security benefits, cash transfers, worker's compensation, employee's contribution to tax deferred retirement savings plans, employer's share of payroll taxes and corporate tax liability. Id. These projections assume that if an AMT patch is enacted for 2012 (i.e., current policy), all the temporary provisions in place for calendar year 2011 are also extended, with the exception of the payroll tax cut. The projections for the AMT patch adopt the AMT patch specified in Senate bill S.3413, which sets the AMT exemption amount for 2012 at $50,600 for individuals and $78,750 for married taxpayers filing jointly.

³⁰ As noted above, JCT recently estimated the cost of a permanent fix would be $855 billion over 10 years, but a two-year patch (for 2010 and 2011) would be $136.7 billion. CBO, An Analysis of the President's 2013 Budget 7 (Mar. 2012) (citing a JCT estimate for a permanent fix); JCT, JCX-54-10, Estimated Budget Effects of the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010," Scheduled for Consideration by the United States Senate (Dec. 10, 2010) (AMT patch).

³¹See, e.g., National Taxpayer Advocate 2007 Annual Report to Congress 3-12 (Most Serious Problem: The Impact of Late-Year Tax-Law Changes on Taxpayers).

³² Letter from Acting IRS Commissioner to Ranking Member, House Committee on Ways and Means (Nov. 13, 2012); Letter from Acting IRS Commissioner to Chairman, House Committee on Ways and Means (Dec. 19, 2012).

³³Id. This figure exceeds the number subject to the AMT because (1) the patch generally includes tax credit ordering rules, which affect many taxpayers who are not subject to AMT, (2) the IRS would not be able to process certain forms and schedules from anyone, and (3) the IRS would not be able to process returns from anyone whose income level might subject them to the AMT. Id.

³⁴ The calculator refers taxpayers to Publication 919. See IRS Withholding Calculator (Jan. 25, 2012), http://www.irs.gov/individuals/article/0,,id=96196,00.html ("CAUTION: If you will be subject to alternative minimum tax, self-employment tax, or other taxes; you will probably achieve more accurate withholding by following the instructions in Publication 919, How Do I Adjust My Tax Withholding?"). Publication 919 instructs taxpayers to project their AMT liability by filling out Form 6251 or the Alternative Minimum Tax Worksheet in the Form 1040A instructions, a daunting task that few are likely to undertake before the end of the year, especially if they believe the law might change on a retroactive basis.

³⁵ IRS Compliance Data Warehouse Individual Returns Transaction File and Individual Master File (Tax Year 2011). The National Taxpayer Advocate has recommended legislation to waive the estimated tax penalty for those who pay at least 100 percent of the amount due for the prior year, are subject to a de minimis penalty, or are first-time estimated taxpayers and have reasonable cause for the violation. National Taxpayer Advocate 2008 Annual Report to Congress vol. 2 30-35.

³⁶ Studies suggest that unexpected tax liabilities reduce filing, payment, and reporting compliance. See National Taxpayer Advocate 2008 Annual Report to Congress vol. 2, at 30-35 (summarizing various studies).

³⁷ TPC, T12-0176, Effect of the AMT on 2001-2010 Individual Income Tax Cuts, 2012 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3519. According to JCT, it would cost $2.4 trillion over 10 years to make the 2001-2003 tax cuts permanent for low and middle income taxpayers if the AMT exemption is increased to 2011 levels and indexed for inflation. See JCT, JCX-27-12, Estimated Budget Effects of the Revenue Provisions Contained In the President's Fiscal Year 2013 Budget Proposal 3 (Mar. 14, 2012), http://www.jct.gov/publications.html?func=startdown&id=4412.

³⁸ TPC, T12-0169, Baseline AMT Projections, Aggregate AMT Projections, 2011-2022 (Sept. 13, 2012), http://www.taxpolicycenter.org/numbers/displayatab.cfm?DocID=3512 (2013-2022).

³⁹ The President's Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System 43 (Nov. 2005), http://govinfo.library.unt.edu/taxreformpanel/final-report/index.html.

⁴⁰ TPC, AMT Preference Items 2002, 2004-2008 (Dec. 21, 2010), http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=468&Topic2id=30=36.

⁴¹See, e.g., sources cited supra note 2.

⁴² Taxpayer Refund and Relief Act of 1999, H.R. 2488, 106th Cong. (1999).

⁴³ American Bar Association Section of Taxation, American Institute of Certified Public Accountants Tax Division & Tax Executives Institute, Tax Simplification Recommendations, reprinted at 2000 TNT 39-82 (Feb. 28, 2000).

⁴⁴2003 Tax Return Filing Season and the IRS Budget for Fiscal Year 2004: Hearing before the House Ways and Means Subcommittee on Oversight, 108th Cong. (2003) (statement of Claudia Hill on behalf of the National Association of Enrolled Agents).

⁴⁵ The President's Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System xvii (Nov. 2005), http://govinfo.library.unt.edu/taxreformpanel/final-report/index.html; The National Commission on Fiscal Responsibility and Reform, The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform, 2010 TNT 231-35 sec. 2, fig. 7 (Dec. 3, 2010).

⁴⁶See, e.g., Tax Reduction and Reform Act of 2007, H.R. 3970, 110th Cong. (2007) (sponsored by Rep. Charles Rangel, Chairman, House Committee on Ways and Means, though the bill limits the benefits of repeal to lower income taxpayers); Individual AMT Repeal Act of 2007, H.R. 1366, 110th Cong. (2007); Taxpayer Choice Act of 2007, H.R. 3818, 110th Cong. (2007); Individual AMT Repeal Act of 2009, H.R. 240, 111th Cong. (2009); End Tax Uncertainty Act of 2011, HR. 86, 112th Cong. (2011); Individual AMT Repeal Act of 2011, H.R. 547, 112th Cong. (2011); Jobs Through Growth Act, H.R. 3400, 112th Cong. (2011); American Opportunity and Freedom Act of 2012, H.R. 3804, 111th Cong. (2012); Individual Alternative Minimum Tax Repeal Act of 2007, S. 55, 110th Cong. (2007) (sponsored by Max Baucus and Chuck Grassley, Senate Finance Committee, Chairman and Ranking Minority member, respectively, among others); Invest in America Act, S.14, 110th Cong. (2007); Individual Alternative Minimum Tax Repeal Act of 2007, S. 2293, 110th Cong. (2007); AMT Repeal and Tax Freedom Act, S. 2318, 110th Cong. (2007); Bipartisan Tax Fairness and Simplification Act of 2011, S. 727, 112th Cong. (2011).

The IRS is significantly and chronically underfunded to serve America's taxpayers and collect the amount of tax due under law. Because of funding shortages:

• The IRS is unable to answer millions of taxpayer telephone calls;

• The IRS is unable to timely process taxpayer correspondence;

• The "tax gap" -- the amount of tax due but uncollected -- stands at nearly $400 billion each year;

• Taxpayers believe the tax laws are not being fairly enforced against others; and

• The federal budget deficit is unnecessarily large.

In this section of the report and in accordance with our statutory mandate, we identify at least 20 of the most serious problems facing taxpayers. Some of the problems we identify result from poor planning or execution, and it is important that the IRS not use lack of funding as a justification for failing to address these problems. Areas where the IRS must improve its strategic approach include assisting victims of tax-related identity theft,¹ accepting voluntary disclosures from persons who belatedly report offshore accounts without subjecting them to draconian penalties in a wider array of cases,² assisting victims of return preparer fraud,³ and allowing parents who adopt children to claim the adoption credit without incurring a vastly increased risk of an audit.⁴

However, the lack of sufficient funding is the sole or significant cause of many of the problems identified in this report. There are practical limits to how well the IRS can respond to tens of millions of telephone calls, more than 10 million letters, and hundreds of thousands of identity theft cases each year, as well as maintain robust tax-compliance programs including outreach and education, if it lacks adequate and educated personnel, technology, and other support.

The IRS is materially different from other discretionary programs in that it serves as the de facto Accounts Receivable Department of the federal government. Each dollar appropriated for the IRS generates substantially more than one dollar in additional revenue. It is therefore ironic and counterproductive that concerns about the deficit are leading to cuts in the IRS budget, when those cuts are making the deficit larger.

ANALYSIS OF PROBLEM

For purposes of the appropriations process, the IRS is treated as a domestic discretionary program, generally subject to the same funding rules as all other such programs. As Congress has curtailed discretionary spending to try to bring the federal deficit under control, the IRS budget has been cut. The IRS's budget was reduced slightly from fiscal year (FY) 2010 to FY 2011,⁵ it was cut by an additional 2.5 percent from FY 2011 to FY 2012,⁶ and it may be facing additional cuts (or small increases that fail to cover its rising costs) for the foreseeable future. From the standpoint of protecting taxpayer rights and maximizing revenue collection, that would be a disaster.

A. Revenue Collection: Reduced Funding Means Reduced Revenue Collection and a Larger Budget Deficit.

From a revenue standpoint, the IRS in FY 2012 collected about $2.52 trillion⁷ on a budget of about $11.8 billion.⁸ That translates to an average return-on-investment (ROI) of about 214:1. The marginal ROI of additional spending will not be nearly so large, but virtually everyone who has studied the IRS budget has concluded that the ROI of additional funding is positive. Just over a year ago, former Commissioner Shulman estimated in a letter to Congress that proposed cuts to the IRS budget would result in reduced revenue collection of seven times as much as the cuts.⁹

If the Chief Executive Officer of a Fortune 500 company were told that each dollar allocated to his company's Accounts Receivable Department would generate seven dollars in return, it is difficult to see how the CEO would keep his job if he chose not to provide the department with the resources it needed to collect its receivables. Yet that is exactly what has been happening with respect to IRS funding for years, and there has been little effort to fix this obvious problem.

This is not a new issue. In our 2006 Annual Report to Congress, we discussed this issue in detail and recommended, among other things, that Congress consider revising its budget rules in a manner that allows the relevant congressional committees to consider and decide: "What level of funding will maximize tax compliance, particularly voluntary compliance, with our nation's tax laws, with due regard for protecting taxpayer rights and minimizing taxpayer burden?" and then set the IRS funding level accordingly, without regard to spending caps.¹⁰

In the course of developing and presenting that recommendation, the National Taxpayer Advocate or her senior advisor met with 14 separate congressional staffs -- specifically, the House and Senate majority and minority staffs of the tax-writing committees, appropriations committees, and budget committees as well as tax counsel for the House and Senate majority leaders. In our discussions, there appeared to be no significant disagreement with the premise that the IRS generates a positive return-on-investment and is underfunded. However, we were repeatedly told that creating a new set of rules to establish IRS funding levels would be a "heavy lift." The last three IRS Commissioners have also raised this issue.¹¹ So have the former chairman and ranking member of the Senate Budget Committee.¹² In our view, the time to attempt the "heavy lift" is now.

B. Taxpayer Services: Reduced Funding Means Taxpayer Needs Are Not Being Met.

We recognize that few people enjoy paying taxes, and for that reason, recommending that Members support more funding for the IRS is not necessarily an easy sell. But there are multiple reasons why adequate IRS funding is important and why we think taxpayers would see it that way as well. The National Taxpayer Advocate is particularly concerned that the IRS is not receiving sufficient funds to meet the basic needs of taxpayers seeking to comply with the law. As we discuss elsewhere in this report, the IRS has received more than 115 million calls in each of the last two fiscal years.¹³ That is a staggering volume of calls, and the IRS cannot come close to handling them all. Last year, the IRS answered only about 68 percent of calls from taxpayers seeking to speak with a telephone assistor, and those who got through had to wait on hold for an average of nearly 17 minutes.¹⁴ That represents a sharp drop-off in performance as compared with the IRS's high-water mark in FY 2004, when it answered 87 percent of its calls and the average hold time was just over 2 1/2 minutes.¹⁵

The IRS's ability to timely process taxpayer correspondence has also diminished in recent years. Last year, the IRS received more than ten million letters from taxpayers responding to IRS adjustment notices.¹⁶ Comparing the final week of FY 2012 with the final week of FY 2004, the backlog of taxpayer correspondence in the tax adjustments inventory increased by 188 percent (from 357,151 to 1,028,539 pieces), and the percentage of correspondence classified as "overage" jumped by 316 percent (from 11.5 percent to 47.8 percent).¹⁷

Congress has enacted laws that now require more than 140 million individuals to file income tax returns. The National Taxpayer Advocate believes that when taxpayers are attempting to comply with laws that require them to turn over a significant portion of their incomes to pay our nation's bills, they have a right to expect that their government will take their telephone calls and answer their letters. When the IRS fails to answer one out of three phone calls, makes callers wait an average of nearly 17 minutes on hold, and cannot timely process nearly half of its pending correspondence, it falls well short of providing the service that taxpayers deserve.¹⁸

The IRS in recent years has also been struggling to cope with a rising volume of tax-related identity theft cases.¹⁹ As of September 30, 2012, the IRS had almost 650,000 identity theft cases in inventory servicewide.²⁰ The victims of tax-related identity theft suffer extraordinary inconveniences and, in many cases, hardships. In general, more than 75 percent of U.S. taxpayers receive refunds, with the amount averaging about $3,000.²¹ Identity theft victims generally cannot receive their significant and sometimes urgently needed tax refunds until the IRS resolves their cases, which is now taking six months or longer.²²

The IRS needs sufficient funding to address an important equity concern as well. Compliant taxpayers pay a great deal of money each year to subsidize noncompliance by others. According to the IRS's most recent estimate, the net tax gap stood at $385 billion in 2006,²³ when there were 116 million households in the United States.²⁴ This means that each household was effectively paying a "surtax" of some $3,300 to subsidize noncompliance by others. That is not a burden we should expect our nation's taxpayers to bear.

Yet because of funding constraints, the IRS's ability to ensure that all taxpayers pay their fair share of taxes is limited. The IRS now audits just about one percent of individual taxpayers, and because traditional face-to-face audits are relatively expensive, it performs many audits by automated correspondence. About three out of four audits of individual taxpayers are now limited-issue examinations conducted by mail.²⁵ Thus, the IRS in FY 2011 conducted traditional face-to-face audits of just one out of every 360 taxpayers.²⁶

C. The "Program Integrity Cap Adjustment" Mechanism Has Significant Drawbacks.

For the reasons described above, the National Taxpayer Advocate recommends that Congress increase funding for the IRS.

In making this recommendation, however, we emphasize that the IRS must maintain a balanced compliance program that places priority emphasis on promoting voluntary front-end compliance and does not place excessive weight on back-end enforcement. Several Appropriations acts in recent years have given the IRS additional funding using a mechanism known as a "program integrity cap adjustment." Under this mechanism, new funding appropriated for IRS enforcement programs generally does not count against otherwise applicable spending ceilings provided:

Although we recognize that the program integrity cap adjustment mechanism is a well-intentioned attempt to provide the IRS with increased funding, we think such an "enforcement-only" cap adjustment is an impeccably poor workaround for two reasons. First, common sense tells us that taxpayer services are a significant driver of tax compliance and generate a very high ROI. Publishing tax forms and instructions, conducting outreach and education to taxpayers, tax preparers, and tax software manufacturers, and otherwise administering the tax filing season are absolute prerequisites for tax compliance. In general, the ROI of these service activities is almost surely greater than the ROI of enforcement actions, and as we document in this report, the IRS could do a lot to improve its taxpayer services if it received additional funding for that purpose.

Second, an enforcement-only cap adjustment will inherently push the IRS to become more of a hard-core enforcement agency. It should be emphasized that in FY 2011, direct enforcement revenue came to only $55.2 billion,²⁷ or 2 percent, of total IRS tax collections of $2.42 trillion.²⁸ The remaining 98 percent of IRS tax collections resulted from voluntary front-end tax compliance. If cap adjustments are applied solely to bolster enforcement funding, the relative allocation of the IRS budget between enforcement and taxpayer service will shift over time in a direction that causes taxpayers to fear the IRS more and voluntarily cooperate less. In our effort to enforce the laws against noncompliant taxpayers, we must take care to avoid steps that may alienate compliant taxpayers and thereby jeopardize the existing tax base.

If the treatment of the IRS budget is not fundamentally revamped along the lines we are recommending and program integrity cap adjustments continue to be used as an alternative, we recommend that compliance measures be defined more broadly, so that they include both an enforcement component and a service component. Because the projected ROI of many enforcement programs is high, a more broadly constructed initiative could still produce a demonstrable ROI of greater than 1:1, even if it contained service components with a positive but unquantifiable ROI. For example, IRS data show that compliance rates among small businesses are relatively low. A portion of the noncompliance is attributable to the fact that financially unsophisticated individuals starting businesses as, for example, landscapers or plumbers do not understand and therefore find it difficult to comply with the income tax accounting rules and the complex payroll tax withholding, reporting, and payment requirements.

Common sense suggests that an initiative aimed at improving small business tax compliance should contain an outreach and education component to help these taxpayers understand the rules. Yet the costs of conducting outreach and education have not been treated as eligible for program integrity cap adjustments because the ROI of those activities cannot be precisely quantified. That should change. If the IRS were to combine the costs of outreach and education with the costs of traditional enforcement measures as part of a comprehensive "small business compliance initiative," it could show that the initiative as a whole would generate a positive ROI based simply on the revenue the enforcement measures would generate -- and the true ROI would be substantially higher, even if unquantifiably so. That approach would produce better results, and it would not require the IRS to emphasize enforcement over taxpayer service activities just to obtain funding.²⁹

CONCLUSION

Because the IRS is the federal government's accounts receivable department and generates a substantially positive return on investment, it is self-defeating to treat the agency like a pure spending program. With most spending programs, a dollar spent is simply a dollar spent from a budget perspective. With the IRS, a dollar spent generates many dollars in additional revenue, and conversely, a dollar not spent translates to a greater decrease in revenue collection, thereby adding to the budget deficit. Recent cuts in the IRS budget have also limited the IRS's ability to meet the basic service needs of the taxpaying public, which erodes public confidence in the tax system and may also lead to greater noncompliance. For these reasons, we believe the time has come for Congress to "fence off" decisions about IRS funding from the otherwise applicable spending ceilings that apply to discretionary appropriations under the budget rules.

RECOMMENDATIONS

The National Taxpayer Advocate recommends that Congress consider the following actions:

²See Most Serious Problem: The IRS's Offshore Voluntary Disclosure Programs Discourage Voluntary Compliance by Those Who Inadvertently Failed to Report Foreign Accounts, infra.

³See Most Serious Problem: The IRS Harms Victims of Return Preparer Misconduct by Failing to Resolve Their Accounts Fully, infra.

⁴See Most Serious Problem: The IRS's Compliance Strategy for the Expanded Adoption Credit Has Significantly and Unnecessarily Harmed Vulnerable Taxpayers, Has Increased Costs for the IRS and Does Not Bode Well for Future Credit Administration, infra.

⁵See Department of Defense and Full-Year Continuing Appropriations Act, 2011, Pub. L. No. 112-10, § 1119, 1125 Stat. 38, 107 (2011), at http://www.gpo.gov/fdsys/pkg/PLAW-112publ10/pdf/PLAW-112publ10.pdf.

⁶See Department of the Treasury, FY 2013 Budget in Brief, at http://www.treasury.gov/about/budget-performance/budget-in-brief/Documents/11.%20IRS_508%20-%20passed.pdf (showing a decline in enacted appropriations levels from FY 2011 to FY 2012).

⁷ Government Accountability Office (GAO), GAO-13-120, Financial Audit: IRS's Fiscal Years 2012 and 2011 Financial Statements 65 (Nov. 2012), at http://www.gao.gov/assets/650/649881.pdf.

⁸ Department of the Treasury, FY 2013 Budget in Brief, at http://www.treasury.gov/about/budget-performance/budget-in-brief/Documents/11.%20IRS_508%20-%20passed.pdf.

⁹ Letter from Douglas H. Shulman, Commissioner of Internal Revenue, to the chairmen and ranking members of the House Committee on Ways and Means (and its Subcommittee on Oversight) and the Senate Committee on Finance (Oct. 17, 2011), at http://democrats.waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/media/pdf/112/Rep_Lewis_IRS_Letter.pdf.

¹⁰ See National Taxpayer Advocate 2006 Annual Report to Congress 442-457 (Legislative Recommendation: Revising Congressional Budget Procedures to Improve IRS Funding Decisions), at http://www.irs.gov/pub/irs-utl/2006_arc_section2_v2.pdf.

¹¹See, e.g., Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to Turn Around the Most Unpopular Organization in America 278 (2005) ("When I talked to business friends about my job at the IRS, they were always surprised when I said that the most intractable part of the job, by far, was dealing with the IRS budget. The reaction was usually 'Why should that be a problem? If you need a little money to bring in a lot of money, why wouldn't you be able to get it?'").

¹² In 2006, Senator Judd Gregg acknowledged that the existing budget procedures have the effect of shortchanging the IRS. He said: "We've got to talk to the [Congressional Budget Office] about scoring on [additional funding provided to IRS]. Clearly there's a return on that money." Dustin Stamper, Everson Pledges to Narrow Growing Tax Gap, 110 Tax Notes 807 (Feb. 20, 2006). Similarly, Senator Kent Conrad stated: "Rather than a tax increase, I think the first place we ought to look . . . is the tax gap. If we could collect this money, we'd virtually eliminate the deficit." Emily Dagostino, Senate Budget Resolution Would Increase IRS Enforcement Funding, 110 Tax Notes 1129 (Mar. 13, 2006).

¹³ IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (weeks ending Sept. 30, 2011 and Sept. 30, 2012); see Most Serious Problem, The IRS Telephone and Correspondence Services Have Deteriorated Over the Last Decade and Must Improve to Meet Taxpayer Needs, infra.

¹⁴ IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (week ending Sept. 30, 2012). The Accounts Management phones lines (previously known as the Customer Account Services (CAS) phone lines) receive the significant majority of taxpayer calls. However, taxpayer calls to compliance phone lines and certain other categories of calls are excluded from this total.

¹⁵ IRS, Joint Operations Center, Snapshot Reports: Enterprise Snapshot (week ending Sept. 30, 2004).

¹⁶See, e.g., IRS, Joint Operations Center, CAS Accounts Management Paper Inventory Reports: FY12 July-September Fiscal Year Comparison.

¹⁷Compare IRS, Joint Operations Center, Weekly Enterprise Adjustments Inventory Report (week ending Sept. 29, 2012) with IRS, Joint Operations Center, Weekly Enterprise Adjustments Inventory Report (week ending Sept. 25, 2004).

¹⁸ Insufficient funding affects the IRS's performance in many other areas as well. For example, the IRS has been ramping up its use of automated processes as a replacement for personnel in handling a greater share of its auditing and collection activities. While most taxpayers do not relish the prospect of being contacted by an examination or collection employee, we have documented previously that taxpayers are substantially better off communicating with a person than a programmed computer. See National Taxpayer Advocate Blog, Are IRS Correspondence Audits Really Less Burdensome for Taxpayers? (Feb. 6, 2012), at http://www.taxpayeradvocate.irs.gov/Blog/are-irs-correspondence-audits-really-less-burdensome-for-taxpayers; National Taxpayer Advocate 2011 Annual Report to Congress 336-349 (Most Serious Problem: The IRS Does Not Emphasize the Importance of Personal Taxpayer Contact as an Effective Tax Collection Tool). Insufficient funds also mean that IRS employees do not receive adequate training to assist taxpayers as well as they should.

¹⁹See Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, infra.

²⁰See IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012).

²¹See IRS Filing Season Statistics -- Dec. 31, 2011, at http://www.irs.gov/uac/Filing-Season-Statistics---Dec.-31,-2011.

²²See Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, infra.

²³See IRS News Release, IRS Releases New Tax Gap Estimates; Compliance Rates Remain Statistically Unchanged from Previous Study, IR-2012-4 (Jan. 6, 2012), at http://www.irs.gov/uac/IRS-Releases-New-Tax-Gap-Estimates;-Compliance-Rates-Remain-Statistically-Unchanged-From-Previous-Study. The "net" tax gap reflects the amount by which tax liabilities exceed tax collection after accounting for late payments and enforced collections. The "gross" tax gap -- the amount unpaid timely and before enforced collections -- was estimated to be $450 billion.

²⁴ U.S. Census Bureau, Table H-1, Income Limits for Each Fifth and Top 5 Percent of All Householders: 1967 to 2011, at http://www.census.gov/hhes/www/income/data/historical/household/index.html.

²⁵ IRS, Fiscal Year 2011 Enforcement and Service Results, at http://www.irs.gov/pub/newsroom/fy_2011_enforcement_results_table.pdf.

²⁶Id.

²⁷ IRS, Fiscal Year 2011 Enforcement and Service Results, at http://www.irs.gov/pub/newsroom/fy_2011_enforcement_results_table.pdf.

²⁸ Government Accountability Office, GAO-13-120, Financial Audit: IRS's Fiscal Years 2012 and 2011 Financial Statements 65 (Nov. 2012), at http://www.gao.gov/assets/650/649881.pdf.

²⁹ In past reports, we have written about local compliance initiatives the IRS has undertaken that include integrated enforcement and outreach and education components. See, e.g., National Taxpayer Advocate 2008 Annual Report to Congress 176-192 (Most Serious Problem: Local Compliance Initiatives Have Great Potential but Face Significant Challenges). One example: In the early 1990s, the IRS launched an initiative designed to address noncompliance by fishermen in Alaska that resulted from confusion as well as community norms and attitudes. The IRS combined stepped-up enforcement activities with an extensive outreach and education campaign in remote fishing villages and on fishing vessels that included assisting with tax return preparation and training local volunteers to assist taxpayers. By the end of the initiative, the number of nonfilers among the target population declined by 30 percent. Id. at 177-178.

Peggy Bogadi, Commissioner, Wage and Investment Division

Becky Chiaramida, Director, Office of Privacy, Governmental Liaison, and Disclosure

DEFINITION OF PROBLEM

In general, tax-related identity theft occurs when an individual intentionally uses the personal identifying information of another person to file a false tax return with the intention of obtaining an unauthorized refund.¹ Identity theft wreaks havoc on our tax system in many ways. Victims not only must deal with the aftermath of an emotionally draining crime, but may also have to deal with the IRS for years to untangle the resulting tax account problems. Identity theft also impacts the public fisc, as Treasury funds are diverted to pay out improper refunds. In addition, identity theft takes a significant toll on the IRS, tying up limited resources that the IRS could shift to taxpayer service or compliance initiatives.

In April 2008, former Commissioner Shulman appeared before Congress and stated, "My overall goal as the IRS Commissioner is that when a taxpayer contacts us with an issue or concern, we have in place a seamless process that gets the issue resolved promptly."² In October 2008, the IRS established the Identity Protection Specialized Unit (IPSU), a unit dedicated to assisting victims of identity theft. However, the Commissioner's vision has yet to be realized. The help the IRS has offered to the victims of this crime has been anything but seamless and prompt.

The National Taxpayer Advocate has written and testified extensively about the impact of identity theft on taxpayers and tax administration, and has made many specific, concrete recommendations to improve IRS efforts to assist taxpayers who become identity theft victims.³ While the IRS has adopted several of TAS's recommendations, it has not responded with the urgency that the identity theft crisis demands. Despite the proclamation of the Commissioner to Congress that identity theft is a top priority, victims who come to the IRS for assistance today will routinely need to speak with multiple employees and wait more than six months to have their issues resolved. In fact, the IRS has now established 21 different units to address identity theft cases,⁴ many with their own rules and procedures -- a far cry from the initial vision of the centralized "traffic cop" function the National Taxpayer Advocate recommended and the Commissioner committed to in 2008.

Meanwhile, tax-related identify theft continues to grow at an alarming pace. In fiscal year (FY) 2012, the IPSU received nearly 450,000 cases, a 78 percent increase over FY 2011.⁵ TAS has experienced a similar increase in stolen identity case receipts; an increase of over 60 percent from FY 2011 to FY 2012, and an increase of more than 650 percent from FY 2008.⁶ Identity theft cases comprise 25 percent of TAS's FY 2012 case receipts and were the number one issue in TAS case receipts for the last two fiscal years.⁷

Identity theft cases are complex, often encompassing multiple issues and tax years.⁸ TAS case advocates are unique in that they both serve as a single point-of-contact for taxpayers and work to resolve all of the taxpayer's related issues completely before closing cases. Despite TAS's extensive experience working complex identity theft cases, TAS was not afforded an opportunity to review the IRS's procedures before some of the specialized identity theft units became operational. The National Taxpayer Advocate believes the IRS's failure to draw upon the collective expertise of TAS and its employees is a significant oversight that will result in less effective case-resolution procedures.

As of September 30, 2012, the IRS had almost 650,000 identity theft cases in inventory servicewide.⁹ Much of the IRS's focus in the past few years has been on revenue protection (that is, developing filters designed to prevent the payout of questionable refund claims). The National Taxpayer Advocate urges the IRS to expend as much effort as necessary to reduce the time it takes to fully resolve an identity theft victim's case.

The National Taxpayer Advocate is concerned that:

• The IRS is moving backward -- away from a centralized approach to assisting identity theft victims -- and is increasing the risk that taxpayer-victims may fall through the cracks;

• After years of ineffective efforts to reengineer its processes, the IRS still takes too long to fully resolve the accounts of victims;

• While the Identity Protection Personal Identification Number (IP PIN) that the IRS has developed provides additional security, it does not cover all victims;

• The Taxpayer Protection Unit may not be sufficiently staffed to handle the volume of calls from impacted taxpayers;

• Congress may unnecessarily create additional exceptions to taxpayer privacy protections; and

• The Social Security Administration still makes the Death Master File available to the public, creating an opportunity for identity thieves to steal and then misuse personal information.

Background

In general, identity theft occurs in tax administration in two ways -- when an individual intentionally uses the SSN of another person to:

The National Taxpayer Advocate has consistently urged the IRS to improve its strategy for assisting identity theft victims. Since 2004, the National Taxpayer Advocate included identity theft as a Most Serious Problem six times in her Annual Report to Congress.¹⁰ In just the past year, the National Taxpayer Advocate has testified about this topic before Congress in five separate hearings.¹¹

In addition, former Commissioner Shulman (or his designee) has discussed the problem in at least five hearings before Congress.¹² The IRS has established numerous task forces and Lean Six Sigma teams focused on improving identity theft processes. Despite all of this attention, victims who need their tax accounts corrected quickly and effectively still face many of the same issues they did five years ago -- a labyrinth of procedures and drawn-out timeframes for resolution.¹³

With the IRS Moving Away from a Centralized Approach to Identity Theft Victim Assistance, Taxpayers Will Fall Through the Cracks.

In former Commissioner Shulman's first month in office, he testified before the Senate Finance Committee on identity theft. At this hearing and through his responses to follow-up questions, the Commissioner described his vision for addressing the issue. In describing the IPSU, the Commissioner stated:

In 2011, the IRS convened yet another task force to look at its victim assistance strategy. In the view of many participants, the external consulting firm leading this task force came in with the pre-conceived notion that the IRS should move away from centralized victim assistance and toward a specialized approach. Based upon a recommendation from this task force, IRS leadership decided to create a specialized unit within each of its 21 individual departments (or functions) to work on identity theft cases.¹⁵ Under this approach, identity theft cases would be assigned to specially trained employees in each function. If an identity theft case involves multiple issues, the case may be transferred to a specialized unit in a different function to address the additional issue(s).¹⁶ The IRS maintains that transfers of cases between functions will be the exception rather than the rule, but based upon TAS's experience with identity theft cases over the years, it is foreseeable that transfers between functions will become commonplace.

In 2012, each function was asked to develop procedures for its embedded identity theft unit. The IRS-wide Office of Privacy, Governmental Liaisons, and Disclosure (PGLD) was tasked with compiling and reviewing such procedures to ensure some level of consistency. Although TAS has asked to review these procedures before these embedded units became operational in October 2012, we were not afforded this opportunity in all cases. At least three of these embedded specialized units began work without having their procedures reviewed by TAS.¹⁷

In addition, PGLD is coordinating the development of employee guidance that spells out how and when a taxpayer's case will be moved from one embedded unit to another. Although the National Taxpayer Advocate and Taxpayer Advocate Service staff have asked to review such procedures to ensure that they do not increase taxpayer burden or impair taxpayer rights, as of October 26, 2012, PGLD has not shared a final transfer matrix with TAS for review.

The National Taxpayer Advocate firmly believes that the IRS needs a centralized body (such as the IPSU) to serve as the "traffic cop." Identity theft cases are often complex, requiring adjustments by multiple IRS departments.¹⁸ Without a case coordinator, the risk that cases requiring involvement from multiple functions will get "stuck" or fall through the cracks is high. The IPSU has already been serving in this capacity for four years. Under the new, specialized approach to identity theft victim assistance, it is unclear what the role of the IPSU will be. In our view, the IPSU should remain the single point of contact for victims, tracking each case from start to finish as it moves from one specialized unit to another. Each function should have a liaison and service level agreement or memorandum of understanding with the IPSU and be held accountable for meeting established deadlines for taking actions.¹⁹

In addition, the IPSU should continue to serve an important role in this process by conducting a global account review on all identity theft cases. To provide the best service, the IPSU should conduct two global account reviews -- an initial one to identify all related issues prior to transferring the case to the appropriate specialized units, and a final global review to ensure that all issues have been resolved prior to closing any identity theft case. Despite its "specialized" moniker, the IPSU should actually operate as a hub in a centralized environment to ensure a "seamless" experience for the victim.²⁰

Identity Theft Cases Now Comprise 25 Percent of TAS Case Receipts and Clearly Show That Many Identity Theft Cases Involve More Than One Issue.

When established IRS procedures do not work as intended, taxpayers turn to the Taxpayer Advocate Service for assistance. The volume of identity theft cases in TAS has risen each year since the IRS established the IPSU, from about 7,100 in FY 2008 to nearly 55,000 in FY 2012, an increase of more than 650 percent.²¹

 

FIGURE 1.4.1, TAS Stolen Identity Case Receipts, FY 2008 to FY

 

2012²²

 

 

 

     TABLE 1.4.2, FY 2012 TAS Identity Theft Closures by Secondary

The IRS Still Takes Much Too Long to Fully Resolve the Accounts of Identity Theft Victims.

As discussed above, the National Taxpayer Advocate and TAS understand all too well that identity theft cases can be very complex, and, it takes time to work through all related issues. When TAS accepts a case, TAS case advocates must work with the appropriate IRS function to get them to make the necessary decisions and take the appropriate steps to resolve issues. Case advocates set specific timeframes within which those actions must be completed by the IRS functions. Thus, TAS case cycle time represents the "best case" for identity theft victims -- there is someone watching over the IRS and making sure that it takes actions timely and correctly, and that cases don't languish or disappear between functions.

The chart below shows the average number of days it took TAS to close a stolen identity case from FY 2009 to FY 2012, along with the relief rate obtained in those cases. As the chart shows, since FY 2009, TAS's identity theft case cycle time decreased by 20 percent, even as its relief rate rose from 79 percent to 88 percent.²⁵ In other words, in 88 percent of the cases, taxpayers who came to TAS were the victims of identity theft and entitled to relief.

 

FIGURE 1.4.3, TAS Stolen Identity Case Cycle Time and Relief Rate,

 

FY 2009 to FY 2012²⁶

 

 

 

We are by no means attempting to minimize the complexity of identity theft cases, but taking well over six months to close an identity theft case is simply not acceptable for the hundreds of thousands of victims. Remarkably, rather than acknowledging the need to work identity theft cases faster and streamlining its procedures, the initial IRS response has been to lower taxpayers' expectations. In September 2012, the IRS instructed employees to advise identity theft victims that it would take 180 days to resolve their cases.²⁸ (These instructions were rescinded shortly thereafter when the National Taxpayer Advocate objected to its release.)

One consequence of the IRS taking so long to resolve an identity theft case is that many victims will enter the following filing season with unresolved account issues. Because the IRS will generally issue identity protection personal identification numbers (discussed later) only to taxpayers with fully resolved identity theft issues, many victims will still be at risk of having a perpetrator steal their refund again the following year, and will require further assistance later on. To avoid such consequences, the IRS must ensure that identity theft cases do not languish and must strive to resolve them completely in well under six months.

The National Taxpayer Advocate believes the IPSU, in its role as the "traffic cop," needs more effective tools to achieve this goal. Although IPSU requests are supposed to receive priority treatment from other IRS organizations, some IPSU cases are not considered "aged" until after 180 days have passed.²⁹ The IPSU has no way to ensure that the other functions adhere to the requested timeframes. The IPSU should enter into agreements with each of the specialized units working identity theft cases to specify timeframes for action, along with consequences for not meeting the timeframes.

While the Identity Protection Personal Identification Number Program Provides Additional Security, It Covers Only Part of the Identity Theft Victim Population.

For the 2012 filing season, the IRS introduced a number of identity theft-related process improvements. For example, to provide a greater level of security for taxpayers, the IRS issued identity protection personal identification numbers (IP PINs) to about 250,000 victims whose identities and addresses it has verified.³⁰ An IP PIN is a unique code that the taxpayer must use, along with his or her taxpayer identification number, to file electronically and bypass certain filters. Letters went out in December 2011, instructing the victims to use the IP PINs to file their 2011 returns. If the taxpayer attempts to e-file without that number, the IRS will not accept it and the taxpayer will need to file a paper return, which will delay processing.

For the 2013 filing season, the IRS plans to expand the IP PIN program to more than 600,000 participants. We support expansion to as many verified identity theft victims as possible, provided the IRS can validate their current addresses. In general, the IRS does not issue IP PINs until after the victim's account is resolved. Contrary to IRS practice, the protection of the taxpayer should begin as soon as the SSN owner and address is verified. Tying the IP PINs to closing of the identity theft case unnecessarily delays this protection.

From the inception of the program, TAS has advocated for immediate delivery of the IP PIN to victims whose identities and addresses the IRS has verified. The IRS advised that it could not do this systemically for the 2012 filing season, but would be open to it for the following year. Yet the IRS still does not allow identity theft victims to be assigned IP PINs throughout the year, increasing the risk of delay and economic hardship to taxpayers who have already been victimized at least once.

We note that many of the nearly 650,000 victims with cases in inventory will not be afforded the protection of the IP PIN because their cases will not be fully resolved by the time IP PINs are mailed out, which means their accounts will be unprotected from fraudulent filings.³¹ This is another reason why it is imperative that the IRS work through identity theft cases as soon as it can. To this end, the IRS has diverted personnel from Taxpayer Assistance Centers and other departments to assist with the backlog of identity theft cases, and continue working on them during the 2013 filing season.³²

In October 2012, the National Taxpayer Advocate expressed concern to W&I management that the nearly 22,000 taxpayers with stolen identity cases in TAS inventory would not receive the benefit of the protections afforded by the IP PIN for the 2013 filing season.³³ The Accounts Management (AM) unit shared this concern and worked feverishly to develop a work-around solution. For identity theft cases that have been through the Electronic Fraud Detection System, the IRS would place an "S" indicator on the account to signify the true SSN owner and an "N" indicator on the account to signify the non-SSN owner. (At the National Taxpayer Advocate's suggestion, the IRS refrained from using the typical "good"/"bad" designation.) We are pleased to report that these taxpayers will be eligible to receive the IP PIN for use in the 2013 filing season and appreciate AM working with us. However, until the IRS changes its procedures to place the IP PIN marker on accounts upon verification rather than closure, the IRS will continue to waste resources on one-off adjustments and work-arounds.

It is inevitable that a certain percentage of taxpayers will misplace or forget to use the IP PIN. Despite the IRS's attempts to verify the taxpayers' addresses, over 9,000 letters containing the IP PINs were returned undeliverable in 2012.³⁴ In addition, the IRS received almost 23,000 (about nine percent) requests for replacement IP PINs in 2012.³⁵

Without replacement numbers, these taxpayers will need to file paper returns and be subject to additional scrutiny and delay. The IRS says that for the 2013 filing season, it will be easier and quicker to obtain a replacement, as taxpayers can request a new PIN by phone from any IRS customer service representative after validating their identity.

The Taxpayer Protection Unit Requires Sufficient Staffing to Handle the Volume of Calls from Impacted Taxpayers.

In the current environment, the IRS is under tremendous pressure to protect Treasury revenue from improper refund claims. During the 2012 filing season, the IRS designed and implemented several identity theft filters to weed out suspicious returns. Through data mining, programmers attempted to detect trends based on a variety of factors and develop customized filters to isolate suspicious claims for refunds.

The IRS notified affected taxpayers by letter that it had a problem processing their returns and instructed them to call the new Taxpayer Protection Unit (TPU) to provide more information.³⁶ Initially, this unit was woefully understaffed to handle the volume of calls from taxpayers trying to figure out why their returns were not being processed. For the week ending March 10, 2012, the level of service (LOS) on this unit's phone line was a dismal 11.7 percent. This means the IRS failed to answer eight of every nine calls -- and taxpayers who got through had to wait on hold an average of an hour and six minutes!³⁷

The chart below shows the level of service and average wait time for the TPU toll-free line for March and April 2012, at the height of the filing season.

 

FIGURE 1.4.4, Taxpayer Protection Unit Toll-Free Line Data (Mar.

 

and Apr. 2012)³⁸

 

 

 

It seems not only that the IRS misjudged the number of customer service representatives needed to staff this line, but also that the identity theft filters have picked up more returns than anticipated. With such a low level of service, it is impossible to assign legitimacy to any IRS estimate of the filters' accuracy. If fewer than half of the attempts at calling the number listed in the notice get through to the TPU, how can the IRS accurately assess the success of the identity theft filters?

Creating New Exceptions to Taxpayer Privacy Protections Poses Risks and Should Be Approached Carefully, If at All.

In the 2011 Annual Report to Congress, the National Taxpayer Advocate recommended that Congress enact a comprehensive Taxpayer Bill of Rights, and suggested that the right to confidentiality is one of those core taxpayer rights.⁴⁰ Taxpayers have the right to expect that any information they provide to the IRS will not be used or disclosed by the IRS unless authorized by the taxpayer or other provision of law.

The Internal Revenue Code (IRC) contains significant protections for the confidentiality of returns and return information. IRC § 6103 generally provides that returns and return information shall be confidential and then delineates a number of exceptions to this general rule. Section 6103(i)(2) authorizes the disclosure of return information in response to requests from federal law enforcement agencies for use in criminal investigations. There is no corresponding exception in IRC § 6103 that allows for the release of identity theft information to state or local agencies.⁴¹ However, IRC § 6103(c) provides that a taxpayer may consent to disclosure of returns and return information to any person designated by the taxpayer.

Some have called for the expansion of exceptions to IRC § 6103, ostensibly to help state and local law enforcement combat identity theft. The National Taxpayer Advocate has significant concerns about loosening taxpayer privacy protections and does not believe that such an expansion of the statute is appropriate at this time. The current framework of IRC § 6103 includes sufficient exceptions to allow the IRS to share information about identity thieves.

The IRS Office of Chief Counsel has advised that the IRS may share the "bad return" and other return information of an identity thief with other federal law enforcement agencies investigating the identity theft.⁴² In light of this advice, the IRS has implemented a pilot program in the state of Florida to facilitate a consent-based sharing of identity theft information with state and local law enforcement agencies.⁴³ Through August 23, 2012, the IRS received 664 requests from identity theft victims to share information.⁴⁴ The IRS stated that it is aware of press articles covering a couple of indictment/arrest type scenarios related to information provided under the pilot program. It should be noted there is no requirement for state and local agencies to provide data regarding the outcome of cases related to the waiver pilot.

We believe this approach strikes an appropriate balance -- protecting taxpayer return information while simultaneously giving state and local law enforcement authorities more information to help them investigate and combat identity theft. However, we are concerned that once the information is in the hands of state and local law enforcement, there is no prohibition in the tax code against redisclosure. Therefore, the National Taxpayer Advocate suggests that Congress consider modifying IRC § 6103(c) to explicitly limit the use of tax return information to the purpose agreed upon by the taxpayer (i.e., to allow state or local law enforcement to use the information solely to enforce state or local laws) and to prohibit the redisclosure of such information.⁴⁵

In the meantime, the IRS should insert into every agreement with state and local agencies an explicit clause that says this information may only be used for prosecution of identity theft-related crimes. Any other disclosure or use should void the agreement.

The Federal Government Facilitates Tax-Related Identity Theft by Publicly Releasing Significant Personal Information of Deceased Individuals.

The federal government unwittingly facilitates tax-related identity theft by making public the Death Master File (DMF), a list of recently deceased individuals that includes their full name, SSN, date of birth, date of death, and the county, state, and ZIP code of the last address on record.⁴⁶ The SSA characterizes release of this information as "legally mandated" under the Freedom of Information Act,⁴⁷ but this position has not been tested.⁴⁸ To eliminate uncertainty, the National Taxpayer Advocate recommended in 2011 that Congress pass legislation to clarify that public access to the DMF can and should be limited.⁴⁹

The National Taxpayer Advocate has raised this issue at every opportunity over the past two years.⁵⁰ Although some genealogy websites have voluntarily agreed to curtail the availability of DMF information, not much has been done by either Congress or the executive branch. In the meantime, taxpayers continue to face harm due to the inaction of the government.⁵¹ Thus, while waiting for legislative action, the National Taxpayer Advocate urges the SSA to reconsider its legal analysis and take steps to restrict access to the DMF.

The IRS Should Include TAS Representatives in All Levels of Identity Theft Program and Procedural Planning

TAS employees work each case they receive until all related issues are resolved. TAS employees also interact with every IRS function during the course of working cases. Their global perspective, along with the experience gained from working the significant volume of identity theft cases that TAS receives, qualifies some TAS employees as experts in identity theft processing. To ensure the IRS receives the benefit of TAS's broad experience in assisting identity theft victims, the IRS should consider TAS as equal partners and include TAS representatives in all levels of identity theft program and procedural planning, including front-line teams, training development, guidance, and advisory and executive steering committees.

CONCLUSION

When former Commissioner Shulman took office in 2008, he expressed to Congress a specific plan of action to address identity theft victim assistance. Almost five years later, it is evident that the IRS has not accomplished its goals of providing seamless account resolution in a timely fashion.

In conclusion, the National Taxpayer Advocate preliminarily recommends that the IRS:

Combating identity theft and providing victim assistance are top priorities of the IRS. The IRS is committed to helping the victims of identity theft and, while more work remains, we have made significant progress this year. As the report recognizes, identity theft cases are complex, often encompassing multiple issues and tax years. Although we cannot stop all identity theft, our efforts in filing season 2012 provide a solid foundation upon which we will continue to build and improve. During the first ten months of this calendar year, the IRS protected more than $20 billion of revenue related to fraudulent returns, including identity theft. We strengthened our preventative measures to catch identity theft before erroneous refunds are issued and increased our investigative efforts to detect and prosecute perpetrators of refund fraud.

We continually review our policies and procedures to ensure we are doing everything possible to minimize the incidence of identity theft, help victims, and investigate perpetrators. Once a legitimate taxpayer's account is identified, marked, adjusted, and closed, it is the IRS's intent to ensure that future filings of returns by these taxpayers are protected from further harm or burden. Business rules are implemented to identify unique characteristics of fraudulent returns submitted by identity thieves, and used as a basis for rejecting them if these characteristics surface. We have also implemented new procedures to resolve cases more efficiently and accurately, as well as found additional ways to reduce customer burden. These efforts include, but are not limited to the following:

• Implementing programming to identify returns with ID theft documentation;

• Revising procedures to utilize Information Returns Processing Transcript data to identify the SSN owner and reduce processing time;

• Implementing a tool to review multiple accounts quickly and identify accounts that have high potential for ID theft;

• Initiating programming changes to systemically identify and send cases with ID theft markers directly to ID theft specialized groups for processing; and

• Expanding the IP PIN program from 53,000 IP PINs in 2010, to more than 250,000 in TY 2011 and more than 600,000 TY 2012.

Contrary to the assertion in the report, the IRS's streamlined approach closely aligns itself with the vision of having the point of contact be a person knowledgeable of the specific identity theft issue and authorized to execute the actions necessary to resolve the problem. Accordingly, we believe it is a mischaracterization to state that the IRS is heading toward a decentralized approach in light of how the specialized groups function. The specialization process allows the IRS to utilize the unique skill sets and experience of dedicated employees, who work in strict accordance of service-wide policy, procedures, and processing timeframes that instill consistency and efficiency. Specialization not only provides a single point of contact for the taxpayer, but it also affords the taxpayer with the expertise needed to handle all aspects of their case. It should be noted that the Identity Theft Assessment and Action Group was a servicewide team represented by all organizations impacted by identity theft, including TAS. We continue to believe that the decision to implement specialized groups was a sound one and is beginning to pay significant dividends.

As stated in the report, IRS functions were asked to develop procedures for their embedded identity theft units; however, the IRS established consistent and mandatory requirements for developing these procedures. For example, these requirements set specific guidelines regarding prioritization, documentation, communications, and adjustments. An essential aspect of these requirements and capabilities is making the taxpayer whole while minimizing instances where accounts are transferred between functions. The IRS's Office of Privacy, Governmental Liaison and Disclosure has overseen the development of a "transfer matrix" which accounts for all identity theft processing scenarios to minimize case transfers and provide taxpayers a seamless customer service experience. As new scenarios are identified, PGLD will work with the other IRS functions and incorporate as necessary. The IRS is currently finalizing the "transfer matrix" and will share this guidance with all identity theft stakeholders, including TAS.

Additionally, in July 2012, PGLD revised its IRM 10.5.3, to serve as the "hub" IRM for the IRS's servicewide identity theft guidance and establish a reference point for all identity theft work. PGLD worked closely with the specialized groups to develop any remaining procedures necessary to account for the intricacies of their respective functions. It should be noted that all identity theft guidance is reviewed by PGLD using the IRS's Internal Management Document (IMD) process in which TAS is also included. Job aids from these functions were posted to the IRS's Servicewide Electronic Research Program (SERP), where they are readily available for review and comment. The functions worked with TAS to provide updates to the TAS Service Level Agreement Addendums for TAS Operations Assistance Request (OAR) routing, and PGLD has met regularly with TAS staff to provide updates on the specialized teams.

In light of the specialized approach and additional reengineering efforts and advancements made by the IRS, the IRS recently convened a multi-functional team, including TAS, to explore the future state of the Identity Protection Specialized Unit. In an effort to ensure efficient processing of IDT cases and the avoidance of duplicate work, the IRS is investigating IPSU activities such as third-party monitoring to determine if IPSU work overlaps with that of the specialized teams. The reengineering team will analyze and evaluate IDT work processes and develop strategic changes to ensure a balance between service to customers and available resources.

The IRS acknowledges that many taxpayers continue to seek TAS assistance on identity theft issues, as evidenced by the increase in case receipts over the past four years. However, it should be noted that the largest number of TAS receipts reflect Economic Burden cases which by their very nature are routed directly to TAS without allowing the IRS an opportunity to take actions to resolve the taxpayer's issue. Additionally, it should be noted that the information in TAS's summary of Secondary Issues (table and subsequent example cited in the Most Serious Problem) supports the need for the IRS's specialized group process. In the example, the taxpayer's account has more than one issue, which, under the "traffic cop" proposal, would require additional coordination between the appropriate functions. Under the specialized process, both issues can be worked by the same function unless a complexity issue required another's involvement. Thus, we believe that the specialized process would prove beneficial to TAS and the taxpayers who come to it for assistance. We will, however, continue to monitor to ensure that the process works as intended.

We disagree that IRS cannot adequately track how many identity theft cases it has in inventory and how much time it takes to work an identity theft case. Since February 2012, all functions report their inventory to PGLD on a monthly basis while working towards the development of servicewide system, and this data is shared monthly with TAS during the Identity Theft Executive Steering Committee and Advisory Council meetings. Additionally, in June 2012, the IRS developed a comprehensive "global report" that tracks servicewide refund fraud and identity theft metrics. The IRS continues to make strides in developing processes to track the time it takes to resolve an identity theft case from receipt to closure. At the present time, only those functions with relatively small amounts of inventory are unable to do so, whereas Accounts Management (which historically works over 90 percent of all identity theft cases) has been providing these data since early 2012.

Similarly, we disagree that the IRS has lowered taxpayer expectations regarding the time it takes to work a case. The IRS has taken numerous steps to quickly identify and streamline its identity theft processes through a variety of reengineering initiatives. New procedures are in place to identify the legitimate taxpayer's return, correct taxpayer account data and initiate refunds to identity theft victims more quickly. One such procedure added the use of Electronic Fraud Detection System data as a tool to determine the true SSN owner, thus eliminating numerous research steps and improving efficiencies. Additionally, new programming to identify returns with identity theft documentation attached was implemented. Cases are now generated directly to the specialized groups, reducing the amount of cases that pass through several areas.

The IRS is dedicating a significant number of additional resources to identity theft. The IRS has nearly tripled the number of employees working identity theft cases. The IRS also initiated the Taxpayer Protection Unit in FY 2012 to provide a centralized staff to assist taxpayers in processing their returns. The overwhelming response to the TPU necessitated additional staffing and the IRS is increasing staffing in this area in FY 2013 to achieve an appropriate level of service. Moreover, the IRS improved its identity theft training efforts in 2011 (and again in 2012) to ensure that all public contact employees had the tools they needed to respond appropriately to those who have been victimized by identity theft. We developed a new training course that includes sensitivity training as well as training on the proper tools and techniques for handling identity theft cases. In all, 35,000 IRS employees received this training in preparation for filing season 2012 and even more have taken (or are scheduled to complete this training) for filing season 2013.

The IRS appreciates the acknowledgement in the report of the work in the Identity Protection PIN program. The IP PIN is issued to select ID theft victims whose identities have been validated by the IRS, allows legitimate returns to be processed, and prevents processing of fraudulent returns, thereby mitigating processing delays in ID theft victims' federal tax return processing. Generally, the IP PIN is mailed out once the taxpayer's account has been resolved. Current programming allows one IP PIN to be generated each year. The IRS is exploring the feasibility of being able to provide IP PINs on demand though current programming limits IP PIN generation to once annually. This limitation is attributable to various factors that include the posting of identity theft markers, the IRS's year-end IT conversion process, and taxpayer correspondence issuance. The inclusion of cases within the IP PIN universe, only after an account was finally resolved, provided an added layer of taxpayer protection through the use of business rules if the taxpayer chose to file their return without an IP PIN. Additionally, for the 2013 filing season, the IRS expanded the IP PIN population by applying a temporary marker to accounts for which the legitimate taxpayer was determined and the correct address verified, even though the account had not been completely resolved. Temporary markers were input on approximately 100,000 accounts. This innovative and collaborative approach to working active ID theft inventory provides added protection and reduces burden on taxpayers in the event the perpetrator attempts to misuse the TP's identity before the account is resolved.

Taxpayers who misplace their IP PIN can contact the IRS by calling the IPSU, the 1-800 assistance line, or visit any taxpayer assistance walk in center. Taxpayers will be asked to validate their identities by answering a series of basic questions mandated by the IRM for disclosure level authentication.⁵² Once the taxpayer's identification is validated through this process, they will be provided with a replacement IP PIN for use on their TY 2012 return. The replacement IP PIN will allow the taxpayer to e-file their return and, subject to standard validation checks, be accepted. The return will be subjected to a manual validation process prior to being allowed to post.

With respect to the IPSU, this unit will continue operations as it has since its inception in October 2008. The cross-functional IPSU Reengineering Team is studying the future role of IPSU. We are awaiting the team's final analysis and recommendations before making any changes to IPSU operations. The IRS will consider the recommendations of the National Taxpayer Advocate regarding the IPSU.

The IRS agrees that the practice of public release of the Death Master File should be changed. The IRS continues to work with SSA and the Administration on a legislative solution that would limit public release of the DMF.

The IRS views TAS as a valued partner in the discussion and development of identity theft procedures and processes and looks forward to continued collaborations in the future. TAS is already included in all identity theft governance meetings (Advisory Council and Executive Steering Committee) and is a team member on numerous other identity theft-related initiatives such as the Accounts Management Reengineering and IPSU future state teams. The IRS will continue to seek the input and participation of TAS on future endeavors.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate appreciates the difficulty the IRS faces in serving as both the protector of the federal fisc and as the tax administrator responsible for delivering refunds to millions of taxpayers. With the volume of fraudulent refund claims, many of which involve identity theft, increasing significantly over the years, IRS resources are understandably stretched thin. To its credit, the IRS is exploring ways to more effectively detect and stop fraudulent claims. It is also moving to a specialized approach to victim assistance.

In its response, the IRS states that its "streamlined approach closely aligns itself with the vision of having the point of contact be a person knowledgeable of the specific identity theft issue and authorized to execute the actions necessary to resolve the problem." The National Taxpayer Advocate does not oppose the IRS's decision to create specialized identity theft units in each function, and recognizes there will be some efficiencies gained in having a small group of employees focus solely on identity theft cases. However, she also notes that these employees will often not have the capability to address all related issues presented in their cases.

As the National Taxpayer Advocate has consistently and frequently pointed out to senior IRS officials, the IRS does not know the full scope of issues presented in any given identity theft case because, unlike TAS, it does not track this information. The IRS works the vast majority of its identity theft cases as "single issue" cases. For example, if a case is in the Accounts Management (AM) function because the processing of taxpayer's current year's return is blocked by the IRS's acceptance of a return filed by an identity thief (known in IRS parlance as a "duplicate return"), AM employees only work that issue. They do not undertake a global account review to identify any prior returns that may be affected or whether there is impending audit or collection action with respect to impacted prior year returns.

Thus, the IRS does not know enough about the make-up or complexity of identity theft cases in its inventory to project how many cases will require the involvement of multiple units. The only comprehensive source of information about the composition of identity theft casework is TAS. Since our inception, we have tracked identity theft cases in our inventory, and until 2012, TAS was the only function in the IRS that could reliably report how many identity theft cases it was working at any one time and over time. While TAS's case inventory may not be identical to the IRS's, TAS is the sole reliable source of historic and current information about the scope of issues and complexity presented in identity theft cases. As noted earlier, identity theft is now the number one issue in TAS casework, constituting over a quarter of our case receipts. This has made us experts on identity theft work.

It is this experience that leads to the National Taxpayer Advocate's sense of urgency. In our view, the IRS still does not understand the full scope of the problem and is developing procedures that will continue to harm identity theft victims. The National Taxpayer Advocate does not want to be in the situation, several years from now, of saying "I told you so." She wants the IRS to address her concerns in a comprehensive way now.

As noted earlier, the vast majority of TAS identity theft cases involve multiple issues. The IRS states that "[u]nder the specialized process, both issues can be worked by the same function unless a complexity issue required another's involvement." The National Taxpayer Advocate disagrees strongly with the IRS's complacent assessment. Our analysis of TAS casework shows that the vast majority of identity theft cases involve multiple issues, often requiring actions by employees from different functions and with different skills. Unless the IRS is going to reproduce each of those functions within each of the 21 embedded units, cases will need to be transferred from one function to another regularly -- and with much greater frequency than the IRS anticipates. And once the case is transferred, it is unclear whether the original employee working the case will continue to be the point of contact for the taxpayer or whether the taxpayer will be given a new contact employee in the new function. As anyone who has ever sought to resolve an issue with the IRS knows, the IRS is not exactly a model of ease and transparency in terms of the taxpayer's ability to communicate with specific employees. It is only TAS that assigns one case advocate to work a case from start to finish, addressing all issues. Without a traffic cop to ensure that the victim's case is properly and timely transferred between functions, the risk is too great that the case will get lost among the 21 different specialized units.

Since writing the initial discussion for this Most Serious Problem, the National Taxpayer Advocate has had in-depth discussions with both the Acting Commissioner and the Commissioner of the Wage and Investment Division, laying out her concerns about the operation of the specialized units. She has proposed what is an extremely reasonable alternative approach. Identity theft cases come to the IRS from multiple sources. Where the IRS receives calls on its toll-free assistance line, cases that appear to present only one issue can be routed to the appropriate specialized unit, as currently planned. The assigned employee in that specialized unit would be required to conduct a global account review on that taxpayer's identification number. If the global account review shows that there are other issues or other years impacted by identity theft, the specialized unit would continue to work its narrow portion of the case, but oversight of the case would be transferred immediately to the IPSU, which would serve as the "traffic cop" for the case and ensure that all units do their part to ensure that the issues are timely and effectively resolved. Where the IPSU receives calls directly, the IPSU would conduct its own global account review and direct cases to the appropriate specialized unit(s). If the global account review shows that there is only a single issue in the case, the IPSU would transfer oversight of the case to the specialized unit.

The National Taxpayer Advocate's proposed approach combines the benefits of having dedicated experts in each specialized unit with the reality of the complexity and number of issues and years presented in the majority of identity theft cases. The IRS's approach, on the other hand, does not address taxpayers' needs and will further burden and harm the victims.

In addition, the IPSU must be strengthened and adequately staffed for either approach to work. Although the IPSU has existed since 2008, it does not appear to us that the IRS has used it optimally. In our view, the IPSU not only should serve as the traffic cop that routes the case to the appropriate function(s), but also should perform triage to prioritize which actions should be taken first to minimize harm. The IPSU re-engineering team made a number of recommendations that TAS concurs with, but it also suggested reducing the monitoring function of the IPSU -- an idea we strongly oppose. As we have stated, we believe the IPSU should have increased ability to monitor ID theft cases.

The National Taxpayer Advocate acknowledges the recent improvements PGLD has made in tracking the inventory of identity theft cases and the case cycle time, but believes it should perform much more data analysis. As noted above, we did not claim that the IRS cannot currently track the number of identity theft cases or its cycle time; rather, we stated that until this year, the IRS could not "track identity theft case inventory, much less monitor how long it takes to resolve cases." We maintain that although many IRS functions now track the time an ID theft case is in its inventory, the IRS cannot provide an overall average cycle time. Furthermore, the IRS starts tracking the age of an identity theft case from the date it processes identity theft documentation, not the date the taxpayer provides the documentation. This means the cycle time reported by the IRS may be significantly shorter than the actual time a victim must wait for his or her account to be resolved.

In its comments, the IRS notes that it has taken steps to streamline its identity theft case resolution processes through a number of reengineering initiatives and by dedicating additional staffing resources. While we applaud these actions, we are disappointed that the IRS has not committed to a firm goal of reducing case cycle time. As we noted, the average closure time for one prominent category of identity theft work was 196 days in FY 2012.⁵³ This does not include the time the IRS spent reviewing and processing the documentation (such as the identity theft affidavit) provided by the taxpayer to substantiate his or her identity, so in reality, the case cycle time is much longer than six months.

As this report goes to press, the IRS is yet again seeking to send letters to identity theft victims asking that they wait 180 days while the IRS works their cases. The National Taxpayer Advocate is concerned that this letter will send a message to IRS employees that it is acceptable to make identity theft victims wait six months. She notes that despite all the improvements to processing that the IRS says it has made over the years, the cycle time for identity theft victim assistance remains as long as it was years ago.

As of September 30, 2012, the IRS had almost 650,000 identity theft cases in inventory servicewide.⁵⁴ The victims of tax-related identity theft suffer extraordinary inconveniences and, in many cases, hardships. In general, more than 75 percent of U.S. taxpayers receive refunds, with the amount averaging about $3,000.⁵⁵ Identity theft victims generally cannot receive their significant and sometimes urgently needed tax refunds until the IRS resolves their cases, which is now taking six months or longer. The IRS's failure to provide timely relief to these identity theft victims is simply unacceptable.

If the IRS prioritizes identity-theft victim assistance to the extent its response suggests, it would set firm goals for its employees to provide prompt and comprehensive relief to victims. Reasonable goals include:

• Conducting a global account review upon receipt of a taxpayer's claim of identity theft in whichever IRS function serves as the taxpayer's first point of contact so that the case is appropriately routed;

• Determining who is the legitimate taxpayer within 45 to 60 days from date of the taxpayer's documentation submission; and

• Taking all closing actions with respect to processing the impacted return, including issuing any refunds in the quickest manner possible and marking the identity theft victim's account as eligible for an IP PIN, within 30 days from the date of making the identity determination.

In conclusion, the National Taxpayer Advocate reiterates that TAS's experience in working thousands of identity theft cases each year from beginning to end affords us a unique perspective on how to improve the process. Since 2004, the National Taxpayer Advocate has made numerous recommendations in her Annual Reports to Congress to strengthen the ways the IRS helps victims. As the table below shows, the IRS ultimately adopted many of TAS's recommendations -- often after initially opposing them. The National Taxpayer Advocate urges the IRS to use the knowledge gained from TAS's vast experience to improve its identity theft victim assistance procedures, and thoughtfully consider all of our recommendations.

               TABLE 1.4.5, TAS RECOMMENDATIONS FOR HELPING

The National Taxpayer Advocate recommends that the IRS:

²See Identity Theft in Tax Administration, Hearing Before the Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Doug Shulman, IRS Commissioner).

³See, e.g., National Taxpayer Advocate 2011 Annual Report to Congress 48-73 (Most Serious Problem: Tax-Related Identity Theft Continues to Impose Significant Burdens on Taxpayers and the IRS); Identity Theft and Income Tax Preparation Fraud, Hearing Before the H. Comm. on the Judiciary, Subcomm. on Crime, Terrorism, and Homeland Security, 112th Cong. (statement of Nina E. Olson, National Taxpayer Advocate) (June 28, 2012).

⁴See IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012).

⁵ IRS, IPSU Identity Theft Report (Sept. 29, 2012). This inventory includes all identity theft cases controlled by the IPSU paper unit, including self-reported non-tax-related identity theft cases, cases the IPSU monitors, and cases undergoing global account review. It does not include cases that meet TAS's "systemic burden" case criteria, which the IPSU tracks separately. Total IRS FY 2012 ID Theft receipts were 449,809 compared to 253,051 in FY 2011, an increase of 77.8 percent.

⁶ TAS analysis of Taxpayer Advocate Management Information System (TAMIS) data. TAS received 54,748 ID theft cases in FY 2012, compared with 34,006 in FY 2011, and 7,147 in FY 2008 for an increase of 666.0 percent

⁷Id. TAS received 54,748 ID theft cases in FY 2012, or 24.9 percent of its 219,666 total cases.

⁸Id. TAS received 54,748 ID theft cases in FY 2012, of which 37,307 (68.1 percent) included more than one issue code per case.

⁹See IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012). Actual number is 646,950.

¹⁰ National Taxpayer Advocate 2011 Annual Report to Congress 48-73 (Most Serious Problem: Tax-Related Identity Theft Continues to Impose Significant Burdens on Taxpayers and the IRS); National Taxpayer Advocate 2009 Annual Report to Congress 307-317 (Status Update: IRS's Identity Theft Procedures Require Fine-Tuning); National Taxpayer Advocate 2008 Annual Report to Congress 79-94 (Most Serious Problem: IRS Process Improvements to Assist Victims of Identity Theft); National Taxpayer Advocate 2007 Annual Report to Congress 96-115 (Most Serious Problem: Identity Theft Procedures); National Taxpayer Advocate 2005 Annual Report to Congress 180-191 (Most Serious Problem: Identity Theft); National Taxpayer Advocate 2004 Annual Report to Congress 133-136.

¹¹See Identity-Theft Related Tax Fraud, Hearing Before the H. Comm. on Oversight and Government Reform, Subcomm. on Government Organization, Efficiency and Financial Management, 112th Cong. (Nov. 29, 2012) (statement of Nina E. Olson, National Taxpayer Advocate); Identity Theft and Income Tax Preparation Fraud, Hearing Before the H. Comm. on the Judiciary, Subcomm. on Crime, Terrorism, and Homeland Security, 112th Cong. (June 28, 2012) (statement of Nina E. Olson, National Taxpayer Advocate); Identity Theft and Tax Fraud, Hearing Before the H. Comm. on Ways and Means, Subcomm. on Oversight and Social Security, 112th Cong. (May 8, 2012) (statement of Nina E. Olson, National Taxpayer Advocate); Tax Compliance and Tax-Fraud Prevention, Hearing Before the H. Comm. on Oversight and Government Reform, Subcomm. on Government Organization, Efficiency, and Financial Management, 112th Cong. (Apr. 19, 2012) (statement of Nina E. Olson, National Taxpayer Advocate); Tax Fraud by Identity Theft Part 2: Status, Progress, and Potential Solutions, Hearing Before the S. Comm. on Finance, Subcomm. on Fiscal Responsibility and Economic Growth, 112th Cong. (Mar. 20, 2012) (statement of Nina E. Olson, National Taxpayer Advocate).

¹²See Identity Theft and Tax Fraud, Hearing Before the H. Comm. on Ways and Means, Subcomm. on Oversight and Social Security, 112th Cong. (May 8, 2012) (statement of Steven T. Miller, IRS Deputy Commissioner for Services and Enforcement); Tax Compliance and Tax-Fraud Prevention, Hearing Before the H. Comm. on Oversight and Government Reform, Subcomm. on Government Organization, Efficiency, and Financial Management, 112th Cong. (Apr. 19, 2012) (statement of Steven T. Miller, IRS Deputy Commissioner for Services and Enforcement); Identity Theft and Tax Fraud: Growing Problems for the Internal Revenue Service, Hearing Before the H. Comm. on Oversight and Government Reform, Subcomm. on Government Organization, Efficiency, and Financial Management, 112th Cong. (Nov. 4, 2011) (statement of Steven T. Miller, IRS Deputy Commissioner for Services and Enforcement); IRS E-File and Identity Theft, Hearing Before the H. Comm. on Oversight and Government Reform, Subcomm. on Government Organization, Efficiency, and Financial Management, 112th Cong. (June 2, 2011) (statement of Doug Shulman, IRS Commissioner); Identity Theft in Tax Administration, Hearing Before the Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Doug Shulman, IRS Commissioner).

¹³ Unfortunately, the IRS did not track cycle time on identity theft cases until this year, so we have no empirical data on ID theft case cycle time to analyze.

¹⁴See Identity Theft in Tax Administration, Hearing Before the Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Doug Shulman, IRS Commissioner).

¹⁵ IRS, Identity Theft Assessment and Action Group (ITAAG) Future State Vision and Supporting Recommendations 44 (Oct. 11, 2011).

¹⁶ If a function contemplates a scenario in which it would not work all aspects of the case, it would submit a request for exception to the office of Privacy, Governmental Liaison, and Disclosure (PGLD). PGLD is currently developing a transfer matrix to facilitate such transfer requests.

¹⁷ The Compliance Post-Adjustment Team and Designated Identity Theft Adjustment units stood up in April 2012, but TAS did not receive procedures until October 2012. Submission Processing's embedded unit became operational in October 2012, without sharing its procedures with PGLD or TAS prior to stand up.

¹⁸ An IRS task force found that up to 28 different functions may touch an identity theft case. IRS, Identity Theft Assessment and Action Group (ITAAG) Future State Vision and Supporting Recommendations 7 (Oct. 11, 2011).

¹⁹ A service level agreement (SLA) outlines the procedures and responsibilities for the processing of casework when the authority to complete certain case actions rests outside of one organization, operating division, or function. The SLA defines roles and responsibilities, and includes procedures for elevating disagreements. TAS established SLAs with each OD/function for the processing of TAS Operations Assistance Requests (OARs). The SLAs identify time-frames for acknowledging and assigning OARs, procedures for handling disagreements over actions requested or timeframes for completing actions.

²⁰ From the outset, the National Taxpayer Advocate has inquired about the role of the IPSU in the new specialized environment. After months of what appeared to be stonewalling, the IRS finally created a team to look at the IPSU and invited TAS to participate. However, the "IPSU re-engineering" team that TAS was invited to join appeared to have no real decision-making authority with respect to the IPSU's interaction with the embedded specialized units.

²¹ Data obtained from TAMIS on October 16, 2012. TAS received 7,147 identity theft cases in FY 2008, compared to 54,748 in FY 2012, a 666.0 percent increase.

²²Id. TAS received 54,748 identity theft cases in FY 2012, out of 219,666 total cases (24.9 percent).

²³ Data obtained from TAMIS on October 16, 2012.

²⁴ Pursuant to TAS guidance, identity theft cases, by definition, have at least one secondary issue. However, a portion of TAS identity theft cases did not specify a secondary issue code, which is an error.

²⁵ Analysis of TAMIS data conducted on October 17, 2012. One reason for the decrease in cycle time is a favorable change in IRS procedures. When we first started writing about identity theft, the IRS had no procedures that would allow its employees to determine the rightful owner of an SSN in question. Instead, the IRS would send the case to the Social Security Administration (SSA) for resolution, which would routinely take two years. See IRM 21.6.2.4.4.2 (Oct. 1, 2012). In the 2005 Annual Report, the National Taxpayer Advocate recommended that the IRS train and empower its employees to make such determinations without involving the SSA. See National Taxpayer Advocate 2005 Annual Report to Congress 183. Today, the IRS not only allows its employees to determine SSN ownership based on documentation, but uses data mining to speed up the process even more. We view this as a significant advance and applaud the IRS for this change.

²⁶ Analysis of TAMIS data conducted on October 16, 2012.

²⁷See IRS response to information request (Nov. 5, 2012). IDTX (monitoring tax-related identity theft cases) cases were open an average of 196 days.

²⁸ SERP Alert 12A0535, Identity Theft Timeframe -- 180 Days (Sept. 4, 2012).

²⁹ IRM 21.9.2.1(6) (Oct. 1, 2011).

³⁰ The IRS issued 251,568 IP PINs. IRS Identity Theft Advisory Council, Identity Theft Status Update (Aug. 23, 2012).

³¹ The inventory of identity theft cases at the end of FY 2012 was 646,950. IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012).

³² To assist with the backlog of identity theft cases in Accounts Management, the IRS temporarily moved 170 employees from Taxpayer Assistance Centers (TACs). Diverting these TAC employees to work identity theft issues reduces their availability to assist taxpayers in other matters. See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

³³ As of October 16, 2012, there were 21,908 open stolen identity cases in TAS.

³⁴ 9,137 letters containing IP PINs were undeliverable through September 30, 2012. IRS Identity Theft Advisory Council, Identity Theft Status Update (Aug. 23, 2012).

³⁵ The IRS received 22,814 requests for replacement IP PINs during 2012 (January through September 30, 2012). IRS Identity Theft Advisory Council, Identity Theft Status Update (Aug. 23, 2012). The actual number of taxpayers who requested a replacement IP PIN was 20,848. See IRS, IP PIN Replacement Program (Apr. 5, 2012).

³⁶ The Taxpayer Protection Unit should not be confused with the IPSU, which assists victims of identity theft. The number to the TPU phone line was provided to taxpayers who received a letter due to the identity theft filters implemented in the 2012 filing season. Victims of identity theft are still instructed to call the toll-free line operated by IPSU.

³⁷ The average speed of answer was 3,991 seconds. IRS, Joint Operations Center Executive Level Summary Report (Mar. 10, 2012).

³⁸ IRS, Joint Operations Center, Executive Level Summary Reports (Mar. 10 - Apr. 28, 2012).

³⁹See IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012).

⁴⁰ National Taxpayer Advocate 2011 Annual Report to Congress 505.

⁴¹ Note, however, that certain disclosures to state law enforcement are permissible. See IRC § 6103(i)(3)(B)(i) (disclosure of return information, including taxpayer return information, can be made to the extent necessary to advise appropriate officers or employees of any state law enforcement agency of the imminent danger of death or physical injury to any individual; disclosure cannot be made to local law enforcement agencies). While identity theft may cause emotional and economic injury, the typical identity theft situation does not pose an imminent danger of death or physical injury.

⁴² IRS Office of Chief Counsel Memorandum, Disclosure Issues Related to Identity Theft, PMTA 2012-05 (Jan. 18, 2012).

⁴³ The IRS has expanded the pilot program to work with law enforcement in eight additional states: Alabama, California, Georgia, New Jersey, New York, Oklahoma, Pennsylvania, and Texas. See http://www.irs.gov/uac/Law-Enforcement-Assistance-Pilot-Program-on-Identity-Theft-Activity-Involving-the-IRS (last visited Nov. 9, 2012).

⁴⁴ E-mail from Senior Advisor, Criminal Investigation Division, Refund Crimes (Aug. 27, 2012).

⁴⁵See National Taxpayer Advocate 2011 Annual Report to Congress 505.

⁴⁶See Office of the Inspector General, SSA, Personally Identifiable Information Made Available to the General Public via the Death Master File, A-06-08-18042 (June 2008).

⁴⁷ FOIA generally provides that any person has a right to obtain access to certain federal agency records. See 5 U.S.C. § 552.

⁴⁸Social Security and Death Information, Hearing Before H. Comm. on Ways & Means, Subcomm. on Soc. Security, 112th Cong. (statement of Michael J. Astrue, Commissioner of Social Security) (Feb. 2, 2012).

⁴⁹See National Taxpayer Advocate 2011 Annual Report to Congress 519-523 (Legislative Recommendation: Restrict Access to the Death Master File).

⁵⁰See National Taxpayer Advocate FY 2012 Objectives Report to Congress xxvii (June 2011); National Taxpayer Advocate 2011 Annual Report to Congress 9, 519; Identity Theft and Tax Fraud, Hearing Before the Subcomm. on Oversight and Social Security, H. Comm. on Ways and Means, 112th Cong. (statement of Nina E. Olson, National Taxpayer Advocate) (May 8, 2012); National Taxpayer Advocate FY 2013 Objective Report to Congress 12 (June 2012).

⁵¹ For a detailed analysis of the government's obligation to release personal information of decedents, see Identity Theft and Tax Fraud, Hearing Before the Subcomm. on Oversight and Social Security, H. Comm. on Ways and Means, 112th Cong. (statement of Nina E. Olson, National Taxpayer Advocate) (May 8, 2012).

⁵² IRM 21.1.3.2.3 (Nov. 13, 2012); IRM 21.1.3.2.4 (Dec. 12, 2011).

⁵³See IRS response to information request (Nov. 5, 2012). IDTX (monitoring tax-related identity theft cases) cases were open an average of 196 days.

⁵⁴See IRS Identity Theft Advisory Council, Identity Theft Status Update (Oct. 24, 2012).

⁵⁵See IRS Filing Season Statistics -- Dec. 31, 2011, available at http://www.irs.gov/uac/Filing-Season-Statistics--Dec.-31,-2011 (last visited Dec. 28, 2012).

Steven T. Miller, Deputy Commissioner for Services and Enforcement

Peggy Bogadi, Commissioner, Wage and Investment Division

Faris Fink, Commissioner, Small Business/Self-Employed Division

DEFINITION OF PROBLEM

Tax return preparers sometimes alter return information without their clients' knowledge or consent in an attempt to obtain improperly inflated refunds or to divert refunds for their personal benefit. Often, the refunds are directed to an account in the preparer's control, leaving the taxpayer with no monetary benefit from the fraudulent filing but having to deal with the IRS in the aftermath. This type of misconduct creates significant challenges for the IRS, harms innocent taxpayers, and undermines trust in our tax system.

We have seen four primary fact patterns in the return preparer fraud cases that have come to the Taxpayer Advocate Service:

According to former Commissioner Shulman, "e-file ensures people can file accurately and get refunds quickly" and "IRS e-file is now the norm, not the exception."⁶ Clearly, the IRS is pushing taxpayers to e-file and use direct deposit. Yet we note that had the taxpayer requested a paper refund check, and it was improperly negotiated by the return preparer, the IRS could reissue a check to the taxpayer upon a timely filed claim.⁷ The IRS should not treat similarly-situated taxpayers differently. Here, the group of taxpayers who are doing what the IRS has pushed them to do -- namely, using return preparers (rather than using IRS-provided resources such as the Taxpayer Assistance Centers to file) and selecting the direct deposit option -- are being treated unfairly.⁸ Even as the IRS promotes electronic filing and payments, its policy of not issuing refunds to victims of return preparer misconduct creates a disincentive for taxpayers to e-file and request a direct-deposited refund.

Because of the IRS's refusal to develop procedures, the National Taxpayer Advocate issued guidance to TAS employees in May 2012,⁹ directing Local Taxpayer Advocates to issue Taxpayer Assistance Orders (TAOs) on return preparer fraud cases.¹⁰ In FY 2012, TAS issued 58 TAOs on these cases, of which 26 are elevated to the National Taxpayer Advocate -- an unprecedented number on any issue. The average adjusted gross income (AGI) of the taxpayers involved in the elevated TAOs was less than $32,000. The refund sought by these taxpayers constituted, on average, 28 percent of their AGI. As of October 25, 2012, these cases were open in TAS for an average of 327 days (11 months) -- and are still open!¹¹

ANALYSIS OF PROBLEM

Background

Under our current tax system, taxpayers are required by law to self-assess taxes and interact with the IRS. Given the complexity of the tax law, preparing and filing returns is a significant undertaking for many taxpayers. In fact, more than 80 percent of American households use paid preparers or tax software to help them prepare and file their tax returns.¹² With fewer Taxpayer Assistance Center resources available to help taxpayers prepare and file their returns, many feel pressure to enlist the services of a return preparer to meet their statutorily-mandated tax filing requirement.¹³

In response to the variety and prevalence of return preparer fraud, the IRS issued an alert on March 2, 2012, warning taxpayers about these schemes:¹⁴

• Fictitious claims for refunds or rebates based on false statements of entitlement to tax credits.

• Unfamiliar for-profit tax services selling refund and credit schemes to church members.

• Internet solicitations that direct taxpayers to toll-free numbers and then solicit Social Security numbers.

• Homemade flyers and brochures implying credits or refunds are available without proof of eligibility.

• Offers of free money with no documentation required.

• Promises of refunds for "Low Income -- No Documents Tax Returns."

• Claims for the expired Economic Recovery Credit Program or for economic stimulus payments.

• Unsolicited offers to prepare a return and split the refund.

• Unfamiliar return preparation firms soliciting business from cities outside of the normal business or commuting area.

In July 2011, the National Taxpayer Advocate brought the issue of return preparer misconduct to IRS leadership's attention by elevating a series of TAOs to the Commissioner of the Wage and Investment (W&I) division. These TAOs, originally issued to the W&I Accounts Management (AM) function in December 2010, involved four taxpayers defrauded by the same preparer. Although the IRS has been aware of the need to provide relief to victims of return preparer misconduct since at least 2000, it had no such procedure in place at the time these TAOs were elevated.¹⁶

The National Taxpayer Advocate issued a Proposed Taxpayer Advocate Directive (TAD) to the Commissioner of W&I on June 13, 2011, to address this systemic issue.¹⁷ This Proposed TAD directed W&I to establish procedures for adjusting the taxpayer accounts in instances where a preparer alters the return without the taxpayer's knowledge or consent. After receiving an unsatisfactory response to concerns raised about this matter in the Proposed TAD and the 2011 Annual Report to Congress,¹⁸ the National Taxpayer Advocate issued a TAD to the W&I and Small Business/Self-Employed (SB/SE) division commissioners on January 12, 2012.¹⁹ This directive included suggestions for how the IRS could unwind the victims' accounts. While both commissioners have acknowledged their intent to comply with the substance of the TAD, they appealed the TAD in an effort to extend the time allowed to comply with the actions, even though the IRS already had over 12 years to develop procedures to assist these victims of fraud.

It took W&I until June 26, 2012, to provide its Accounts Management employees with interim guidance on resolving return preparer misconduct cases -- and even then, the information was incomplete.²⁰ The National Taxpayer Advocate objected to the issuance of guidance on the grounds that it did not address many of the common fact patterns in our cases; for example, it does not provide procedures for scenarios 3 and 4 above.

In scenario 3, once the victim notifies the IRS of the misconduct, the IRS will ask the taxpayer to submit a correct return as intended to be filed and then will remove the altered return information from the taxpayer's account. However, the IRS will not issue the refund the taxpayer is due. Instead, the IRS informs the victim that preparer misconduct is a civil matter to be settled without its assistance. AM employees are instructed to suspend action on the case pending Chief Counsel guidance.

On October 17, 2012, the National Taxpayer Advocate issued a Proposed TAD to the W&I Commissioner, seeking procedures for issuing replacement refunds for victims of return preparer fraud.²¹ Among other things, the Proposed TAD directed that W&I:

• Develop procedures to issue refunds to taxpayers who have had their direct deposit routing information altered by a third party without the taxpayer's consent; and

• Provide relief to taxpayers victimized by another individual who has prepared their return and committed fraud, even if the other individual does not fall within the definition of a "tax return preparer" receiving compensation (e.g., family member, friend, neighbor, clergy).

The IRS is pushing taxpayers to electronic filing, to both improve the accuracy of return processing and reduce costs.²² Yet when taxpayers who are trying to comply with their obligations are victimized by return preparer misconduct, they are often left to deal with the aftermath with little help from the IRS. If the taxpayer requested a refund using direct deposit, the IRS will not reissue the refund to the taxpayer, even if the taxpayer has documented that he or she was a victim of return preparer misconduct. Instead, the IRS views this as a civil matter between the victim and the return preparer or bank. In contrast, if a third party fraudulently endorses a victim's paper refund check, the FMS will investigate and may reissue a check to the taxpayer.²³

The Check Forgery Insurance Fund (CFIF) legislation merely established a fund; it did not create a new authority for the IRS to replace fraudulently negotiated checks. This authority had always existed, so the designation of a source of funding is irrelevant to the discussion of whether the IRS should issue replacement funds to a taxpayer that never received the initial refund. In the case of a stolen direct deposit, the IRS Office of Chief Counsel previously has advised that, "the Service is legally permitted to reissue the refund to the taxpayer."²⁴ Therefore, we believe the IRS can and should establish a process by which a taxpayer can show that whoever wrongfully altered the bank account number on a return was not an authorized agent, and upon confirmation of these facts, the IRS should pay the refund to the taxpayer -- regardless of whether the taxpayer requested a direct deposit or a check.

An Unauthorized Tax Return Should Not Be Treated as a Legitimate Return of the Taxpayer.

In Beard v. Commissioner,²⁵ involving a taxpayer who altered a Form 1040, U.S. Individual Income Tax Return, the Tax Court applied a four-part test to determine whether a document filed with the IRS qualifies as a "return" for tax purposes. Those requirements are that the document:

The signature requirement derives from IRC § 6065, which states that generally, any return, declaration, statement, or other document required under any provision of the internal revenue laws or regulations shall contain or be verified by a written declaration that it is made under penalties of perjury. This requirement authenticates the signed document and verifies its truthfulness.

In a typical return preparer misconduct case scenario, the preparer alters some information on the return after the taxpayer has authorized a prior version. The return submitted by the return preparer was not reviewed, authorized, or signed by the taxpayer under penalties of perjury. It is not a valid return, as it fails the signature requirement of the Beard test, and thus should not be processed as a return of the taxpayer. However, under current procedures, the IRS considers this type of unsigned return to be an "authorized" return and will not issue a refund to a victim of return preparer fraud.

Relevant Chief Counsel Advice Permits the IRS to Issue Refunds to Victims of Return Preparer Misconduct.

Return preparer misconduct is not a new phenomenon. While W&I only recently issued partial guidance to its employees on how to assist victims, the IRS Office of Chief Counsel has provided advice on such situations dating as far back as 2000. These opinions provide the IRS ample advice to permit it to reissue refunds to victims of preparer misconduct in scenarios 3 and 4 described above.

In 2000, Chief Counsel issued advice addressing a situation where a taxpayer used the Volunteer Income Tax Assistance (VITA) program to file her return electronically, and the VITA volunteer subsequently changed the bank routing and account numbers to direct the refund into the account of a third party.²⁶ The Office of Chief Counsel concluded that there is "no legal impediment to reissuing a direct deposit refund" and noted that situations in which direct deposits are stolen are closely analogous to the stolen refund check situation, where there is a process for issuing a replacement.²⁷

In 2003, Chief Counsel again addressed a situation where an e-filed return was altered without the taxpayer's knowledge, and declared that a return altered by a preparer after the victim has verified the accuracy of the return is a nullity.²⁸ In this 2003 memorandum, the Office of Chief Counsel analyzed the four-part test in Beard, and concluded that when the taxpayer is unaware of the alterations to the return, and the version that the taxpayer reviewed and approved is not what the preparer filed, the taxpayer did not sign that return under penalties of perjury. Consequently, the return filed by the preparer is a nullity and any assessment on the IRS's books and records relating to that return is invalid. Counsel advised that the taxpayer should file an original return (not an amended return) so the IRS can then adjust the taxpayer's Master File account to reflect the correct tax information.

In 2008, the Office of Chief Counsel once again looked at a situation where a refund was improperly directed to a preparer.²⁹ The memorandum makes clear that the IRS "can and should" adjust each affected taxpayer's account for any refund (or portion of one) illegally obtained by the preparer. The memorandum further advised that the IRS could bring an erroneous refund suit against the preparer to recover the amounts improperly obtained.

In 2011, the Office of Chief Counsel was again asked whether a return was valid if it was altered by a preparer to inflate income, deduction, credits, or withholding without the taxpayer's consent.³⁰ Again using the Beard analysis, Counsel concluded, "[a] tax return signed by a taxpayer that is altered by a tax return preparer without the taxpayer's knowledge and submitted to the IRS by the preparer is not a valid tax return."

In short: since 2000, the IRS has received four legal opinions from its Office of Chief Counsel addressing return preparer misconduct. Two of the opinions indicate that if a purported return fails the Beard test, it is a nullity.³¹ Three of the opinions indicate that nullified returns should be backed out of the taxpayer's account.³² And one of the opinions clearly indicates that there is no legal impediment to issuing the taxpayer his or her correct refund when he or she has not received it due to fraudulent misconduct by a preparer.³³ Thus, when reading all four opinions together, the IRS has received ample advice to permit it to reissue refunds to victims of return preparer misconduct in scenarios 3 and 4 described above.

Current Guidance Does Not Fully Address The Impact of Return Preparer Misconduct.

Under current guidance, when the IRS is made aware of the return preparer misconduct, it is willing to reverse the entries from the altered return filed by the preparer (i.e., treat it as a nullity) and process the correct original return.³⁴ However, the IRS has declined to issue a replacement refund to victims, despite the guidance from the Office of Chief Counsel (discussed above).

The IRS draws a distinction between taxpayers who never authorized a preparer to file a return and those who authorized a filing but did not authorize the particular return the preparer filed. In the first situation, the guidance instructs AM employees to "Follow steps in Accounts Resolution Initial Steps" and issue a manual refund if the taxpayer did not receive the full refund.³⁵ The IRS considers this situation analogous to identity theft, where a third party steals a taxpayer's information and files a return claiming a refund. In the second situation, if the taxpayer is seeking a refund from the IRS, AM is instructed to suspend action on the case pending Chief Counsel guidance. The IRS considers the return filed to be "invalid" but not "unauthorized."

There should be no distinction between these two situations. In both instances, the return preparer filed a tax return that the taxpayer did not authorize. In many cases, the taxpayer is given a copy of the correct, authorized return, but the preparer later alters that return and files a fraudulent version. The fact that a taxpayer authorized the return preparer to file "a" return does not mean that the taxpayer authorized "the" return that was actually filed.

Well-established principles of agency law state that if an agent acts outside of the scope of the agency relationship, then this is an unauthorized act and thus not an action of the principal, unless later ratified (i.e., approved) by the principal.³⁶ A return preparer altering portions of the tax return without the taxpayer's consent is an agent acting outside of the scope of the agency relationship -- meaning the return as filed is not a valid return of the taxpayer and should be backed out of the victim's account. The IRS's current guidance ignores longstanding principles of agency law and leaves taxpayers with little recourse to recover their stolen direct deposit tax refunds.

Further, it seems intellectually dishonest for the IRS to treat the initial, altered return as a nullity when it does not require a payment to the taxpayer, yet refuse to fully process the taxpayer's correct original return when it requires an additional payment of a refund to the taxpayer. The IRS is willing to go halfway and back out the nullified return, but is unwilling to abide by the notion that the first return filed was not the return of the taxpayer when it is asked to issue a second refund. It is as though the IRS is employing a budgetary approach to legal and policy issues.

In an analogous situation, the IRS does make taxpayers whole by issuing a refund after initially processing a nullity. In this regard, when an identity thief files a tax return with falsified information purporting to be the taxpayer, the IRS initially processes the return and pays the refund to the thief. Later, when the victim provides sufficient documentation establishing the identity theft, the IRS moves the nullity to a temporary tax identification number (an IRSN) and accepts the correct original return from the victim. If a refund is associated with the return, the IRS pays it to the victim, regardless of whether it already paid a refund to the thief.

It makes little sense from a policy standpoint to treat victims of return preparer misconduct more harshly than victims of identity theft, when neither victim had any culpability. To be clear, we are not advocating that the IRS agree to hold the taxpayer harmless if there is any evidence that the taxpayer colluded with the return preparer to scam the government. However, the National Taxpayer Advocate disagrees wholeheartedly with the notion that by bringing the return preparer into the equation, the taxpayer automatically is assigned some degree of culpability.

Altering the Bank Routing and Account Numbers Is Tantamount to Altering the Tax Return.

IRS procedures state that when the preparer altered the direct deposit information (rather than items of income, deduction, credits, etc.), AM should suspend action on the case pending Chief Counsel guidance.³⁷ The National Taxpayer Advocate does not believe the IRS should make a distinction on the basis of the type of information altered by the preparer. There appears to be no legal basis for arbitrarily deciding that the bank routing and account information is not material to, or part of, the tax return. In fact, to the taxpayer, the instructions on where to send the refund may be the most important part of the return. Seldom would a taxpayer authorize the filing of a return knowingly directing the refund to an account controlled by an unrelated third party who will abscond with the funds. As discussed above, the Office of Chief Counsel concluded in 2000 that the IRS can issue a second refund in a case where the bank routing and account numbers are altered by a third party.³⁸ To avoid further harm to taxpayers, the National Taxpayer Advocate requests that the IRS guidance incorporate this advice.

Taxpayers Must Be Able to Substantiate Return Preparer Misconduct.

The National Taxpayer Advocate recognizes that the IRS is concerned about the practical and financial effect of issuing refunds to victims after already paying out a refund with the altered return. Some taxpayers will certainly attempt to game the system, perhaps by colluding with a return preparer. We appreciate the need for the IRS to request documentation supporting the return preparer misconduct. It may be difficult for some taxpayers to meet the burden of proof the IRS requires. However, many are able to do so easily -- some taxpayers have gone as far as file a police report against the return preparer. For years, the National Taxpayer Advocate has recommended that the IRS conduct a comprehensive consumer protection campaign, educating taxpayers about the need to get a copy of their tax return that is signed by their paid preparer.³⁹ The IRS's failure to conduct such a campaign robs taxpayers of their most persuasive evidence in the event of return preparer fraud.

The National Taxpayer Advocate urges the IRS to separate the problems of proof from its analysis of legal and policy issues. For taxpayers who provide sufficient documentation to support their claims, the IRS must quickly issue the refunds to which they are entitled and should not further victimize such taxpayers by depriving them of their tax refunds.

Scope of "Return Preparer Fraud" Should Be Expanded.

As mentioned above, taxpayers frequently use the services of return preparers to comply with their federal tax obligations. Often, these return preparers are professionals who are licensed and regulated. However, some taxpayers rely upon neighbors, co-workers, clergy, or family friends who may offer to help in filing their tax returns. Under current guidance, the IRS will not provide relief to taxpayers defrauded by preparers who are not in the business of preparing returns. As a result, many taxpayers who have been victimized by such preparers who are not "in the business of preparing returns" will not receive assistance from the IRS.

Rather than inquiring about the relationship between the taxpayer and the preparer, the IRS should instead focus on whether the taxpayer authorized the filing of the return that was submitted. We fully recognize the IRS's concern that some taxpayers with a non-business relationship with their return preparer may not truly be innocent victims of fraud. We do not suggest that the IRS relax its requirement that the taxpayer support his or her assertion that the return preparer filed an unauthorized return with appropriate documentation. But once the IRS is convinced that the return submitted was not the one authorized by the taxpayer, it does not matter whether the preparer was in the business of preparing tax returns.

Regulation of Return Preparers Should Give Taxpayers a Greater Level of Confidence in Choosing Trustworthy Practitioners.

The IRS began regulating return preparers in the 2012 filing season. Unenrolled preparers who prepare Form 1040 series returns must now take a competency test administered by the IRS Return Preparer Office.⁴⁰ Creating a class of certified return preparers is a very positive step toward combatting fraud.

In conjunction with the regular training and testing, a comprehensive communications plan targeting the most vulnerable taxpayers (e.g., the elderly, those who speak English as a second language or are low income, college students) would be a worthwhile investment. By educating taxpayers on how to choose a qualified return preparer, the IRS can attempt to steer taxpayers away from the less scrupulous preparers. As noted above, the IRS should also remind taxpayers that a paid preparer is required to sign the tax return and provide the taxpayer with a copy of that signed tax return. These documents are the taxpayer's best defense against return preparer fraud, and the IRS's failure to educate taxpayers about how to protect themselves is, in the National Taxpayer Advocate's opinion, a gross dereliction of the government's duty to promote and protect the interests of its taxpayers.

CONCLUSION

Return preparer misconduct is a growing problem for the IRS. Return preparer misconduct ties up IRS resources, drains the public fisc, and harms taxpayers. The IRS must do all it can to deter return preparer misconduct and develop comprehensive procedures to assist victims.

When a return preparer diverts a taxpayer's refund using an altered bank routing number and obtains the funds using direct deposit, the IRS will not issue a refund to the taxpayer. Instead, the IRS's position is that this is a civil matter between the victim and the return preparer or bank. At a time when the IRS is pushing taxpayers to electronic filing, its refusal to issue replacement refunds to those who requested direct deposit payment while agreeing to issue a replacement paper check is illogical and bad for tax administration.

Even as the IRS promotes electronic filing and payments, its policy of not issuing refunds to victims of return preparer misconduct creates a disincentive for taxpayers to e-file and request a direct deposited refund. In essence, the message the IRS is sending to taxpayer is this: Prepare and file your tax returns using a return preparer because it is almost impossible to keep up with the increasingly complex tax law, and utilize e-file and direct deposit to keep processing costs down and human errors to a minimum, but if the return preparer you choose is dishonest and absconds with your tax refund, you are on your own.

The National Taxpayer Advocate preliminarily recommends that the IRS:

The IRS acknowledges that the perpetration of fraud by a tax return preparer is a very serious issue and one that presents unique challenges and difficult legal questions for the IRS. In addition, the issues have changed over time with new types of fraud developing as we work through this process. These types of cases are intensely factual in nature and involve varying forms of interaction between the IRS and taxpayers as well as third party return preparers. As a result, there are many new and varying factual situations to analyze, some of which have raised novel legal questions for our consideration. For these reasons, careful and thoughtful processing of these cases has taken longer than expected. We know that some taxpayers have been waiting a longer time than we would normally consider appropriate for resolution of their cases, and we hope that this will not continue going forward. As a steward of federal tax dollars, the IRS must ensure that legal requirements are satisfied before the government makes payments to taxpayers whose refunds may have been stolen by a third party. The IRS is attempting to strike a balance in this area so that federal tax dollars are used appropriately.

The circumstances surrounding preparer fraud have been evolving. The IRS has devoted considerable time and resources in 2011 and 2012 toward the resolution of many of these issues. In April 2012, the IRS issued Servicewide Electronic Research Program (SERP) Alert 12A0238, Contacts Regarding Specific Return Preparer Complaint Issues, which provided internal guidance to assist taxpayers who contact the IRS claiming they have been victims of preparer fraud or misconduct. In conjunction with this new guidance, the IRS created a new form, Form 14157-A, Tax Return Preparer Fraud or Misconduct Affidavit, for taxpayers to use along with a Form 14157, Return Preparer Complaint, to submit their complaint and request account adjustments.

The IRS established a special unit in Memphis for Accounts Management to receive claims. Internal guidance to process claims was issued on those scenarios for which all legal issues have been resolved. On June 26, 2012, the IRS issued SERP Alert 12A0417, Memphis AM ONLY-Return Preparer Misconduct Interim Guidance. This SERP Alert, and subsequent internal guidance issued on September 6, 2012, provide internal guidance on how to resolve cases in which the taxpayer visits a return preparer but does not authorize that return preparer to file a tax return on their behalf. The guidance also addresses cases where the taxpayer authorized a tax preparer to file a tax return but the return is subsequently altered by the preparer without the consent of the taxpayer, provided the preparer did not misdirect a tax refund due and owing to the taxpayer. The IRS also issued guidance to Collection employees and posted it to the Technical Digest for all SB/SE compliance employees in July 2012.

The unresolved issues raised more recently present new and varying factual situations that need further legal analysis. Most of the remaining cases involve a third-party preparer, who has been authorized to file a tax return, but misappropriated tax refunds that were due and owing to the taxpayer. We have been actively coordinating with the Operating Divisions and Counsel to reach resolution. As a result, these types of cases are on hold awaiting guidance we expect to be forthcoming.

The National Taxpayer Advocate has recommended that the IRS conduct outreach and seek authorization to use appropriated funding for a comprehensive consumer safety information campaign for taxpayers, targeting the most vulnerable segments of the taxpayer population. The IRS website currently provides information to taxpayers on how to choose a Tax Return Preparer. See Tax Topic 254 on IRS.gov. It cautions taxpayers about unscrupulous preparers and provides a link regarding how to choose a tax preparer and how to interact with that preparer to avoid fraud (See hyperlink to IRS Tax Tip 2011-106). This page also provides a link to information on reporting suspected fraud (See "Where Do You Report Suspected Fraud?"). We agree that further education and outreach would be beneficial and will leverage our resources by engaging our partners and stakeholders.

In addition, the Return Preparer Office is continuing to phase in a multi-year plan that began in 2010 to regulate the paid preparer industry. Future steps of the plan include a public database of authorized preparers and a taxpayer education campaign. The database, which is scheduled to launch in 2013, will include a public listing of those individuals who are registered with the IRS, have met minimum competency and suitability requirements, and have appropriate credentials for preparing individual income tax returns for compensation. The taxpayer education campaign will include public service announcements and outreach and education about how to choose a paid preparer, including the types of credentials paid preparers should have, and how to use the database to find or check the credentials of a preparer.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate understands that the IRS has been placed in the difficult position of protecting the public fisc while processing over 140 million individual tax returns annually. We also recognize the IRS's desire to get a firm grasp of its legal obligations before developing procedures. However, the National Taxpayer Advocate believes that the IRS has already received sufficient guidance from the Office of Chief Counsel to proceed to make whole these victims of return preparer fraud.

Contrary to the IRS's assertion that "there are many new and varying factual situations to analyze," the IRS has known for at least 12 years -- more than a decade -- that some tax preparers have perpetrated fraud on their clients, including diversion of refunds. Since 2000, the IRS Office of Chief Counsel has issued several opinions that address similar situations. We have summarized the relevant conclusions, and believe that based on this guidance, the IRS is legally permitted to take all of the actions we have recommended.

The IRS has had 12 years to develop procedures to (1) back out the return information contained in the invalid or unauthorized return, (2) stop any collection action associated with a refund that the taxpayer never received, (3) process the taxpayer's true return, and (4) issue the proper refund to the taxpayer. While the IRS has finally developed interim procedures to address the first three steps, it stopped short of establishing a method of delivering refunds to the victims of preparer fraud -- which is the most important aspect of case resolution from the victims' perspective. We do not believe that the IRS needs further guidance in order to assist the growing number of victims of return preparer fraud.

The IRS's inexcusable delay in acting on these cases and issuing guidance is inflicting real harm on real taxpayers. These are not mere cases where "some taxpayers have been waiting a longer time than we would normally consider appropriate for resolution of their cases" nor do they require such "careful and thoughtful processing" as to take over a decade to issue guidance. As we noted above, in FY 2012, TAS issued 58 TAOs on these cases, of which 26 are elevated to the National Taxpayer Advocate. The average adjusted gross income (AGI) of the taxpayers involved in these 26 TAOs was less than $32,000, and the refund sought by these taxpayers constituted, on average, 28 percent of their AGI. In the face of these numbers, IRS inaction is callous.

As we go to press with this report, the total number of TAOs involving preparer fraud that have been elevated to the National Taxpayer Advocate is 60. To date, the Commissioner of the Wage and Investment Division has appealed ten of these TAOs, and the National Taxpayer Advocate is sustaining these TAOs to the Acting Commissioner of Internal Revenue. In each of these cases, the National Taxpayer Advocate has presented to the IRS significant documentary evidence of the preparer's actions and the harm sustained by the taxpayer, and laid out a road map of what corrective actions the IRS should take to remedy that harm. In these cases, there are few difficult policy calls to be made. A fraud has been committed, similar to what occurs when paper refund checks are misappropriated, and the IRS has the legal authority to make the taxpayer whole and seek restitution from the perpetrator. Never before has the National Taxpayer Advocate had to fight so hard for such a simple, basic issue of justice and fairness for taxpayers who were simply trying to comply with their tax filing obligations.

The IRS's ongoing failure to conduct a vigorous and extensive outreach and education campaign about preparer selection and protection against preparer fraud is unacceptable. Since 2002, the National Taxpayer Advocate has recommended that the IRS actively inform taxpayers who use paid preparers to ask for and obtain a copy of their returns, signed by that preparer, as required by law.⁴¹ The IRS's own research demonstrates that the taxpayer populations most vulnerable to this type of fraud either do not have regular access to the Internet or do not actively use it for this type of information.⁴² Thus, by failing to conduct an active and direct marketing campaign targeted to the most vulnerable populations and by merely putting cautionary information on its website, the IRS facilitates the very fraud that it should be warning against.

In October 2012, the National Taxpayer Advocate issued a proposed Taxpayer Advocate Directive (TAD) to the W&I Commissioner requesting that the IRS establish procedures for issuing refunds to victims of return preparer fraud, a copy of which immediately follows this discussion.⁴³ The division responded by saying it is meeting with senior leadership and Counsel in an attempt to reach resolution. Because the IRS has refused to develop such procedures, even though it has known since 2000 about the problems that return preparer fraud can thrust upon taxpayers, the National Taxpayer Advocate will issue a formal TAD in January 2013 directing the IRS to develop such procedures.

Recommendations

² For example, suppose the taxpayer is entitled to a $500 refund. The preparer alters the data so the refund amount is $1,000. The preparer splits the refund to direct $600 to the preparer and $400 to the taxpayer, who does not receive the full refund to which he is entitled ($100 shortfall).

³ For example, suppose the taxpayer is entitled to a $900 refund. The preparer alters the tax data so that the amount is $1,900. The preparer splits the refund to direct $1,000 to the preparer and $900 to the taxpayer. The IRS stores only the information from the first bank account listed on Form 8888, Allocation of Refund. The refund is held for some reason beyond the first cycle when the split account information from Form 8888 is still in the system, so the refund is not split and the entire $1,900 refund is direct-deposited into the first account listed on Form 8888, which is the preparer's account.

⁴See Field Service Advice 200038005 (June 6, 2000); IRS Office of Chief Counsel Memorandum, Horse's Tax Service, PMTA 2011-13 (May 12, 2003); IRS Office of Chief Counsel Memorandum, Refunds Improperly Directed to a Preparer, POSTN-145098-08 (Dec. 17, 2008); IRS Office of Chief Counsel Memorandum, Tax Return Preparer's Alteration of a Return, PMTA 2011-20 (June 27, 2011).

⁵See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

⁶ IRS, IR-2011-4, IRS e-file Launches Today; Most Taxpayers Can File Immediately (Jan. 14, 2011).

⁷See IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

⁸ For an in-depth discussion of the IRS's failure to provide all taxpayers with a free method to preparer and e-file their individual returns, see Most Serious Problem: The IRS Is Striving to Meet Taxpayers' Increasing Demand for Online Services, Yet More Need to Be Done, infra.

⁹See Interim Guidance for Preparing Taxpayer Assistance Orders (TAOs) to Accounts Management Involving Return Preparer Fraud, TAS-13-0512-017 (May 23, 2012).

¹⁰ Internal Revenue Code (IRC) § 7811 authorizes the National Taxpayer Advocate to issue a Taxpayer Assistance Order upon a determination that a taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the Secretary.

¹¹ TAS analysis of 26 return preparer fraud cases elevated to the National Taxpayer Advocate level as of October 25, 2012. Some averages were calculated with as few as 22 cases because not all data was available.

¹² IRS, IR-2010-1, IRS Proposes New Registration, Testing and Continuing Education Requirements for Tax Return Preparers Not Already Subject to Oversight (Jan. 4, 2010).

¹³See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

¹⁴ IRS, IR-2012-29, Tax Scam Warning: Beware of Phony Refund Scheme Abusing Popular College Tax Credit; Senior Citizens, Working Families and Church Members Are Targets (Mar. 2, 2012).

¹⁵See Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, supra; Most Serious Problem: Despite Some Improvements, The IRS Continues to Harm Taxpayers by Unreasonably Delaying Processing of Refunds that Trigger Systemic Filters, infra.

¹⁶See Field Service Advice 200038005 (June 6, 2000).

¹⁷ Pursuant to Delegation Order No. 13-3, the National Taxpayer Advocate has the authority to issue a TAD "to mandate administrative or procedural changes to improve the operation of a functional process or to grant relief to groups of taxpayers (or all taxpayers) when implementation will protect the rights of taxpayers, prevent undue burden, ensure equitable treatment, or provide an essential service to taxpayers." IRM 1.2.50.4, Delegation Order 13-3 (formerly DO-250, Rev. 1), Authority to Issue Taxpayer Advocate Directives (Jan. 17, 2001). See also IRM 13.2.1.6, Taxpayer Advocate Directives (July 16, 2009).

¹⁸See National Taxpayer Advocate 2011 Annual Report to Congress 59-60.

¹⁹See Taxpayer Advocate Directive 2012-1 (Establish procedures for adjusting the taxpayer's account in instances where a tax return preparer altered the return without the taxpayer's knowledge or consent, and the preparer obtained a fraudulent refund) (Jan. 12, 2012).

²⁰See Servicewide Electronic Research Program (SERP) Alert 12A0417, Memphis AM ONLY -- Return Preparer Misconduct Interim Guidance (June 26, 2012). This guidance was later incorporated into an interim guidance memorandum from the Director of AM on September 6, 2012.

²¹See Proposed Taxpayer Advocate Directive 2012-5, Establish procedures for issuing a replacement refund for victims of return preparer misconduct (Oct. 17, 2012).

²² IRS, IR-2011-4, IRS e-file Launches Today; Most Taxpayers Can File Immediately (Jan. 14, 2011).

²³See IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

²⁴ FSA 200038005 (June 6, 2000); see also 31 C.F.R. § 210.4(a)(1) (indicating that an agency that accepts an ACH authorization shall verify "the validity of the recipient's signature").

²⁵ 82 T.C. 766, 777-78 (1984), aff'd per curiam, 793 F.2d 139 (6th Cir. 1986).

²⁶ Field Service Advice 200038005 (June 6, 2000). While Field Service Advice is not binding and may not be cited as precedent, it does allow us some insight on how similar situations may be analyzed.

²⁷See IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

²⁸See IRS Office of Chief Counsel Memorandum, Horse's Tax Service, PMTA 2011-13 (May 12, 2003).

²⁹See IRS Office of Chief Counsel Memorandum, Refunds Improperly Directed to a Preparer, POSTN-145098-08 (Dec. 17, 2008).

³⁰See IRS Office of Chief Counsel Memorandum, Tax Return Preparer's Alteration of a Return, PMTA 2011-20 (June 27, 2011).

³¹See IRS Office of Chief Counsel Memorandum, Horse's Tax Service, PMTA 2011-13 (May 12, 2003); IRS Office of Chief Counsel Memorandum, Tax Return Preparer's Alteration of a Return, PMTA 2011-20 (June 27, 2011).

³²See IRS Office of Chief Counsel Memorandum, Horse's Tax Service, PMTA 2011-13 (May 12, 2003); IRS Office of Chief Counsel Memorandum, Refunds Improperly Directed to a Preparer, POSTN-145098-08 (Dec. 17, 2008); IRS Office of Chief Counsel Memorandum, Tax Return Preparer's Alteration of a Return, PMTA 2011-20 (June 27, 2011).

³³See Field Service Advice 200038005 (June 6, 2000).

³⁴See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

³⁵Id.

³⁶See American Law Institute, Restatement (Third) of Agency § 6.05 (2006).

³⁷See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

³⁸ Field Service Advice 200038005 (June 6, 2000).

³⁹See National Taxpayer Advocate 2011 Annual Report to Congress 431-432; National Taxpayer Advocate 2009 Annual Report to Congress 41-69; National Taxpayer Advocate 2008 Annual Report to Congress 503-512; National Taxpayer Advocate 2006 Annual Report to Congress 197-221; National Taxpayer Advocate 2005 Annual Report to Congress 223-237; National Taxpayer Advocate 2004 Annual Report to Congress 67-88; National Taxpayer Advocate 2003 Annual Report to Congress 270-301; National Taxpayer Advocate 2002 Annual Report to Congress 216-230; Fraud in Income Tax Return Preparation, Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and Means, 109th Cong. (2005) (statement of Nina E. Olson, National Taxpayer Advocate).

⁴⁰ The Return Preparer Office develops the questions, but the IRS selects a vendor to administer the test nationwide.

⁴¹See National Taxpayer Advocate 2002 Annual Report to Congress 216-230 (Legislative Recommendation: Regulation of Federal Tax Return Preparers).

⁴²See generally Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra. See also Kathryn Zickuhr, Pew Internet, Generations and Their Gadgets (Feb. 2011), http://www.pewinternet.org/Reports/2011/Generations-and-gadgets.aspx; Kathryn Zickuhr, Aaron Smith, Pew Internet, Digital Differences (Apr. 2012), http://www.pewinternet.org/Reports/2012/Digital-differences.aspx; IRS Oversight Board, 2006 Service Channels Survey; IRS, 2006 Market Segment Survey, Many Unprotected from Fraudulent Tax Preparers, http://press-room.lawyers.com/Many-Unprotected-from-Fraudulent-Tax-Preparers.html.

⁴³See Proposed Taxpayer Advocate Directive 2012-5, Establish procedures for issuing a replacement refund for victims of return preparer misconduct (Oct. 17, 2012). A TAD may be issued to (1) mandate administrative or procedural changes to improve the operation of a functional process, or (2) grant relief to groups of taxpayers (or all taxpayers) when its implementation will protect the rights of taxpayers, prevent undue burden, ensure equitable treatment, or provide an essential service to taxpayers. IRM 1.2.50.4, Delegation Order 13-3 (formerly DO-250, Rev. 1), Authority to Issue Taxpayer Advocate Directives (Jan. 17, 2001). See also IRM 13.2.1.6, Taxpayer Advocate Directives (July 16, 2009). IRM 13.2.1.6.1 (July 16, 2009) provides that in advance of issuing a TAD, the National Taxpayer Advocate attempts to work with and communicate with the owners of the process in order to correct the problem.

Delegation Order No. 13-3 grants the National Taxpayer Advocate the authority to issue a Taxpayer Advocate Directive (TAD). A TAD may be issued to (1) mandate administrative or procedural changes to improve the operation of a functional process, or (2) grant relief to groups of taxpayers (or all taxpayers) when its implementation will protect the rights of taxpayers, prevent undue burden, ensure equitable treatment, or provide an essential service to taxpayers.¹ Internal Revenue Manual (IRM) 13.2.1.6.1 (July 16, 2009) provides that in advance of issuing a TAD, the National Taxpayer Advocate attempts to work with and communicate with the owners of the process in order to correct the problem. This Proposed TAD serves as a formal alert that I will issue a TAD if the IRS does not take the following concrete actions:

I. ISSUES

My office is seeing an increasing number of return preparer misconduct cases. Often, victims are individuals who are facing economic hardship and are in dire need of their tax refunds. I have written extensively about the need for the IRS to develop procedures to ensure that the tax accounts of the victims are appropriately adjusted and that the victims are not held responsible for the actions of these return preparers.³

Among our return preparer misconduct cases, there are four common scenarios.

In scenario 3, once the victim notifies the IRS of the return preparer misconduct, the IRS will back out the altered return information from the taxpayer's account and ask the victim to submit a correct original return. Although a refund is due, the IRS will not issue a refund to the taxpayer. Instead, the IRS informs the victim that preparer misconduct is a civil matter to be settled without its assistance. AM employees are instructed to suspend action on the case pending Chief Counsel guidance.

In contrast, if a third party fraudulently endorses a victim's paper refund check, the IRS has procedures to re-issue a check to the taxpayer upon a timely filed claim.⁸ However, if the return preparer diverts a victim's refund using altered bank routing and account numbers and obtains the funds using direct deposit (scenario 4), the IRS will not issue a refund to the taxpayer. Instead, the IRS's position is that it is a civil matter between the victim and the return preparer or bank.

II. PROCEDURAL HISTORY

TAS has previously discussed in depth the problems taxpayers encounter when they are the victims of return preparer misconduct. On January 12, 2012, I issued a TAD that covered the issue thoroughly.⁹ In response to the TAD, on June 26, 2012, the Wage and Investment division (W&I) issued guidance that partially addressed my concerns, but failed to adequately provide relief for all victims of return preparer misconduct.¹⁰

III. ANALYSIS

Pursuant to the Beard Test, an Unsigned Return Is Not a Valid Return.

Beard v. Commissioner¹¹ involved a taxpayer who altered a Form 1040, U.S. Individual Income Tax Return. In Beard, the Tax Court applied a four-part test to determine whether a document filed with the IRS qualifies as a "return" for tax purposes. Those requirements are that the document: (1) purport to be a return; (2) be signed under penalties of perjury; (3) contain sufficient data to permit a tax to be calculated; and (4) evince an honest and genuine endeavor to satisfy the requirements of tax law. Beard has become the generally accepted test for determining the validity of a tax return.

The signature requirement derives from IRC § 6065, which states that generally, any return, declaration, statement, or other document required to be made under any provision of the internal revenue laws or regulations shall contain or be verified by a written declaration that it is made under penalties of perjury. This requirement authenticates the signed document and verifies its truthfulness.

In a typical return preparer misconduct case scenario, the preparer alters some information on the tax return after the taxpayer has authorized a prior version of the return. The return submitted by the return preparer was not reviewed, authorized, or signed by the taxpayer under penalties of perjury. It is not a valid return, as it fails the signature requirement of the Beard test.

Relevant Chief Counsel Advice Permits the IRS to Issue Refunds to Victims of Return Preparer Misconduct.

Return preparer misconduct is not a new phenomenon that the IRS is just now facing. While W&I only recently issued partial guidance to its employees on how to assist victims of return preparer misconduct, the IRS Office of Chief Counsel has provided advice on such situations dating as far back as 2000.

In 2000, the Office of Chief Counsel issued advice addressing a situation where a taxpayer used the Volunteer Income Tax Assistance (VITA) program to electronically file her tax return, and the VITA volunteer subsequently changed the bank routing and account numbers, with the result that the taxpayer's refund was directed into the account of a third party.¹² The Office of Chief Counsel concluded that there is "no legal impediment to reissuing a direct deposit refund." The Office of Chief Counsel noted that situations in which direct deposits are stolen are closely analogous to the stolen refund check situation, where there is a process for issuing a replacement refund check.¹³

In 2003, the Office of Chief Counsel again addressed a situation where an electronically filed tax return was altered without the taxpayer's knowledge, and declared that a return altered by a preparer after the victim has verified the accuracy of the return is a nullity.¹⁴ In this 2003 memorandum, the Office of Chief Counsel analyzed the four-part test set forth in Beard, and concluded that when the taxpayer is unaware of the alterations to the return and the version that the taxpayer reviewed and approved is not what the preparer filed with the IRS, the taxpayer did not sign that return under penalties of perjury. Consequently, the return filed by the preparer is a nullity and any assessment on the IRS's books and records relating to that return is invalid. Counsel advised that the taxpayer should file an original return (not an amended return) so that the IRS can then adjust the taxpayer's Master File account to reflect the correct tax information.

In 2008, the Office of Chief Counsel once again looked at a situation where a refund was improperly directed to a preparer.¹⁵ The memorandum makes clear that the IRS "can and should" adjust each affected taxpayer's account for any refund (or portion of one) illegally obtained by the preparer. The memorandum further advised that the IRS could bring an erroneous refund suit against the preparer to recover the amounts improperly obtained.

In 2011, the Office of Chief Counsel was again asked whether a return that was altered by a return preparer to inflate items of income, deduction, credits, or withholding without the taxpayer's consent was a valid tax return.¹⁶ Again utilizing the Beard analysis, Counsel concluded that "[a] tax return signed by a taxpayer that is altered by a tax return preparer without the taxpayer's knowledge and submitted to the IRS by the preparer is not a valid tax return."

Since 2000, the IRS has received four legal opinions from its Office of Chief Counsel addressing return preparer misconduct. Two of the opinions indicate that if a purported return fails the Beard test, it is a nullity. Three of the opinions indicate that nullified returns should be backed out of the taxpayer's account. And one of the opinions clearly indicates that there is no legal impediment to issuing the taxpayer his or her correct refund when he or she hasn't received it due to fraudulent misconduct by a return preparer. Thus, when reading all four opinions together, the IRS has received ample advice to permit it to reissue refunds to victims of return preparer misconduct in scenarios 3 and 4 described above.

Current Guidance Does Not Fully Address Impact of Return Preparer Misconduct.

Under current guidance,¹⁷ when the IRS is made aware of the return preparer misconduct, it is willing to back out the altered return filed by the preparer (i.e., treat it as a nullity) and process the correct original return once it is obtained from the taxpayer. However, the IRS has declined to issue a replacement refund to victims, despite the guidance it has received from the Office of Chief Counsel (discussed above).

The IRS makes a distinction between (1) taxpayers who never authorized a return preparer to file a return, and (2) taxpayers who authorized a return preparer to file a return but did not authorize the particular return filed by the return preparer. In the first situation, the interim guidance instructs AM employees to "Follow steps in Accounts Resolution Initial Steps" and issue a manual refund if the taxpayer did not receive the full refund.¹⁸ My understanding is that the IRS considers this situation to be analogous to identity theft where a third party steals a taxpayer's information and files a return claiming a refund. In the second situation, if the taxpayer is seeking a refund from the IRS, AM is instructed to suspend action on the case pending Chief Counsel guidance. The IRS considers the return filed to be "invalid" but not "unauthorized."

There should be no distinction between these two situations. In both instances, the return preparer filed a tax return that the taxpayer did not authorize. In many cases, the taxpayer is given a copy of the correct return that he or she authorized the return preparer to file, but the return preparer alters information on the return and ends up filing a different version of the return. The fact that a taxpayer authorized the return preparer to file "a" return does not mean that the taxpayer authorized "the" return that was actually filed.

Well-established principles of agency law state that if an agent acts outside of the scope of the agency relationship, then it is an unauthorized act and thus not an action of the principal, unless later ratified by the principal.¹⁹ A return preparer altering portions of the tax return without the taxpayer's consent is an agent acting outside of the scope of the agency relationship -- meaning the return as filed is not a valid return of the taxpayer and should be nullified. The taxpayer should be given the opportunity to file a valid return and receive the full refund associated with that return. The interim guidance ignores longstanding principles of agency law and leaves taxpayers with little recourse to recover their stolen direct deposit tax refunds.

The IRS may argue that it reasonably relied upon the apparent authority of the return preparer, and acted to its detriment in processing the refund. I agree that the doctrine of apparent authority is necessary to protect a helpless third party. But I would hardly characterize the IRS as a helpless party in such a transaction; the taxpayer is the party that requires protection. Under our current tax system, taxpayers are required by law to self-assess taxes and interact with the IRS. Given the complexity of the tax law, preparing and filing returns is a significant undertaking for many taxpayers. In fact, more than 80 percent of American households use paid preparers or tax software to help them prepare and file their tax returns.²⁰ With less Taxpayer Assistance Center resources available to help taxpayers prepare and file their tax returns, many feel pressure to enlist the services of a return preparer to meet their statutorily-mandated tax filing requirement. The filing of one's taxes is an entirely different situation than the typical contractual relationship under which apparent authority is exercised.

Further, it seems intellectually dishonest for the IRS to treat the initial, altered return as a nullity when it does not require a payment to the taxpayer, yet refuse to fully process the taxpayer's correct original return when it requires an additional payment of a refund to the taxpayer. The IRS is willing to go halfway and back out the nullified return, but it is unwilling to abide by the notion that the first return filed was not the return of the taxpayer when it is asked to issue a second refund. I have not been provided an adequate explanation to support this decision. It is as though the IRS is employing a budgetary approach to legal and policy issues.

In an analogous situation, the IRS does make taxpayers whole by issuing a refund after initially processing a nullity. In this regard, when an identity thief files a tax return with falsified information purporting to be the taxpayer, the IRS initially processes the return and pays out the refund to the identity thief. Later, when the identity theft victim provides sufficient documentation establishing the identity theft, the IRS moves the nullity to a temporary tax identification number (an IRSN) and accepts the correct original return from the victim. If there is a refund associated with the return, the IRS pays the refund to the identity theft victim, regardless of whether it paid a refund to the identity thief initially.

It makes little sense from a policy standpoint to treat victims of return preparer misconduct more harshly than victims of identity theft, when neither victim had any culpability in the refund misconduct scam. To be clear, I am not advocating that the IRS agree to hold the taxpayer harmless if there is any evidence that the taxpayer colluded with the return preparer to scam the government. However, I disagree wholeheartedly with the notion that by bringing the return preparer into the equation, the taxpayer automatically is assigned some degree of culpability.

Altering the Bank Routing and Account Numbers Is Tantamount to Altering the Tax Return.

The interim guidance on return preparer misconduct provides that in situations where the preparer altered the direct deposit information (rather than items of income, deduction, credits, etc.), AM should suspend action on the case pending Chief Counsel guidance. I do not believe there should be a distinction made on the basis of the type of information altered on the return by the return preparer. I see no legal basis for arbitrarily deciding that the bank routing and account information is not material to, or part of, the tax return. In fact, to the taxpayer, the instructions on where the refund payment is to be sent may be the most important part of the tax return. No taxpayer would authorize the filing of a return knowingly directing the refund to an account controlled by a third party over which the taxpayer has no control. As discussed above, the Office of Chief Counsel issued advice in 2000 concluding that the IRS is permitted to issue a second refund in a case where the bank routing and account numbers are altered by a third party on a taxpayer's return.²¹ To avoid further harm to taxpayers, I request that the IRS guidance incorporate this advice.

I note that had the return preparer diverted a victim's refund by requesting a paper refund check, the IRS has procedures to re-issue a check to the taxpayer upon a timely filed claim.²² The Financial Management Service, upon determining that the taxpayer was not involved in the negotiation of the check, will issue a replacement to the taxpayer and charge the Check Forgery Insurance Fund (CFIF).²³ The CFIF is a revolving fund created by a statute that specifically refers to a "check," with longstanding rules and regulations that do not contemplate electronic payments.²⁴

The CFIF legislation merely established a fund; it did not create a new authority for the IRS to replace fraudulently negotiated checks. This authority had always existed, so the designation of a source of funding is irrelevant to the discussion of whether the IRS should issue replacement funds to a taxpayer that never received the initial refund. In the case of a stolen direct deposit, the IRS Office of Chief Counsel previously has advised that, "the Service is legally permitted to reissue the refund to the taxpayer."²⁵ Therefore, I believe the IRS can and should establish a process by which a taxpayer can show that whoever wrongfully altered the bank account number on a return was not an authorized agent, and upon confirmation of these facts, the IRS should pay the refund to the taxpayer -- regardless of whether the refund was requested via direct deposit or by check.

Taxpayers Must Be Able to Substantiate the Occurrence of Return Preparer Misconduct.

I recognize that the IRS is concerned about the practical and financial effect of issuing refunds to victims after already paying out a refund initially with the altered return. There will certainly be taxpayers attempting to game the system, perhaps by colluding with a return preparer. I appreciate the need for the IRS to request documentation substantiating the return preparer misconduct. It may be difficult for some taxpayers to meet the burden of proof the IRS requires. However, many are able to easily -- some taxpayers have gone as far as file a police report against the return preparer.

I urge the IRS to separate the problems of proof from its analysis of legal and policy issues. For those taxpayers who are able to provide sufficient documentation supporting their claim, the IRS must act quickly to issue the refunds to which they are entitled. We should not further victimize such taxpayers by depriving them of their tax refunds.

Scope of "Return Preparer Fraud" Should Be Expanded.

As I mentioned above, taxpayers often use the services of return preparers to comply with their federal tax obligations. Often, these return preparers are professionals who are licensed and regulated. However, some taxpayers rely upon the services of neighbors, coworkers, clergy, or family friends that may offer to assist in filing their tax returns. Under current guidance, the IRS will not provide relief to taxpayers who have been defrauded by tax return preparers who are not in the business of preparing returns. As a result, many taxpayers who have been victimized by return preparers who are not "in the business of preparing returns" will not receive assistance from the IRS.

Rather than inquiring about the relationship between the taxpayer and the return preparer, the IRS should instead focus on whether the taxpayer authorized the filing of the particular return that was submitted for processing. I fully recognize the IRS's concern that some taxpayers with a non-business relationship with their return preparer may not truly be innocent victims of fraud. I do not suggest that the IRS relax its requirement that the taxpayer support with appropriate documentation his or her assertion that the particular return filed by the return preparer was an unauthorized return. But once the IRS is convinced that the return submitted by the return preparer was not the one authorized by the taxpayer, it matters not whether the return preparer was in the business of preparing tax returns.

IV. CONCLUSION

According to Commissioner Shulman, "e-file ensures people can file accurately and get refunds quickly" and "IRS e-file is now the norm, not the exception."²⁶ At a time when the IRS is pushing taxpayers to electronic filing, as a way to both improve the accuracy and reduce the costs of return processing, its refusal to issue replacement refunds to those who requested direct deposit payment while agreeing to issue a replacement paper check is illogical and bad for tax administration.

When taxpayers who are trying to comply with their tax filing obligations are victimized by return preparer misconduct, such victims are often left to deal with the aftermath with little help from the IRS. I suspect that victims of return preparer misconduct take little solace in the fact that, as the IRS is quick to suggest, they might be able to track down the return preparer and file a civil suit to obtain their tax refund money. Even as the IRS promotes electronic filing and payments, its policy of not issuing refunds to victims of return preparer misconduct creates a disincentive for taxpayers to e-file and request a direct deposited refund.

V. REQUESTED ACTIONS

For these reasons, I am issuing this Proposed TAD to protect the rights of taxpayers and prevent undue burden. In light of the significant harm taxpayers are suffering as a result of the IRS's inability to develop a process for providing relief to these victims, I request that you:

² It is my understanding that the IRS has refused to provide relief to a taxpayer victimized by someone who prepared the taxpayer's return who was not in the business of preparing returns.

³See Proposed Taxpayer Advocate Directive 2011-1, Establish procedures for adjusting the taxpayer's account in instances where a tax return preparer altered the return without the taxpayer's knowledge or consent, and the preparer obtained a fraudulent refund (June 13, 2011); National Taxpayer Advocate 2011 Annual Report to Congress 59-60; Taxpayer Advocate Directive 2012-1 (Establish procedures for adjusting the taxpayer's account in instances where a tax return preparer altered the return without the taxpayer's knowledge or consent, and the preparer obtained a fraudulent refund) (Jan. 12, 2012); Identity Theft and Income Tax Preparation Fraud, Hearing Before the House Judiciary Committee, Subcommittee on Crime, Terrorism, and Homeland Security, 112th Cong. (statement of Nina E. Olson, National Taxpayer Advocate).

⁴ In some cases, the taxpayer receives the amount directly from the IRS via direct deposit; in other cases, the preparer has the entire refund amount (taxpayer's correct refund plus the inflated refund) direct deposited to the preparer, and then issues the taxpayer a check.

⁵ For example, suppose TP is entitled to a $500 refund. The preparer alters the tax data so that the refund amount is $1,000. The preparer splits the refund on Form 8888, $600 to the preparer, $400 to TP. TP has not received the full refund amount to which he is entitled ($100 shortfall).

⁶ For example, suppose TP is entitled to a $900 refund. The preparer alters the tax data so that the refund amount is $1,900. The preparer splits the refund on Form 8888, $1,000 to the preparer, $900 to TP. IMF stores only the information from the first bank account listed on Form 8888. The refund is held for some reason beyond the first cycle when the split account information from Form 8888 is still in the system, so a split refund does not occur, and the entire $1,900 refund is direct-deposited into the first bank account listed on Form 8888, which in this example is the preparer's bank account.

⁷See SERP Alert 12A0417, Memphis AM ONLY -- Return Preparer Misconduct Interim Guidance (June 26, 2012). This guidance was later incorporated into an interim guidance memorandum from the Director of AM on September 6, 2012. See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

⁸See IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

⁹ Taxpayer Advocate Directive 2012-1 (Establish procedures for adjusting the taxpayer's account in instances where a tax return preparer altered the return without the taxpayer's knowledge or consent, and the preparer obtained a fraudulent refund) (Jan. 12, 2012).

¹⁰See SERP Alert 12A0417, Memphis AM ONLY -- Return Preparer Misconduct Interim Guidance (June 26, 2012). This guidance was later incorporated into an interim guidance memorandum from the Director of AM on September 6, 2012. See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

¹¹ 82 T.C. 766, 777-78 (1984), aff'd per curiam, 793 F.2d 139 (6th Cir. 1986).

¹² Field Service Advice 200038005 (June 6, 2000). While Field Service Advice is not binding and may not be cited as precedent, it does allow us some insight on how similar situations may be analyzed.

¹³Id. See also IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

¹⁴See IRS Office of Chief Counsel Memorandum, Horse's Tax Service, PMTA 2011-13 (May 12, 2003).

¹⁵See IRS Office of Chief Counsel Memorandum, Refunds Improperly Directed to a Preparer, POSTN-145098-08 (Dec. 17, 2008).

¹⁶See IRS Office of Chief Counsel Memorandum, Tax Return Preparer's Alteration of a Return, PMTA 2011-20 (June 27, 2011)

¹⁷See Interim Guidance on Return Preparer Misconduct (For Memphis Accounts Management ONLY), WI-21-0812-02 (Sept. 6, 2012).

¹⁸Id.

¹⁹See American Law Institute, Restatement (Third) of Agency § 6.05 (2006).

²⁰ IRS, IR-2010-1, IRS Proposes New Registration, Testing and Continuing Education Requirements for Tax Return Preparers Not Already Subject to Oversight (Jan. 4, 2010).

²¹ Field Service Advice 200038005 (June 6, 2000). While Field Service Advice is not binding and may not be cited as precedent, it does allow us some insight on how similar situations may be analyzed.

²²See IRM 21.4.2.4.15.3.1, Check Forgery Insurance Fund (CFIF) (Oct. 1, 2006).

²³ A settlement check is a replacement check based on the Form 1133 claim issued by FMS to replace the original check. IRM 21.4.2.4.13 (Dec. 20, 2010).

²⁴ Congress established the CFIF by law in 1941, before the advent of electronic checks. Pub. L. No. 77-310, 55 Stat. 777 (Nov. 21, 1941). While unrelated regulations provide for electronic checks, the CFIF regulations and rules contemplate forgery of signatures on paper.

²⁵ FSA 200038005 (June 6, 2000); see also 31 C.F.R. § 210.4(a)(1) (indicating that an agency that accepts an ACH authorization shall verify "the validity of the recipient's signature").

²⁶ IRS, IR-2011-4, IRS e-file Launches Today; Most Taxpayers Can File Immediately (Jan. 14, 2011).

Peggy Bogadi, Commissioner, Wage and Investment Division

Jodi Patterson, Director, Return Integrity and Correspondence Services

DEFINITION OF PROBLEM

The IRS's Questionable Refund Program (QRP), which detects and prevents false refunds, is an integral part of the IRS revenue protection program. The National Taxpayer Advocate first identified problems with the administration of the QRP in her 2005 Annual Report to Congress.¹ The report revealed that the data mining selection process used to identify questionable returns was flawed, resulting in too many legitimate refunds being frozen. The affected taxpayers waited inordinate amounts of time for their refunds while the IRS attempted to verify their returns.² Many of these taxpayers would never receive their refunds, as their accounts were among the 240,000 with permanent (hard) refund freezes languishing in the QRP inventory.³

Following the National Taxpayer Advocate's report and subsequent congressional and public criticism, the IRS agreed to dramatically alter the QRP, including moving it out of the Criminal Investigation (CI) unit and into the Wage and Investment (W&I) division in October 2009, under the Accounts Management Taxpayer Assurance Program (AMTAP). However, many of the problems we identified in 2005 persist today.

• In the second quarter of fiscal year (FY) 2012, the IRS reported that QRP inventory had increased three-fold over the previous year.⁴ As a result, the IRS has not been able to work this increased inventory within 70 calendar days, as agreed to between the National Taxpayer Advocate and Criminal Investigation in 2006, and began to apply hard freezes on these accounts.

• In FY 2012, AMTAP imposed a "hard freeze"⁵ on more than 142,000 returns because it could not complete the verification within the allotted time, not because the returns show "badges of fraud" or are otherwise suspect.⁶ In other words, AMTAP is using a hard freeze -- normally designated for accounts in which potentially fraudulent activity has been "verified" -- as an inventory management tool, without sufficient analysis of relative risk.

• TAS receipts of AMTAP cases -- one indicator of flawed IRS procedures -- rose approximately 468 percent since FY 2010, from 3,171 case receipts in FY 2010 to 18,012 in FY 2012. AMTAP cases currently constitute 8.2 percent of all TAS case receipts and are the second most common issue in TAS casework.⁷

• TAS is increasingly receiving cases from taxpayers who are experiencing crippling economic burden because of IRS AMTAP delays.

• Seventy percent of all taxpayers who sought TAS help with the refund freezes in 2012 were experiencing some kind of financial harm as a result of IRS actions (or inaction), compared to 38 percent in 2010.⁸

• A representative sample of TAS wage verification cases closed in 2012 found that 86 percent of these taxpayers were facing potential adverse impact.⁹

• Seventy percent of these taxpayers with hardships received full relief (with another two percent receiving partial relief).¹⁰

• In the same representative sample of TAS pre-refund cases, 53 percent of the taxpayers claimed and received the Earned Income Tax Credit (EITC). These taxpayers waited more than three months for a median refund of $5,175. The refunds comprised 38 percent of their Adjusted Gross Income (AGI).¹¹

Despite improvements to the AMTAP program, the National Taxpayer Advocate remains extremely concerned with AMTAP's continued lack of urgency with respect to assisting taxpayers ensnared by IRS refund fraud filters. This disregard for taxpayers' rights is evidenced by the IRS's decision to:

• Increased inventory levels without the corresponding resources needed to resolve cases timely, as shown by the continued imposition of hard freezes;

• More taxpayers with legitimate refund claims being ensnared by filters each year;

• Frustrated taxpayers forced to deal with phone assistors who cannot advise them about the status of their refunds; and

• Confusion among IRS functions about whose responsibility it is to resolve cases.

Background

In 2005, the National Taxpayer Advocate identified the IRS's use of permanent refund freezes in connection with questionable refund claims as the most serious problem facing taxpayers. A 2005 TAS study of refund freeze cases in which taxpayers sought TAS assistance determined that approximately 66 percent of these taxpayers ultimately received the full amounts they originally claimed on their returns and over 80 percent received at least partial refunds,¹³ but only after waiting a median time of more than eight and one-half months.¹⁴ When we again analyzed AMTAP cases in TAS inventory in 2011, we found approximately 78 percent of taxpayers who came to TAS ultimately received the full relief.¹⁵ The median refund amount was $4,062, which the taxpayer waited more than six months to receive.¹⁶

AMTAP's main objective is to identify and stop fraudulent refunds before they are paid out. AMTAP uses the Electronic Fraud Detection System (EFDS) to screen, score, and select returns suspected of fraud for review. The IRS updates its screens each year based on its experience with prior years' returns. Current-year returns requesting refunds are passed through the updated knowledge base and scored for likelihood of fraud. Returns that are flagged are diverted for further inspection before the IRS issues any refund.

The IRS states that the EFDS filters are 93 percent accurate in detecting potentially fraudulent returns.¹⁷ With EFDS selecting nearly one and one-half million returns, even if we take the 93 percent accuracy rate at face value, we note that the screens impact over 102,000 taxpayers with legitimate refund claims.¹⁸ Our continued case reviews reveal that a significant percentage of taxpayers who come to TAS for assistance with their refund holds have received full relief.

When EFDS selects a return for screening, it systemically holds the refund for 11 weeks.¹⁹ At that time, AMTAP sends a letter informing the taxpayer that income, withholding, or tax credits are being "reviewed" and that the IRS is holding the refund for a more thorough assessment.²⁰ The 11 weeks allows the IRS time for wage and withholding verification.

One method AMTAP uses to verify return information during this review period is to compare it with the Information Returns Master File (IRMF). The IRMF contains third-party information such as wage and withholding reported on Forms W-2, Wage and Tax Statement, and most Forms 1099, U.S. Information Return.²¹ If AMTAP cannot initially verify wage and withholding documents systemically via the IRMF, it moves on to a manual "verification" process. AMTAP employees attempt to contact the employer to verify the amounts reported on the return by disc, fax, or phone.²² If AMTAP verifies the wages and withholding as accurate, the IRS will release the refund.

If AMTAP cannot verify the information through internal records or by contacting the employer, the IRS sends the taxpayer a notice or a letter requesting documentation (e.g., pay stubs, Forms W-2), and extends the refund hold.²³ AMTAP will also convert the hold from a temporary (soft) hold to a permanent (hard) one when it has not completed the verification process before the temporary hold expires.²⁴

AMTAP Employees Given Early Access to Information Reporting Data.

Traditional manual verification of wage information is a time-consuming process, making it difficult for AMTAP to meet the 70-day response time promised to taxpayers. One of the tools used to verify wage withholding on questionable returns is the Information Returns Processing Transcript Requests (IRPTR) command code.²⁵ Historically, current tax year IRPTR information was not available until mid-May of the following year.

The National Taxpayer Advocate has previously noted that taxpayers would benefit greatly if the IRS could find a way to utilize IRPTR data in real time, or even a month earlier.²⁶ Beginning in the 2012 filing season, AMTAP employees were given access to IRPTR in March, which enabled AMTAP to systemically verify wages and withholding on almost 530,000 questionable refund claims (34 percent of all returns verified) much more efficiently.²⁷

Lack of Resources and Increasing Inventory Selection Are Reminiscent of Problems Identified in 2005.

The old adage that history repeats itself appears to apply to the QRP, regardless of whether AMTAP or CI is responsible for the program. Even though AMTAP staffing has increased, it appears the growth is not sufficient to handle the volume of cases the program selects for screening and verification, a number that rises each year.²⁸ In FY 2012, AMTAP selected over 1.4 million information documents for verification, compared to just over 430,000 in 2010.²⁹ This represents a 238 percent increase over the last three years. Thus, it is not surprising that AMTAP cannot complete the verification process in the agreed-upon time.³⁰

The IRS Should Use Hard Refund Freezes Only When There Is an Indication of Fraud, Not as an Inventory Management Tool.

Given the importance of protecting taxpayers and the tax system from refund fraud and improper payments, the National Taxpayer Advocate believes the IRS should have a reasonable time to determine whether a refund claim bears the "badges of fraud" or is otherwise suspect, such that it should be held for further investigation or examination. As provided in the 2006 memorandum, the IRS and the National Taxpayer Advocate agreed that, unless IRS referred the claim for criminal investigation, releasing refunds systemically within 70 calendar days of the initial claim struck an appropriate balance between revenue protection and taxpayer burden.³¹ As a consequence, CI issued guidance stating that claims "must be resolved within 70 calendar days; if not, the refund will be automatically released through master file programming."³²

However, when the QRP transferred from CI to W&I, the IRS reneged on its commitment to release refunds if it cannot determine in a reasonable time that a claim requires additional investigation. Current procedures advise IRS employees that "[i]t may be necessary to take additional actions to hold the refund after the 11 cycle freeze [77 days] if a permanent freeze has not posted and the final return disposition still is uncertain."³³ In practice, the IRS routinely extends refund freezes by placing hard freezes on accounts, as evidenced by the subsequent freeze applied to 142,000 taxpayer accounts in FY 2012 -- almost 10 percent of all taxpayer accounts selected for verification by AMTAP.³⁴ Instead of releasing refunds after 11 weeks when it cannot determine they warrant deeper scrutiny, AMTAP is placing hard freezes on the accounts in which fraudulent activity is suspected, because it could not verify wages and withholding within the established timeframe. In other words, AMTAP is using a hard freeze as an inventory management tool, without sufficient analysis of relative risk.

Concerned about the increasing delay in AMTAP's review of these cases, the National Taxpayer Advocate asked that AMTAP extend the "soft" freeze, rather than applying a hard freeze on these 142,000 accounts. EFDS systems limitations prevent AMTAP from extending the soft freeze of 11 weeks originally placed on the accounts, and a "hard" freeze must be applied to prevent the systemic release of these refunds.³⁵ The inherent problem with a hard freeze is that once it is placed on an account, the IRS faces no external pressure to work the case quickly. These returns can be left to languish while IRS works subsequent returns, re-creating the 2005 debacle all over again.³⁶

As Yearly Screening Volumes Increase, Imperfect Screens Trap and Harm Taxpayers.

As the total volume of tax returns selected for screening has increased over the past several years, so has the volume of information documents selected for manual verification of wages. The number of information documents (IDOC's) that IRS selects for verification has risen 238 percent from 2010 to 2012. See Figure 1.6.1 below.³⁷

 FIGURE 1.6.1, Increase in AMTAP Verification of Information Documents

As the IRS stops refunds, TAS receives more requests for help from the taxpayers. Between FY 2010 and FY 2012, TAS pre-refund cases rose 468 percent and constituted 8.2 percent of TAS case receipts in FY 2012.⁴⁰

     FIGURE 1.6.2, TAS Pre-refund Wage Verification Case Receipts,

Returns claiming the EITC made up nearly 17 percent of all cases the IRS selected for verification in calendar year (CY) 2012.⁴³ When the IRS holds legitimate refunds for extended periods, it further exacerbates the taxpayers' hardships, especially for low income taxpayers who may need the refunds for food, medical care, rent, or utilities. Previous studies of AMTAP cases revealed that the frozen refunds on cases claiming EITC and showing low income strata represented over 25 percent of the taxpayers' yearly incomes.⁴⁴

In TAS's 2012 review of pre-refund cases, 53 percent of the taxpayers claimed and received EITC. These taxpayers waited more than three months for a median refund of $5,175. The refunds comprised 38 percent of their adjusted gross income.⁴⁵

The IRS Does Not Always Send Notices or Verify Returns When It Identifies Questionable Refund Claims, Contrary to its 2006 Agreement with the National Taxpayer Advocate.

The IRS encounters many different types of schemes designed to defraud the government and its taxpayers. One significant scheme, identified by the IRS in 1999, has been dubbed "Operation Mass Mail" (OMM). Originally, the perpetrators used Social Security numbers (SSNs) from Puerto Rican residents due to the unlikely probability that those individuals will file a U.S. tax return. In recent years, perpetrators have been using SSNs from U.S. territories as well as the 50 states. As a way to combat this scheme, the IRS looks for tax returns containing certain characteristics. If a return fits this profile, it is not processed (in IRS parlance, it is "auto-voided").⁴⁶ When a return is auto-voided, the IRS does not process the return; rather, the IRS archives the return. If the taxpayer later comes forward and confirms his/her identity as a legitimate taxpayer with a filing obligation, the IRS will retrieve the return and process it as of the original filing date.

The IRS stops hundreds of thousands of OMM returns each year, and believes the OMM matrix it developed to combat the scheme is highly effective. In CY 2012, AMTAP identified approximately 934,504 returns that fit OMM criteria.⁴⁷

The National Taxpayer Advocate commends the IRS for taking proactive measures to protect the public fisc from fraudulent refund claims. However, we are concerned that the criteria used to identify an OMM return are sweeping in their reach and could ensnare legitimate taxpayers.⁴⁸

As the IRS does not send notices to OMM-affected taxpayers or verify the information on returns that it suspects may belong to the OMM scheme, taxpayers only learn their returns were auto-voided when they call to inquire about their refunds. At that point, the IRS Customer Service Representative (CSR) will instruct the taxpayer to re-submit the return, but will not tell him or her about its auto-void status.⁴⁹ When the taxpayer resubmits the return (e.g., TAS secures and forwards the taxpayer's return), AMTAP will screen and verify it. If the return verifies as good, AMTAP will code it with a Special Processing Code (SPC) "B" and forward it to be processed. However, the resubmitted return will not post and must be manually "forced" to post.⁵⁰

The IRS has an obligation to expedite the processing of a resubmitted return when it is known to be legitimate. These taxpayers have already been harmed by the IRS's failure to notify them that their returns have been deemed invalid and auto-voided. The IRS should institute programming that will allow the taxpayers' subsequent valid returns, once verified, to post immediately. Instead, returns identified as OMM will not automatically be processed, even after they are reviewed and coded as "good." The IRS has indicated that it planned to revise its programming to allow the returns with SPC B to be processed without further delay.⁵¹ However, the IRS has not committed resources to change the programming.

To summarize, after waiting months for a refund, not knowing that the IRS voided the return, calling, and re-submitting the return, the taxpayer must still wait. The resubmitted return will automatically go unpostable, even after verification shows it is correct, because the IRS has not made it a priority to allow these returns to post. Thus, the IRS's inaction continues to harm these taxpayer-victims of IRS processes, and creates re-work for its own employees.

Lack of Transparency in the AMTAP Operation Leaves Both IRS Employees and Taxpayers in the Dark, and Generates Downstream Work.

The Electronic Fraud Detection System allows AMTAP to screen and verify returns suspected of fraud, but it is much more. EFDS is AMTAP's inventory management program and records actions taken on returns. There is one big disadvantage to this approach, though -- for the most part, only AMTAP employees have access to EFDS.

Under the 2006 agreement with the National Taxpayer Advocate, EFDS now automatically generates a notice to a taxpayer when his or her return is selected for screening. The letter advises the taxpayer that the refund is being held for additional review, lists four items that may be reviewed (income, withholding, credits, and business income), and includes a toll-free number that the taxpayer can call if he or she does not receive the refund or hear from the IRS within 45 days.⁵² The number will connect the taxpayer with an AM customer service representative.⁵³

Almost 25 percent of those receiving these notices called the IRS in 2012.⁵⁴ As of October 8, 2012, the IRS had issued over one million such notices and the CSRs in AM had received almost 265,000 calls about them.⁵⁵ When a taxpayer calls, the CSR cannot advise the taxpayer about the status of the review, as only AMTAP has access to that information. Instead, the taxpayer, who has already waited 45 to 60 days, must wait again while the CSR completes and sends Form 4442 (which CSRs use to record a taxpayer's request in regard to a tax return) to AMTAP to inform it that the taxpayer has called.⁵⁶ If after another 45 days have passed, the taxpayer still does not receive a response from AMTAP, and the case involves identity theft, the CSR will send a second Form 4442 to the AM Identity Protection Specialized Unit (IPSU).⁵⁷ Cases that do not involve identity theft are referred to TAS.⁵⁸

Delays in the AMTAP process generate additional calls and paperwork, and consume the resources of multiple IRS units.⁵⁹ The IRS should revamp and streamline its process to more efficiently assist taxpayers whose returns have been selected for review by EFDS. Phone calls in response to notices should be directed to AMTAP in real time, as only AMTAP employees can apprise the taxpayer of the status of his or her account. Not only is it a waste of IRS resources for the taxpayer to speak to IRS employees from various functions, but the taxpayers are more likely to be confused about what documentation the IRS needs, or may have to submit documentation multiple times, or they may just give up -- not because they aren't entitled to the refund, but because they just don't have the wherewithal to handle the runaround.

Coordination Between Business Functions Is Imperative to the Efficient and Smooth Transfer of Case Work.

Few things are more frustrating for taxpayers than calling the IRS about their refunds and being told that the IRS cannot locate their cases. It is understandable that different functions within the IRS will need to work on a case, but the IRS must ensure that the transfer is seamless, and cases do not get lost.

In 2011 and 2012, TAS worked with AMTAP and Examination ("Exam") trying to locate taxpayer returns targeted for transfer to Exam from AMTAP. AMTAP could not tell TAS what campus Exam office received the work, because the case had not opened up on Exam's Audit Information Management System. It was ascertained that Exam's case codes did not match the issues on the returns that needed to be examined, and conversely the returns could not be systemically transferred to Exam. Some were rejected back to AMTAP, where they languished without being reviewed; others just remained in limbo. TAS case advocates endured months of not being able to respond substantively to taxpayers' inquiries, increasing taxpayer and TAS burden. This problem continues, revealing both a lack of recordation and coordination to ensure the successful transfer of returns from one function to another.

CONCLUSION

The IRS must deal with the challenging combination of increasing opportunities for refund fraud and decreasing resources to combat such activities. However, in using new screens and programs, the IRS must be careful not to repeat the mistakes identified in the QRP program in 2005. When the IRS deletes returns without notifying taxpayers or imposes extended delays on refunds, taxpayers will call. Exacerbating the situation, the taxpayer often cannot get through, or must wait extended periods to speak to a phone assistor, only to find that the assistor cannot tell the taxpayer anything about the status of the account. This situation creates both downstream work and taxpayer burden. Taxpayers need timely notice of refund holds, the ability to talk to a phone assistor when calling, accurate accounting of their return status, clear notification that explains consequences, and prompt and accurate resolution of legitimate claims. The fact that over 100,000 taxpayers, many of whom are low income and waiting for refunds that make up more than a third of their AGI, are ensnared in these processes, should drive the IRS to resolve these problems immediately, with a sense of urgency.

In conclusion, the National Taxpayer Advocate offers these preliminary recommendations:

The Taxpayer Assurance Program, known as AMTAP, recently completed its third filing season, and its first as part of the new Return Integrity and Correspondence Services (RICS) organization. RICS was established in October 2011 to create a centralized organization for ensuring revenue protection and refund compliance. The new RICS office has quickly moved to balance the taxpayer experience, revenue protection and resource efficiency. For filing season 2012, RICS increased AMTAP staffing significantly and trained all AMTAP permanent employees on account work to dedicate more highly skilled employees to successfully tackle the complex challenges of refund fraud and identity theft work. To further protect taxpayers and their refunds, the RICS organization deployed a specialized identity theft unit in FY 2012.

The IRS recognizes the need to always protect taxpayer rights. We must continually balance the rights of taxpayers with our responsibility to protect the interests of the United States and the majority of taxpayers who accurately file and pay their federal taxes. The voluntary compliance design of America's tax system requires the IRS to take efforts to support compliant taxpayers by detecting fraud and errors of those looking to be noncompliant. It is a continuous challenge to quickly identify perpetrators and individuals who use sophisticated methods to defraud the nation's tax system. This detection can be more time-consuming when individuals are not associated with a known scheme, and cases require analysis, third-party information, and actions to assure that legitimate taxpayers are protected.

As those attempting to commit refund fraud become more sophisticated, the IRS must take steps to respond accordingly. As discussed above, the IRS continues to recognize the importance of taxpayer rights, but we must ensure that processes are in place to effectively stop refund fraud. We consistently work to improve our fraud detection methods by developing improved system models to combat new fraud trends.

Those looking to defraud the government have become more brazen and are availing themselves to a variety of resources both outside and within the system to try to force the release of false refunds. In some cases, this even includes calling Taxpayer Assistance toll-free telephone numbers or seeking support through the Taxpayer Advocate Service. One example involves over 200 filings that IRS deemed fraudulent with associated revenue protected of more than $800,000. Thirty of those false returns had an open TAS case; meaning that perpetrators have contacted the IRS through TAS to try to force the release of the associated refunds. As another example, Operation Mass Mail is a scheme where perpetrators contact toll-free assistors and TAS to force refund release. In dealing with these situations, the IRS follows established taxpayer support requirements, which require use of valuable resources to ensure that the fraud determination is correct. These two examples are just a snapshot of the challenges to the IRS in maintaining a balance between protecting federal revenue and providing valid taxpayer support while minimizing taxpayer burden.

The IRS has increased its AMTAP staffing for the upcoming filing season and will assess the efficiencies gained from accelerated availability of Information Returns data to determine appropriate resource utilization and allocation for handling inventory. We will explore options to direct taxpayers to the personnel who can provide them with the most recent account status information.

With respect to the recommendation that the IRS track the number of tax returns "verified bad" by EFDS in addition to information documents, note that returns are verified as "bad" through the verification process, not by EFDS. Returns are selected for screening while verification occurs based upon the information documents associated with the return. AMTAP does track the number of bad/stopped returns in addition to information documents.

With respect to case transfers, a system exists for tracking referrals to Exam. Any return referred to Exam in a particular processing year can be tracked via EFDS. Reviews of rejected returns currently occur on a regular basis. RICS performed an in-depth analysis surrounding the specific reject reasons in 2012. For 2013, a work request has been submitted for system updates to help facilitate with the processing of rejected returns.

While the IRS strives to release all valid returns as soon as possible, we cannot commit to an automatic release in cases in which issues are suspected. The IRS developed revenue protection processes over many years using historical data to determine that fraud is indicated. The IRS refines fraud models each year based on performance and new characteristics and updates procedures for reviewing and processing revenue protection inventory accordingly to ensure that there are indications of fraud before holding a refund. Manual screening processes also ensure that a return meets established fraud characteristics before designation for verification and refund hold. Due to the historical evidence of known fraud, the explosion in fraud and identity theft in the past two years, and the consistent amount of revenue protected by IRS fraud detection efforts developed from this analysis, the IRS must maintain the right to determine when a hard refund freeze is appropriate. The IRS is exploring options to extend the soft freeze in increments. Note that the IRS corresponds with taxpayers when returns are sent through the fraud verification process.

With respect to the OMM scheme, IRS developed the policy to "auto-archive" returns based on historical analysis of repeated fraud characteristics. For example, the Operation Mass Mail scheme is a very high volume scheme attempted annually. Part of the scheming effort is to inundate IRS with returns to force release of some of the refunds. In calendar year 2012, we received 363,837 OMM returns through EFDS and only 0.7 percent of these were valid. Because of the low incidence that valid returns are impacted, attempting to correspond on these fraudulent returns would be an ineffective use of resources and taxpayer dollars. These returns often have an address not associated to the Social Security number owner or may use a decedent SSN or be a first-time filing where there is no good address. Experience with corresponding on other types of revenue protection inventory shows us that it is highly likely that correspondence would come back as undeliverable, resulting in a waste of the resources used to create and mail the correspondence, as well as the creation of unnecessary back-end. Expending our limited resources on this work is not prudent. In addition, corresponding provides those committing fraud with additional or new avenues to try to force refund release by giving them toll-free numbers to contact. By auto-archiving the massive volumes of these fraud returns and only processing a return when a true SSN owner is known and submits a valid filing, the IRS saves taxpayer dollars and reduces negative impact that would result from trying to treat them as legitimate filings when they meet well-established, known fraud markers. We have found that where a real taxpayer exists, they will contact the IRS. At that point we will work with the taxpayer to issue the refund.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate fully recognizes the need for the IRS to thoroughly screen refund claims before processing payments to taxpayers. We do not disagree that perpetrators have become more crafty, bold, and persistent in their attempts to obtain refunds to which they are not entitled. We encourage the IRS to continue improving its fraud detection filters to combat refund fraud more effectively.

Yet even in this environment, the National Taxpayer Advocate is compelled to remind the IRS that all taxpayers are entitled to due process. Assuming that the IRS is accurate when it estimates 93 percent of the 1.4 million returns stopped by EFDS contain inflated refund claims, that could leave more than 100,000 taxpayers whose legitimate claims will be held up unnecessarily. Although the IRS may view EFDS scoring or OMM matrices as reliable indicators of fraud, it is important that the taxpayer be given an opportunity to present facts to support his or her claim. Even the most reliable filters will ensnare legitimate filers. The IRS must be prepared to assist these honest taxpayers as quickly as possible.

In 2006, the National Taxpayer Advocate met with IRS leadership to discuss what would be an acceptable amount of time for a taxpayer whose return has been frozen to wait for the IRS to complete its verification. All parties agreed that 70 days should be sufficient, and if the verification could not be finished within that period, the IRS would release the refund freeze unless it had reason to believe further investigation was necessary. Today, the IRS is saying that 70 days is not long enough, and is routinely applying hard freezes on taxpayer accounts, in violation of the 2006 memorandum of understanding.

The National Taxpayer Advocate has never questioned the IRS's right to impose a "hard freeze" where the facts of the case warrant one. However, in its response, the IRS is maintaining that it should have the ability to impose a "hard freeze" even where the facts do not warrant. The IRS bases this position on what it calls "historical evidence of known fraud." Yet in justifying its position, the IRS ignores the most compelling "historical evidence" cited in our report -- namely, that the number of legitimate tax returns ensnared in IRS anti-fraud filters has increased by 75 percent over the last three years, from 58,013 in 2010 to 101,678 in 2012. If the IRS cared about providing relief to these legitimate taxpayers as much as it cared about stopping fraud, TAS would have far fewer refund fraud cases in its inventory.

If AMTAP is truly inundated by so many questionable refund claims that the unit cannot keep up with its verification inventory, then the IRS should bring all parties together and propose an adjustment to the 70-day timeframe. At a minimum, the IRS should institute programming that would allow AMTAP to extend the temporary freeze by 30 days on a case-by-case basis. Instead, AMTAP unilaterally decided to permanently freeze accounts -- more or less as an inventory management tool. The National Taxpayer Advocate is concerned that when AMTAP applies a permanent freeze, the unit will feel no external pressure to complete the verification in a timely manner, and taxpayers will be harmed by waiting significantly longer than the 70 days agreed upon in 2006.

In this Most Serious Problem discussion, the National Taxpayer Advocate has proposed several extremely reasonable recommendations that will bring relief to legitimate taxpayers who are caught up in the IRS' necessary fraud protection actions while still allowing the IRS to vigorously protect revenue. The IRS's dismissal of these recommendations in its response demonstrates its lack of commitment to taxpayers who are the victims of its processes. The National Taxpayer Advocate wonders how many more taxpayers must be harmed in this way before the IRS decides it is "worth" acting.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

² The IRS uses third-party data in an attempt to verify wages and withholding reported on returns claiming refunds.

³ Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2007-10-076, Actions Have Been Taken to Address Deficiencies in the Questionable Refund Program; However, Many Concerns Remain, with Millions of Dollars at Risk 11 (May 2007).

⁴ Wage and Investment Division (W&I) Business Performance Review, 2nd Quarter 2012 (May 18, 2012).

⁵ A hard freeze (designated with transaction code 570) indicates an additional liability is pending and keeps the module from refunding or offsetting credit out (transferring funds to other federal debt owed by the taxpayer). A hard freeze may be released manually or when the refund request has been disallowed.

⁶ Email from AMTAP (May 10, 2012). The National Taxpayer Advocate had requested IRS extend the "soft freeze" on these unworked accounts instead of placing a hard freeze on them, which would retain pressure on the IRS to work these cases quickly. The IRS stated that "systems limitations" prevent it from extending soft freezes. Id.

⁷ TAS Business Performance Review, 4th Qtr. 2010 thru 4th Qtr. 2012. TAS started using Primary Issue Code (PIC) 045 on March 24, 2010, to identify AMTAP pre-refund cases. FY 2010 PIC 045 receipts: 3,171; FY 2011 PIC 045 receipts: 21,286; FY 2012 PIC 045 receipts: 18,012. TAMIS/Business Objects (BOBJ) Report FY Receipts 2010, 2011, 2012.

⁸ TAMIS/Business Objects (BOBJ) Report FY Receipts 2010, 2011, 2012.

⁹ TAS 2012 analysis of Compliance Data Warehouse (CDW) data from the Individual Returns Transaction File of 474 closed TAS cases with PIC 045 (Pre-Refund Wage Verification) pulled on October 5, 2012 (hereinafter "TAS 2012 Study"). This was a representative sample of TAS cases and had a confidence level of 95 percent.

¹⁰See TAS 2012 Study.

¹¹See id. There were 241 EITC taxpayers in our random sample of 494 PIC 045 cases. The median AGI was $14,101, median refund was $5,175, and median refund hold was 99 days.

¹² When a return is auto-voided, the IRS does not process the return; rather, the IRS archives the return, either electronically in Tax Return Data Base (TRDB) or on paper in Files. If the taxpayer later comes forward and confirms his/her identity as a legitimate taxpayer with a filing obligation, the IRS will retrieve the return and process it as of the original filing date. All returns being suspected as part of the Operation Mass Mailing scheme are auto-voided.

¹³See National Taxpayer Advocate 2005 Annual Report to Congress vol. 2, 2 (Criminal Investigation Refund Freeze Study).

¹⁴See id. at 15.

¹⁵See TAS analysis of CDW data from the Individual Returns Transaction File of 373 closed TAS cases with PIC 045 (Pre-Refund Wage Verification) and PIC 425 (Stolen Identity) with secondary issue code (SIC) 045 cases pulled on October 11, 2011 (hereinafter "TAS 2011 Study"). This was a representative sample of TAS cases and had a confidence level of 95 percent.

¹⁶See TAS 2011 Study.

¹⁷See W&I response to TAS information request (Aug. 28, 2012).

¹⁸ There were 1,452,549 cases selected for verification in 2012 through October 15. Seven percent, or 102,236, were not verified "bad." See W&I response to TAS information request (Nov. 19, 2012).

¹⁹ The temporary freeze is automated within EFDS, and is evidenced by TC 971-134 on the taxpayer's account. IRM 21.9.1.2.3 (Mar. 1, 2012).

²⁰ Notice CP 05, Information Regarding Your Refund.

²¹ Under present law, issuers who file these forms electronically have until March 31 to file them with the government. Issuers send Forms 1099 directly to the IRS and Forms W-2 directly to the Social Security Administration (SSA), which in turn sends information extracted from the forms to the IRS each week, starting in late March. Internal Revenue Code (IRC) §§ 6051(a), 6049(a), 6042(a); see IRS Instructions for Forms W-2 and W-3, Wage and Tax Statement and Transmittal of Wage and Tax Statements; Social Security Administration, Employer W-2 Filing Instructions & Information, available at http://www.ssa.gov/employer/gen.htm (last visited Oct. 24, 2012). For a more detailed discussion of third- party information reporting and its uses, see Status Update: The Preservation of Fundamental Taxpayer Rights Is Critical as the IRS Develops a Real-Time Tax System, infra.

²² IRM 21.9.1.8(1) (May 4, 2012). The IRS employs several methods to contact employers for verification of wages, adhering to the employer preference if one exists. Letters are sent annually to certain large employers, requesting them to provide wage information on a computer disc. Requests for verification are automatically generated by fax; phone calls are made based on employer preference.

²³ IRM 21.9.1.8(1) (May 4, 2012). Letter 4115 requests income documentation from the taxpayer/employee (e.g., copies of checks, bank statements, pay statements, check stubs, and employer letters).

²⁴ Email from AMTAP analyst (Sept. 28, 2011).

²⁵ The IRPTR command code allows IRS employees to request either online or hardcopy Information Returns Processing transcripts from the Information Returns Master File. IRM 2.3.35.1 (Aug. 1, 2003).

²⁶See National Taxpayer Advocate 2011 Annual Report to Congress 32, 47.

²⁷ As of June 30, 2012, IRS used IRPTR to verify 529,842 returns, 34 percent of the total returns verified as of that date. See W&I response to TAS information request (Aug. 28, 2012).

²⁸ AMTAP was staffed with 336 full-time equivalents in 2010 and 477 full-time equivalents in 2012. See W&I response to TAS information request (Aug. 28, 2012).

²⁹See W&I response to TAS information request (Nov. 19, 2012).

³⁰ On October 17, 2012, TAS requested information from the IRS showing the number of returns over a period of years that AMTAP selected for screening, the volume selected for manual verification, and the volume ultimately cleared for refund. AMTAP instead provided TAS with the volume of information documents (IDOCs) selected for verification. As TAS cannot directly correlate the number of IDOCs to the number of returns, we are unable to show the relationship of selected/verified/released returns. See W&I response to TAS information request (Nov. 19, 2012).

³¹See Memorandum Regarding IRS Criminal Investigation Questionable Refund Program Procedures (Feb. 3, 2006); National Taxpayer Advocate 2006 Annual Report to Congress 412; IRS, Fraud Detection Center -- FDC Guidelines for Processing Year 2007 Issued by Refund Crimes and the Fraud Detection Centers 17 (Dec. 2006). When AMTAP inputs a TC 971 AC 134, the module is systemically frozen from refunding for 11 weeks. If AMTAP has missed the cutoff to input the TC 971 AC 134, it must input a "hard" freeze, which has no systemic release.

³²See IRS, Fraud Detection Center -- FDC Guidelines for Processing Year 2007 Issued by Refund Crimes and the Fraud Detection Centers 17 (Dec. 2006). At that time, returns underwent a one-week "re-sequencing" period (now two weeks) while processing, so the refund hold was for 77 days.

³³ IRM 21.9.1.2.3 Stopping the Refund (Mar. 1, 2012). Generally, returns selected for verification before the refund stop date will follow an automatic EFDS process to stop the refund for 11 weeks (with input of the TC 971-134). Returns that require manual verification or have unsubstantiated withholding, etc., will require a manual hold or "hard" freeze, which holds the refund permanently (until another action is taken to release the refund).

³⁴ Email from AMTAP (May 10, 2012).

³⁵Id.

³⁶See National Taxpayer Advocate 2005 Annual Report to Congress 25.

³⁷See W&I responses to TAS information requests (Aug. 28, 2012, and Nov. 19, 2012).

³⁸ On October 17, 2012, TAS requested information from the IRS showing the number of returns over a period of years that AMTAPselected for screening, the volume selected for manual verification, and the volume ultimately cleared for refund. AMTAP instead provided TAS with the volume of IDOCs selected for verification. AMTAP stated that data mining modeling is applied against "returns" and "returns" are selected for screening. Verification is performed on "Information Documents" associated to those returns that were determined to need verification. See W&I response to TAS information request (Aug. 28, 2012); see email from AMTAP (Oct. 29, 2011).

³⁹See W&I response to TAS information request (Nov. 19, 2012). AMTAP reports that 93 percent of information return documents in FY 2012 could not be verified as accurate (the IRS refers to these as "verified bad"). The remaining seven percent may include information return documents that are inconclusive or take longer to verify as inaccurate. However the National Taxpayer Advocate has repeatedly questioned what the IRS means by "verified bad." A significant percentage of taxpayers who come to TAS for assistance with AMTAP-related cases subsequently receive full refunds, as the information reported on their returns is ultimately verified as accurate. See TAS 2011 Study and TAS 2012 Study.

⁴⁰ TAMIS/Business Objects (BOBJ) Report FY Receipts 2010, 2011, and 2012.

⁴¹See TAS 2011 Study; TAS 2012 Study. The 2011 TAS study included 2009 and 2010 tax returns closed in 2011.

⁴²See id. The 2012 study included only 2011 tax returns closed in 2012. As the 2012 study did not include prior year returns, the refund hold time was considerably shorter than in the 2011 study. In the 2012 study, 71 percent of taxpayers received full relief and waited on average more than three months to receive that refund.

⁴³See W&I response to TAS information request (Nov. 19, 2012).

⁴⁴ National Taxpayer Advocate 2005 Annual Report to Congress vol. 2, 2, 12 (Criminal Investigation Refund Freeze Study). Over half of the taxpayers in this study had an adjusted gross income of less than $13,000. On average, the frozen refunds represented 25 percent of the taxpayers' yearly income. Nearly 75 percent of the taxpayers who claimed the EITC were allowed the credit after IRS processing. The average amount of the EITC initially claimed was $2,853. Overall, 80 percent of the taxpayers in the study received at least a partial refund, after waiting on average nine months.

⁴⁵ TAS 2012 study. There were 241 EITC taxpayers in our random sample of 494 PIC 045 cases. The median AGI was $14,101, median refund was $5,175, and median refund hold was 99 days.

⁴⁶ IRM 3.12.2.279.7 (Jan. 1, 2012). Auto-voided or auto-rejected cases are closed automatically without human intervention. These processes apply to all unpostable areas/functions. See IRM 3.12.179.4.6 (Jan. 1, 1998).

⁴⁷ AMTAP identified 934,504 OMM returns through October 15, 2012. See W&I response to TAS information request (Nov. 19, 2012).

⁴⁸ The National Taxpayer Advocate is not at liberty to disclose these OMM criteria, but has expressed her concern to the highest levels of the IRS about the sweep of these rules and their underlying assumptions.

⁴⁹See IRM 21.5.6.4.35.3 (May 9, 2012).

⁵⁰ IRM 10.5.3.2.2.4.4 (Nov. 15, 2011). Some of the taxpayers whose returns were marked "OMM" came to TAS for help in obtaining their refunds. In the 2011 TAS study, 23 out of 373 cases (six percent) were identified as OMM cases. Of these, TAS was able to obtain relief in 17 cases, or 74 percent of the time (with full relief in 16 cases, 70 percent of the time). For further details, see National Taxpayer Advocate 2011 Annual Report to Congress 36-37.

⁵¹ IRM 10.3.2.2.4.4 (July 8, 2010). Special Processing Code "B will bypass the UPC 147.

⁵²See IRS CP05 notice.

⁵³Id.

⁵⁴See W&I response to TAS information request (Nov. 19, 2012).

⁵⁵ The volume of CP05 notices was as of October 8, 2012. The call volumes are estimates. See W&I response to TAS information request (Nov. 19, 2012). Note: Some calls received on these issues may be from perpetrators posing as legitimate taxpayers in a further attempt to receive a fraudulent refund.

⁵⁶ IRM 21.5.6.4.35.3 (Oct. 3, 2012).

⁵⁷ In general, cases will be forwarded to IPSU if the taxpayer is a victim of identity theft and the case meets TAS criteria 5-7 (systemic burden). See Memorandum of Understanding Between the National Taxpayer Advocate and the Commissioner, Wage & Investment to Transition TAS Criteria 5-7 Identity Theft Cases to Wage & Investment Identity Protection Specialized Unit (IPSU) (Mar. 31, 2010).

⁵⁸ IRM 21.5.6.4.35.3 (Oct. 3, 2012).

⁵⁹See Most Serious Problem: The IRS Telephone and Correspondence Services Have Deteriorated Over the Last Decade and Must Improve to Meet Taxpayer Needs, infra.

Peggy Bogadi, Commissioner, Wage and Investment Division

DEFINTION OF PROBLEM

The adoption tax credit was created in 1996 to encourage adoption and help offset the potentially onerous costs associated with the process, particularly for low and middle income families.¹ The Patient Protection and Affordable Care Act increased the maximum credit amount under Internal Revenue Code (IRC) § 36C and made the credit fully refundable for 2010 and 2011.² The changes to the credit caused the IRS to alter its compliance strategy to focus on minimizing improper payments and stopping potentially fraudulent claims. As a result:

• During the 2012 filing season, 90 percent of returns claiming the refundable adoption credit were subject to additional review to determine if an examination was necessary.³ The most common reasons were income and a lack of documentation.

• Sixty-nine percent of all adoption credit claims during the 2012 filing season were selected for audit.⁴

• Of the completed adoption tax credit audits, over 55 percent ended with no change in the tax owed or refund due in fiscal year 2012.⁵ The median refund amount involved in these audits is over $15,000 and the median adjusted gross income (AGI) of the taxpayers involved is about 64,000.⁶ The average adoption credit correspondence audit currently takes 126 days, causing a lengthy delay for taxpayers waiting for refunds.⁷

• Seventy-nine percent of returns selected for audit in filing season 2012 had missing, invalid, or insufficient documentation.⁸

• Despite Congress' express intent to target the credit to low and middle income families, the IRS created income-based rules that were responsible for over one-third of all additional reviews in FY 2012.⁹

• Of the $668.1 million in adoption credit claims in tax year (TY) 2011 as a result of adoption credit audits, the IRS only disallowed $11 million -- or one and one-half percent -- in adoption credit claims.¹⁰ However, the IRS has also had to pay out $2.1 million in interest in TY 2011 to taxpayers whose refunds were held past the 45-day period allowed by law.¹¹

• The IRS did not inform taxpayers how long it would take to audit their returns and when they could expect a refund;

• The hold on the adoption credit portion of the refund caused financial burden for some eligible taxpayers;

• Auditors asked taxpayers to provide documentation before reviewing the information the taxpayers included with their original returns, so taxpayers who already submitted documentation had to send it twice;

• The inability of taxpayers to e-file returns claiming the credit resulted in delays and additional burden on taxpayers and the IRS;

• A lack of outreach has left many taxpayers unaware of their responsibilities in claiming the credit; and

• Examiners were not knowledgeable about the expanded adoption credit and how to handle the credit claimed for special needs children, thereby undermining the public policy the credit was designed to address.

As the National Taxpayer Advocate has noted in prior discussions of administering social policies through the Internal Revenue Code, the IRS must tailor its procedural requirements to the characteristics and capabilities of the target taxpayer population.¹⁵ With respect to the Adoption Credit, and in particular the credit for adoption of special needs children, the IRS has failed abysmally to take into account that over 45 percent of adopting families are at or below 200 percent federal poverty level, presenting particular communication and functional literacy challenges even as they are desperately in need of the funds which Congress has sought to deliver to them.¹⁶

The IRS's misguided procedures, and its failure to adequately adjust these processes when it learned its approach was seriously flawed, have caused significant economic harm to thousands of families who are selflessly trying to improve the lives of vulnerable children.¹⁷ Unless the IRS changes its approach to refundable credits and adopts more taxpayer-focused procedures, it will continue to cause problems for eligible taxpayers, including those eligible for the new refundable credit contained in the Patient Protection and Affordable Care Act -- the Premium Tax Credit.¹⁸

ANALYSIS OF PROBLEM

Background

As of September 30, 2010, over 400,000 children were in foster care. Over 100,000 of them, who are awaiting adoption,¹⁹ have been in continuous foster care for an average of more than three years.²⁰ The out-of-pocket costs associated with adoption vary. Domestic adoptions through a public adoption agency can cost from zero to $2,500. However, private and international adoptions can range from $5,000 to more than $40,000.²¹ As seen in Figure 1.7.1, over 30 percent of all adopted children and over 45 percent of the children adopted from foster care live in households with incomes no higher than twice the poverty threshold.²²

 

FIGURE 1.7.1, Household Income-to-Poverty Ratio of Adoptive

 

Families²³

 

 

 

The Adoption Tax Credit was established in 1996 to promote adoption and help offset its costs, particularly among low- and middle-income families. As noted during congressional discussion of the new credit:

In 2010, as part of the Patient Protection and Affordable Care Act, Congress increased the maximum credit to $13,170 per child and made it fully refundable for the 2010 and 2011 TYs.²⁶ This meant that even taxpayers who had no tax liability in 2010 or 2011 (or whose liability was less than their credit amount) could receive the credit as a refund.²⁷ For those adopting a child with special needs, the credit is available in the year in which the adoption becomes final, regardless of the expenses (if any) the taxpayer actually incurred in connection with the adoption.²⁸ The credit is complex and has different eligibility rules depending on the type of adoption: domestic, foreign, or special needs.²⁹

To qualify for the adoption credit, an individual must have adopted a child and paid qualified expenses related to the adoption (for non-special needs adoptions). Qualified expenses are those reasonable and necessary and directly related to the legal adoption of an eligible child.³⁰ These expenses include court costs, attorney fees, and travelling expenses.³¹ To claim the credit, taxpayers must file Form 8839, Qualified Adoption Expenses, with their tax return and attach the required documentation.

As shown in Table 1.7.2, the number of taxpayers claiming the adoption credit and the total amount of credit claimed increased dramatically after the expansion of the credit.

              TABLE 1.7.2, Adoption Credit Claims by Tax Year

Increased Audit Rate Burdens Both Taxpayers and the IRS and Offers Little Benefit

Given the refundability of the adoption credit and the dollars at stake, the IRS appears to have focused its efforts on enforcement and trying to stop potentially false or fraudulent credit payments rather than educating potentially eligible taxpayers and helping them claim the credit correctly. The IRS itself has admitted that it is "being very careful because it's a big chunk of money."³⁷ As a result, 69 percent of adoption credit claims were subject to examination in filing season 2012.³⁸

 

FIGURE 1.7.3, Filing Season 2012 Adoption Credit Claims vs.

 

Examinations³⁹

 

 

 

Of the tax returns that were subject to additional review, 26 percent of the delayed returns in FY 2012 were due to missing, invalid, or insufficient documentation.⁴⁰ The IRS subjected all adoption credit claims with missing or potentially invalid documentation to correspondence audit. Seventy nine percent of all adoption credit correspondence examinations in filing season 2012 involved problems with documentation.⁴¹

In addition to documentation issues, over one-third of filter breaks in FY 2012 were caused by income issues.⁴² The credit was designed, in part, to help offset the cost of adoption, and statistics show that a significant portion of individuals who adopt are lower and middle income. Yet the IRS still chose to create an income-based filter that flags the returns of the exact taxpayers the credit was designed to assist.

Despite the high number of audits, over 55 percent of adoption credit claims resulted in no change to the taxpayers' accounts during FY 2012.⁴³This means that more than 55 percent of taxpayers selected for audit were forced to wait 18 weeks for their refunds while the IRS verified that they were in fact entitled to the amount of the credit they claimed on their returns.⁴⁴ The median refund amount involved in these audits is over $15,000 and the median AGI of the taxpayers involved is about $64,000.⁴⁵

Examination Delays Burden Taxpayers.

As with other refundable credits, once selected for examination, the IRS holds the adoption credit portion of the refund until it completes the exam process. According to the IRS, the average correspondence audit for adoption credit cases took 126 days in FY 2012. This was up from 83 days in FY 2011.⁴⁶ As a result, many taxpayers experienced delays in receiving their adoption credit -- which was a potentially sizeable amount of money. In TY 2011, $332 million in refunds were delayed as a result of adoption credit audits.⁴⁷ This amounts to half of the $668.1 million in total adoption credit claims during the same period.⁴⁸ Some taxpayers may have been waiting on this money to help pay adoption expenses, and many expressed their frustration through Facebook, blogs, and tax software forums.⁴⁹ One taxpayer complained:

IRS's Adoption Credit Cost the IRS Valuable Resources.

As noted earlier, the vast majority of adoption credit claims were due to missing or potentially invalid documentation. Rather than picking up the phone and calling taxpayers to request the missing documentation, the IRS simply sent these returns to the correspondence exam unit. The IRS has a limited pool of correspondence exam resources, a portion of which were spent on adoption credit cases. However, the data show that very few of these cases resulted in additional tax. While the complexity of the adoption credit may mean that these cases may take longer to work, the no change rate demonstrates that the IRS's case selection mechanism is flawed. Rather than allowing the correspondence exam group to work its traditional inventory -- which has a no change rate of 15 percent in FY 2012 -- the IRS's overreaction to the size and refundability of the adoption credit created a drain on resources that would have been better spent on other cases.⁵⁴

Of the $668.1 million in adoption credit claims in TY 2011 as a result of adoption credit audits, the IRS only disallowed $11 million -- or one and one-half percent -- in adoption credit claims.⁵⁵ However, the IRS has also had to pay out $2.1 million in interest in TY 2011 to taxpayers whose refunds were held past the 45-day period allowed by law.⁵⁶ For FY 2012, the average audit results for adoption credit audits were $1,727 compared with the overall correspondence exam average results of $7,421 for FY 2011.⁵⁷

These meager revenue savings came at the expense of a disproportionate share of IRS correspondence exam resources, compared with the overall number of claims. GAO noted that adoption credit claims represent less than one-tenth of one percent of all individual returns for the 2011 filing season. By comparison, the IRS spent approximately 3.5 percent of its staff days on initial review and correspondence audit of adoption credit claims.⁵⁸ Additionally, the IRS reported to GAO that it did not find any fraudulent adoption credit claims or refer any cases to Criminal Investigation.⁵⁹

Documentation Issues Cause Significant Problems for Taxpayers and the IRS.

As noted earlier, for the 2012 filing season, the IRS selected 69 percent of adoption credit claims for correspondence audit -- 79 percent of which involved missing or insufficient documentation.⁶⁰ Thirty-five percent of all 2011 adoption credit returns filed during the 2012 filing season had no documentation attached.⁶¹ The GAO noted a similar -- but much more severe -- problem in its review of the adoption credit during the 2011 filing season.⁶²

Taxpayers Are Forced to Navigate Complex Documentation Rules.

The adoption credit requires taxpayers to provide substantiation at the time they file their returns -- in the form of an adoption order or decree. When it first enacted the credit, Congress intended to require taxpayers "to provide available information about the name, age, and taxpayer identification number of each adopted child." (Emphasis added.)⁶³ There was concern that even these minimal requirements might prove burdensome:

        FIGURE 1.7.4, Documentation requirements for Adoption Credit⁶⁶

The IRS is Unable to Quickly Address Documentation Issues or Identify Whether Provided Documentation is Sufficient.

As noted earlier, Congress specifically stated that it wanted to minimize the burden on adoptive parents when it imposed documentation requirements. However, the IRS's action in automatically sending claims that lack sufficient documentation to correspondence exam is the exact opposite of Congress's intent. The IRS could develop a way to quickly reach out to taxpayers to address the documentation problem, but instead chose the more burdensome and time-intensive approach. Once again, the IRS failed to look at the impacted taxpayers and design a compliance strategy around their particular needs and characteristics. Instead, it relied on its traditional processes and increased burden for taxpayers and its own employees.

While some taxpayers simply failed to provide any documentation, the IRS experienced problems identifying whether documentation was sufficient. In its audit, GAO spoke with adoption agency representatives that "acknowledged that IRS examiners faced challenges in identifying what documentation would be acceptable as proof of special needs status in each state."⁶⁸

The National Taxpayer Advocate is encouraged that the IRS took steps to update training materials for examiners and provide examples of acceptable assistance agreements for most states. However, the IRS failed to provide the same documentation samples to taxpayers and practitioners. In its response to the GAO audit, the IRS claimed such examples could lead to fraud. As GAO noted, even if someone used the sample documentation to file a fraudulent adoption credit claim, the person still needs to provide sufficient proof of adoption expenses to qualify for the credit. The sample documentation -- on its own -- is not sufficient to result in a fraudulent claim. Given the significant percentage of adoption credit audits that result from documentation problems and the costs to both taxpayers and the IRS -- the benefits of providing sample documentation clearly outweigh the risks.

Additionally, given the difficulties the IRS experiences with the various third-party forms, the IRS should develop a standard affidavit form that taxpayers could complete and have signed and certified by a designated official, to establish the critical information needed to establish eligibility for the credit. The IRS has undertaken similar efforts with the affidavit designed for the EITC pre-certification study.⁶⁹ Generally, this pilot program found affidavits more reliable than traditionally accepted documents: "Affidavits were believed to be easier for taxpayers to obtain than official documents or letters. The results show that affidavits had a higher acceptance rate than the other two types of documents."⁷⁰

Additionally, as observed by GAO, the IRS failed to adequately cooperate with state adoption agencies when it identified problems with documentation.⁷¹ By failing to work closely with state agencies, the IRS missed an opportunity to connect with the impacted population in order to learn what documentation was most easily available and least burdensome and to inform them about the final documentation requirements. The IRS needs to capitalize on partnerships to provide information to taxpayers when it identifies a particular problem. By failing to engage in proactive outreach, the documentation problems continued to plague taxpayers and the IRS.

The IRS Failed Taxpayers By Not Engaging in Proactive Outreach.

The adoption tax credit is a unique refundable credit in that the eligible population is somewhat small and -- if the IRS were willing to commit the time and limited resources -- relatively easy to identify. Many adoptions take place through state agencies, which have direct contact with eligible taxpayers and are highly incentivized to help eligible taxpayers receive the credit. Additionally, because of the nature of adoption, countless adoption groups have direct contact with adoptive parents. By partnering with state agencies and adoption groups, the IRS would have a direct line to eligible taxpayers. The IRS could have capitalized on these connections to educate taxpayers about the credit and reached out to these same groups to help resolve problems with documentation.

Initially, the IRS's limited outreach efforts involved posting information to the IRS website.⁷² The National Taxpayer Advocate is pleased that in 2012, the IRS offered two phone forums with state agencies and adoption agencies, allowing them to call in and ask questions about the credit.⁷³ However, this outreach was not proactive -- it placed the burden on the adoption groups to contact the IRS to receive information.⁷⁴ The IRS partners with stakeholders on an annual outreach campaign for the Earned Income Tax Credit, which kicks off with EITC Awareness Day.⁷⁵ The adoption community launched a similar effort -- Adoption Tax Credit Awareness Day -- to make adoptive families aware that the credit exists.⁷⁶ This would have been a perfect opportunity for the IRS to capitalize on an already planned outreach effort in order to reach impacted taxpayers.

Inability to e-File Adoption Credit Returns Causes Delay for Both Taxpayers and the IRS.

Taxpayers claiming the adoption tax credit can no longer file their returns electronically because the IRS requires paper documentation on Form 8839, Qualified Adoption Expenses. The prohibition on e-filing is burdensome to taxpayers who must now file paper returns. Additionally, it causes delay for both taxpayers and the IRS due to processing times and an inability to identify problematic returns more easily. E-filing capabilities for adoption credit returns would:

• Address some of the documentation problems and audit delays discussed previously;

• Require taxpayers to attach documentation to their returns before they could be submitted, reducing the number of returns submitted without documentation; and

• Allow the IRS to identify claims without supporting documentation earlier in the process, preventing delays for both taxpayers and the IRS.

Many of the Adoption Problems Could Have Been Minimized by Considering Administrative Issues Unique to Refundable Credits.

The National Taxpayer Advocate has previously noted that compliance issues with refundable credits often stem from the design of the credits, including

• Identification of the targeted population;

• Use of data to determine eligibility;

• Use of third-party affidavits; and

• Responsiveness of the IRS in administering the credit.⁸⁰

The IRS's Implementation of the Expanded Adoption Credit Does Not Bode Well for its Implementation of the Premium Tax Credit.

The adoption credit was not the only refundable credit in the Patient Protection and Affordable Care Act. The Premium Tax Credit, which goes into effect in 2014, has the potential to be one of the largest refundable credits the IRS has had to administer. The Premium Tax Credit raises the same potential for documentation, training, and fraud problems as the adoption credit. The IRS needs to evaluate the difficulties it encountered with the adoption credit and identify potential lessons learned that can be applied to the administration of the Premium Tax Credit. If the IRS does not take the time to learn from its adoption credit experience and be thoughtful about how it administers future refundable credits, it may face problems with the Premium Tax Credit -- including high examination rates -- that will overwhelm IRS resources and severely burden taxpayers.

CONCLUSION

By design, the adoption tax credit plays a critical role in helping taxpayers -- particularly low and middle income taxpayers -- meet the financial burden that may be involved in adopting a child. The IRS, facing a sizeable refundable credit, reacted with an enforcement strategy that was focused on stopping nearly all returns claiming the credit and subjecting a large percentage of them to an audit, instead of reaching out to stakeholders (including states) to understand the impacted taxpayer population. When problems emerged, the IRS simply continued selecting returns for audit. This approach forced taxpayers to withstand lengthy delays and the IRS to expend valuable resources with very little to show for them. As the IRS faces a new refundable credit in the form of the Premium Tax Credit, it should study and learn from its mistakes to avoid repeating them again, when there will be even more at stake.

The National Taxpayer Advocate preliminarily recommends that the IRS:

The IRS modeled the adoption credit program on processes and procedures in place for other refundable credits and built upon lessons learned from our experience in administering those programs. Our programs for refundable credits emphasize outreach to taxpayers and supporting stakeholders as well as overall compliance with the tax laws. The IRS is committed to ensuring adoptive parents receive the benefits to which they are entitled, and that they understand and fulfill their tax obligations.

The IRS implemented the adoption credit program with an approach that balanced the objective of paying legitimate credits in a timely manner with that of ensuring that claims were accurate. Our experiences and lessons learned from other refundable credits taught us that high dollar credits have high risk and the potential for fraud. We must ensure delivery of the credit to those entitled while protecting the government's interest in minimizing exposure to fraud.

As noted in the Most Serious Problem, the adoption credit environment and rules are varied and complex, making the credit challenging to administer. There are different rules for special needs, foreign, and domestic adoption options, nonqualification of expenses paid for by federal, state or local adoption grant programs, and carryforward provisions. Centralized third-party data does not exist for the IRS to validate all claims.

The IRS evaluated the risk associated with this high-dollar credit and decided to require taxpayers to attach documentation to their returns. We implemented new procedures within the IRS to review the documentation and quickly process the returns, our goal being to avoid refund delays for taxpayers who attached requested documents. We developed examination filters, based on historical filing data, characteristics of taxpayers claiming the adoption credit in the past, other research data we gathered, and lessons learned from other refundable credits. We used that information to develop our filters and adjusted as needed for new information and experience.

The IRS held monthly cross-functional meetings that included TAS representatives to review implementation of the strategy, to immediately address issues, to streamline internal processes and to cultivate servicewide best practices. This involved continual monitoring and adjustment of our examination filters. The IRS analyzed the data collected and compiled lessons learned from the first year of the adoption credit program. As a result, changes were made to examination filtering, selection processes and outreach based on a reexamination of associated risk through data captured. The changes made improved and reduced audit selections and reduced taxpayer burden.

Recognizing the taxpayer impact of holding large-dollar refunds, the IRS placed additional emphasis on processing adoption credit audits in an expeditious manner. Due to the upfront documentation requirement, the processes we put in place and the priority we assigned these cases, the cycle time for closed examination adoption cases has been significantly less than other audits. We believe the lack of fraud identified with this credit was in large part due to the documentation requirements that were implemented.

In FY 2012, we found errors in 44 percent of the returns we examined and closed, protecting revenue of almost $135.5 million. During both FY 2011 and FY 2012, we protected almost $164 million on cases closed in our examination functions. Examinations on TY (TY) 2011 returns continue, and we expect that the overall change rate and dollars assessed will continue to increase as the cases close.

As part of our effort to help adopting taxpayers understand and fulfill their tax obligations, we emphasized information on internal and external websites regarding the documentation requirement as well as the examination process. We emphasized information such as documents needed and potential consequences of not including documentation, which could cause refund delays and subject returns to audits. We included information on expected timing, including average examination process time as well as post examination refund issuance.

In addition to the compliance part of our strategy around the adoption credit, the IRS implemented an equally important strategic communication plan for outreach. The communication strategy included collaboration with external stakeholders and extensive training for our tax examiners. The IRS coordinated with various state agencies to identify third party data that could be used to verify legitimate domestic and special needs claims. Our communication plan included outreach activities and products and guidance. We updated forms and publications, posted information on our internal and external websites, issued public service announcements, communicated with the professional preparer community and collaborated with software developers. Our goal was to ensure taxpayers, preparers, adoption organizations, and software developers who supported the taxpayers in different roles, understood the new adoption credit requirements and procedures.

When a high percentage of taxpayers did not attach required documents, the IRS immediately took action with a new communications effort. The IRS issued a Tax Tip, email blasts to adoption organizations, e-News for Tax Professionals, and a YouTube video, all of which focused on the new documentation requirement. The IRS reached out to software developers and large tax preparation firms to notify them of the documentation problem and to request their assistance. As a result, these partners improved software and issued guidance to preparers. These efforts resulted in a 40 percent improvement in the percentage of returns filed with no documentation from the 2011 to 2012 filing season.

In FY2012, based on stakeholder feedback, we expanded and further improved our outreach. In addition to making standard yearly updates for amounts and limitations, we (i) revised the Instructions and Form 8839 to include statements at the top and bottom of the form to direct taxpayers to attach required documents; (ii) developed a Tax Talk Today webcast for preparers which included information on steps preparers could take to assure eligible taxpayers receive the adoption credit; (iii) recognized National Adoption Credit Month with an IRS News Tweet with a link to irs.gov; (iv) held two Webinars with various state and private adoption agencies; and (v) posted an If/Then Chart to simplify documentation requirements for the different types of adoptions.

The IRS agrees it is important for taxpayers to understand what documentation is acceptable. However, the IRS believes while posting examples of acceptable documentation may help some taxpayers, we remain concerned that other individuals could use that information to perfect fictitious documents that they could be used to make fraudulent claims for the adoption credit. The IRS used other outreach, as explained above, to communicate with taxpayers about documentation.

The IRS agrees that, when implementing any new credit, we should use a proactive approach. We did this with the expanded adoption credit. The IRS used historical research data and lessons learned from other refundable credits to develop and implement a strategic communication plan. This plan included extensive communication and outreach beginning in September 2010 and continuing through the present. The IRS proactively sought and established relationships with various state adoption agencies, advocacy groups and tax preparers to learn more about this unique population. This allowed us to develop key messages and target audiences as appropriate for our adoption credit communications. This process also improved our knowledge of related adoption issues. Very importantly, this approach was established early and relied on continued open lines of communication with stakeholders who communicated issues on which we immediately took action.

The IRS considered the feasibility of implementing a third party affidavit form for verification of a child's special need status and made a business decision not to do so. The states and/or counties provide special needs documentation during or after the adoption process to adoptive parents. The IRS decided to minimize burden on taxpayers and to avoid undue delays in issuing refunds by accepting the documents already available to adoptive parents. We also considered the burden to the third parties in many levels of many government agencies who would be completing the affidavits and the challenges to those agencies and to the IRS in educating the parties involved for a time-limited potential need.

The IRS investigated electronic filing and possible attachment of documentation to electronic returns for TY 2011. However, based on the expected significant decrease in the volume of adoption credit returns in 2011 (which occurred), limited e-filing capabilities, and equipment necessary, we were unable to pursue an electronic option for TY 2011. The IRS is not requiring documentation to be attached to 2012 returns when the credit becomes nonrefundable (however, as with other claims, taxpayers must maintain proof that their claim is accurate). Unfortunately, we are unable to re-implement electronic filing for the upcoming filing season, but expect to be able to allow electronic filing for future years. We will ensure that our outreach efforts to preparers and the adoption community would clearly communicate this information.

With respect to the recommendations related to the Premium Tax Credit, the IRS will consider the input of the National Taxpayer Advocate in our administration of the Premium Tax Credit while we build upon our knowledge and recent experience in implementing and administering other refundable tax credits.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS is committed to ensuring adoptive parents receive the benefits to which they are entitled. The IRS's commitment to emphasizing outreach and education and partnering with advocacy groups to understand the target population is encouraging. In addition, the IRS's efforts to share information through monthly cross-functional meetings -- of which TAS was a participant -- allowed a proactive approach to some compliance issues as they arose.

The rules associated with the adoption credit are complex and varied, posing a compliance challenge for the IRS. However, it is clear that the IRS failed to take into account the specific characteristics of the target population -- particularly low and middle income taxpayers -- when designing its examination filters. While the IRS states it took efforts to continually adjust the system, 90 percent of returns claiming the refundable adoption credit during the 2012 filing season tripped filters that select returns for examination.⁸¹ Income-based filters were responsible for over one-third of these additional reviews.⁸² The IRS clearly did not take into account the demographics of the impacted taxpayers as it designed -- and adjusted -- its filters. And although the IRS states that it conducted extensive research about the credit, it clearly did not read or review either the congressional record laying out Congress' focus on low and middle income families or its concerns about IRS unduly burdening credit applicants. Nor does it appear that the IRS reviewed or heeded the National Taxpayer Advocate's comprehensive analysis of and recommendations for effective administration of social programs in the Internal Revenue Code.⁸³

In its response, the IRS states that "In FY 2012, we found errors in 44 percent of the returns we examined and closed, protecting revenue of almost $135.5 million." This means that in 56 percent of its adoption credit audits, the IRS found no errors. This no-change rate is among the highest the National Taxpayer Advocate has ever seen since she was appointed to this position. For the IRS to say, with a straight face, that this is a positive result of any audit strategy makes a mockery of effective tax administration. It also signals that the IRS continues to underestimate or ignore the true burden it placed on taxpayers who are legitimately claiming a tax benefit to which they are entitled and sorely need.

Despite the fact that taxpayers are not required to attach documentation for 2012 adoption credit claims, they still cannot electronically file these claims. The current approach causes significant additional burden on both taxpayers and the IRS. The National Taxpayer Advocate is hopeful that the IRS will change this policy for future filing seasons, as the IRS comments indicate.

The National Taxpayer Advocate is disappointed that fear of possible fraudulent claims has prevented the IRS from providing sample documentation that could have eased the process of claiming the credit for taxpayers and prevented some costly, time-consuming documentation problems for the IRS. Sample documentation, on its own, is not enough to allow a fraudulent claim. While the IRS must take action to prevent fraudulent claims, it cannot allow potential fraud to also prevent eligible taxpayers from receiving much-needed guidance.

The National Taxpayer Advocate is pleased that the IRS recognizes the critical role of proactive outreach and education in ensuring the success of a refundable credit targeted to a specific group of taxpayers. We hope the IRS's efforts to develop relationships with state adoption agencies and advocacy groups in order to understand the population eligible for the adoption credit will encourage the IRS to reach out to similar groups in the future. We also are encouraged that the IRS engaged in proactive outreach when it identified documentation issues with a significant number of adoption credit claims. However, the IRS should not rely on its standard outreach procedures of working through practitioners and software developers. It must capitalize on the ability of various advocacy groups to communicate with the target population.

While the National Taxpayer Advocate is pleased that the IRS considered the use of a third-party affidavit, we are disappointed by the decision not to use this tool. The affidavit would not impose a burden on taxpayers or third parties -- it is designed to be an option that taxpayers can use to meet the IRS's documentation requirements with as little burden as possible. The National Taxpayer Advocate urges the IRS to reconsider its position on the use of the third-party affidavit.

The adoption tax credit is just the first refundable credit to emerge from the Affordable Care Act. While the IRS claims its approach to the adoption credit emphasized outreach and ensuring that taxpayers received the tax credits to which they were entitled, the data indicate that this was not always the case. The National Taxpayer Advocate commits to working collaboratively with the IRS as it develops procedures to administer the Premium Tax Credit to ensure that the IRS takes a taxpayer-focused approach and does not make the same mistakes it made with the adoption credit. We encourage the IRS to consider the factors for refundable credits that we have previously outlined as it moved forward with administering the Premium Tax Credit.

Recommendations

The National Taxpayer Advocate recommends the IRS take the following actions:

² Pub. L. No. 111-148, § 10909, 124 Stat. 119 (2010) (codified in IRC § 36 C).

³ IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (Through Sept. 14, 2012).

⁴Id. Includes late filed 2010 returns as well as 2011 returns. IRS 7-day response (Nov. 29, 2012).

⁵ IRS Compliance Data Warehouse Automated Information Management System (AIMS) FY 2010, 2011 and 2012 (Nov. 2012).

⁶ Individual Master File (IMF), Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2010 returns processed in calendar year 2011 and tax year 2011 returns processed in calendar year 2012 and Individual Returns Transaction File tax year 2010 and 2011 from Compliance Data Warehouse (Nov. 2012).

⁷ IRS, Compliance Data Warehouse Automated Information Management System (AIMS), Project codes 355 and 423 for FY 2012 (Nov. 2012).

⁸ Wage and Investment Division (W&I) response to TAS research request (Nov. 28, 2012). Numbers shown are for tax year 2011 returns filed in 2012 (through October 12, 2012), down slightly from 80 percent with missing, invalid, or insufficient documentation in TY 2010.

⁹ IRS Production Report, Adoption Credit Compliance Filters Report through Cycle 2012-38 (through Sept. 14, 2012). Includes late-filed 2010 returns as well as 2011 returns. A single claim can trip more than one filter.

¹⁰ W&I response to TAS research request (Nov. 16, 2012). Of the $1.1 billion in adoption credit claims in tax year 2010 as a result of adoption credit audits, the IRS disallowed $115 million -- or ten percent -- in adoption credit claims. IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2010 returns processed in calendar year 2011 and tax year 2011 returns processed in calendar year 2012 from Compliance Data Warehouse (Nov. 2012).

¹¹ IMF, Transaction History File, Transaction Codes 770, 771, 772, 776, and 777 for FY 2011 and 2012 Adoption Credit Audits in Project Codes 355 and 423 on AIMS from Compliance Data Warehouse (Nov. 2012). IRC § 6611. For a timely filed return, the IRS must pay any overpayment within 45 days from the due date of the return, or pay interest as established in IRC § 6621.

¹² National Taxpayer Advocate Fiscal Year 2012 Objectives Report to Congress 35-36; National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 46-47. GAO, GAO-12-98, Adoption Tax Credit (Oct. 2011).

¹³ National Taxpayer Advocate 2009 Annual Report to Congress 75 (Study: Running Social Programs Through the Tax System).

¹⁴ IRS, Tax Topics, Topic 607: Adoption Credit and Adoption Assistance Programs for 2010 and 2011 available at http://www.irs.gov/taxtopics/tc607.html (last visited Nov. 15, 2012).

¹⁵ National Taxpayer Advocate 2010 Annual Report to Congress 15 (Most Serious Problem: The IRS's Mission Statement Does Not Reflect the Agency's Increasing Responsibilities for Administering Social Benefits Programs); National Taxpayer Advocate 2009 Annual Report to Congress 75 (Study: Running Social Programs Through the Tax System).

¹⁶ U.S. Dep't of Health and Human Services, Adoption USA: A Chartbook Based on the 2007 National Survey of Adoptive Parents, 60 (2009).

¹⁷ In FY 2012, over 55 percent of adoption credit audits -- over 35,000 audits -- ended with no change in the tax owed or refund due. However, those taxpayers were forced to wait until the end of the audit to receive the adoption tax credit portion of their tax refund. IRS Compliance Data Warehouse Automated Information Management System (AIMS) FY 2010, 2011 and 2012 (Nov. 2012).

¹⁸ Beginning in 2014, the Affordable Care Act creates a refundable tax credit for coverage under a qualified health plan. The credit is available to eligible individuals and families with incomes below a specified threshold (subject to an income phase-out range) and subsidizes the purchase of health insurance through an exchange. IRC § 36B.

¹⁹ U.S. Dep't of Health and Human Services, The AFCARS Report: Preliminary FY 2010 Estimates as of June 2011, 1, 5 (June 2011).

²⁰Id. at 5 (June 2011).

²¹ Child Welfare Information Gateway, Funding Adoption: Adoption Packet 2, 2 (Feb. 2011).

²² U.S. Dep't of Health and Human Services, Adoption USA: A Chartbook Based on the 2007 National Survey of Adoptive Parents, 60 (2009).

²³Id. Entries marked with a * indicate that the relative standard error exceeds 0.30. Percentages may not add up to 100 due to rounding.

²⁴ Remarks of Hon. Louis Stokes, 142 Cong. Rec. E787 (May 10, 1996). The Adoption Credit first appeared in the Adoption Promotion and Stability Act of 1996, H.R. 3296, 104th Cong., (1996), and was rolled into the Small Business Job Protection Act of 1996, which provided for a nonrefundable credit for adoption expenses not to exceed $5,000, or $6,000 for children with special needs. Pub. L. No. 104-188, 110 Stat. 1755 (codified as amended in 19 U.S.C., 26 U.S.C., 29 U.S.C., and 42 U.S.C.). A child has special needs if the child is a U.S. citizen or resident, a State determines that the child cannot or should not be returned to his or her parent's home, and a State determines that the child probably will not be adopted unless assistance is provided. IRC § 36C(d)(3).

²⁵ See Nathanial S. Hibbin, The Inequitable Tax Benefits of Adoption, 4 Liberty Univ. L. Rev. 135, 148-9 (Fall, 2009).

²⁶ This amount increased to $13,360 in 2011 due to inflation adjustments. The credit begins to phase out for taxpayers with modified adjusted gross income of $185,210 and phases out completely when modified adjusted gross income exceeds $225,210. Pub. L. No. 111-148, § 10909, 124 Stat. 119 (2010) (codified in IRC § 36C); IRS, Tax Topics, Topic 607: Adoption Credit and Adoption Assistance Programs for 2010 and 2011 available at http://www.irs.gov/taxtopics/tc607.html (last visited Nov. 15, 2012).

²⁷ The refundability of the credit expired on Dec. 31, 2011, and the credit has reverted to a nonrefundable credit of up to $12,650 for tax year 2012. Rev. Proc. 2011-52. For 2013 and beyond, the credit will be available only for special needs adoptions and may only be claimed for qualified expenses incurred up to a maximum of $6,000. Economic Growth and Tax Reconciliation Act of 2001, Pub. L. No. 107-16, raised the limit of the original credit to $10,000 and does not apply to taxable years beginning after Dec. 31, 2012.

²⁸ IRC § 36C(a)(3). The credit available to taxpayers who adopt children who do not have special needs is the lesser of the qualified adoption expenses they paid or incurred or the statutory maximum.

²⁹ Taxpayers may claim the adoption credit for a child who is a U.S. citizen or resident (U.S. child), children with special needs, or a foreign child. IRS Instructions for Form 8839, Qualified Adoption Expenses (Dec. 30, 2011).

³⁰ An eligible child for the purposes of claiming the adoption credit is an individual who has not attained age 18, or is physically or mentally incapable of caring for him/herself. IRM 4.19.15.7.1, (Nov. 29, 2011).

³¹ For a detailed discussion of qualified expenses, see Instructions to Form 8839, Qualified Adoption Expenses. If the individual attempts to adopt a non-special-needs child within the United States, he or she may be able to claim the credit even if the adoption does not become final. If the adopted child is a U.S. citizen or resident of the United States and has special needs, the individual may qualify for the full amount of the Adoption Credit once the adoption is final, even if he or she paid few or no adoption-related expenses.

³² IRS Statistics of Income (SOI) Bulletin, Individual Income Tax Returns, Preliminary Data 2009 Figure A, Page 9 (Winter 2010).

³³ IRS SOI Bulletin, Individual Income Tax Returns, Preliminary Data 2010 Figure A, Page 8 (Winter 2011).

³⁴ IRS, IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2010 returns processed in calendar year 2011 from Compliance Data Warehouse (Nov. 2012).

³⁵ IRS, IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2011 returns processed in calendar year 2012 from Compliance Data Warehouse (Nov. 2012).

³⁶ H.R. 4373, Making Adoption Affordable Act of 2012, 112th Congress 2nd Sess. (Apr. 2012). S. 3616, Making Adoption Affordable Act of 2012, 112th Congress 2nd Sess. (Sept. 2012). In addition to legislative efforts to extend the credit, a similar proposal was included in the president's FY 2013 budget. Department of Treasury, General Explanations of the Administration's Fiscal Year 2013 Revenue Proposals, 198 (Feb. 2012).

³⁷ Rosemary Parker, Internal Revenue Service Failed to Pay Refunds for Adoption Credits on Tax Returns, Families Say, MLive, available at http://www.mlive.com/news/index.ssf/2011/04/internal_revenue_service_faile.html (Apr. 1, 2011) (last visited Oct. 26, 2012).

³⁸ Out of all processed returns with an adoption credit claim. IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (through Sept. 14, 2012). Includes late filed 2010 returns as well as 2011 returns. IRS 7-day response (Nov. 29, 2012).

³⁹ IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (through Sept. 14, 2012). Includes late-filed 2010 returns as well as 2011 returns.

⁴⁰ IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (through Sept. 14, 2012). Includes late-filed 2010 returns as well as 2011 returns. A single claim can trip more than one filter.

⁴¹ W&I response to TAS research request (Nov. 28, 2012). This includes missing, invalid, or insufficient documentation. Numbers shown are for tax year 2011 returns filed in 2012 (through Oct. 12, 2012), down slightly from 80 percent with missing, invalid, or insufficient documentation in TY 2010.

⁴² IRS Production Report, Adoption Credit Compliance Filters Report through Cycle 2012-38 (through Sept. 14, 2012). Includes late-filed 2010 returns as well as 2011 returns.

⁴³ IRS Compliance Data Warehouse AIMS FY 2011 and 2012 (Nov. 2012). The no change rate was 80 percent in FY 2011.

⁴⁴ IRS, Compliance Data Warehouse AIMS, Project codes 0355, 1067 and 0981 for FYs 2011 and 2012 (Nov. 2012).

⁴⁵ IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2011 returns processed in calendar year 2012 and Individual Returns Transaction File tax year 2011 from Compliance Data Warehouse (Nov. 2012). The median refund amount is $15,446 and the median AGI is $64,839 for tax year 2011.

⁴⁶ IRS, Compliance Data Warehouse AIMS, Project codes 0355, 1067 and 0981 for FYs 2011 and 2012 (Nov. 2012).

⁴⁷ W&I response to TAS research request (Nov. 16, 2012). This includes adoption credit refunds held. Amounts are rounded to the nearest million. In tax year 2010, $850 million in refunds were delayed.

⁴⁸ IRS IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2010 returns processed in calendar year 2011 and tax year 2011 returns processed in calendar year 2012 from Compliance Data Warehouse (Nov. 2012).

⁴⁹ There are groups on FaceBook -- Adoption Tax Credit/Refund Problems and Adoption Credit Stories -- dedicated to discussing problems related to the adoption tax credit.

⁵⁰ Rosemary Parker, Adoption Tax Credit Facebook Page Generates Stories of Snarled Returns, MLive, available at http://www.mlive.com/news/kalamazoo/index.ssf/2011/06/adoption_tax_credit_facebook_p.html (June 24, 2011) (last visited Oct. 26, 2012). The North American Council on Adoptable Children encourages people to share their experiences on their FaceBook page. Taxpayers noted countless problems with receiving the credit, including delays and duplicate requests for documentation. One taxpayer noted, "Ours is currently in the review process. They asked for additional documents . . . the same ones we submitted originally." North American Council on Adoptable Children FaceBook page, available at www.facebook.com/NACACadoption (last visited Oct. 25, 2012). The National Taxpayer Advocate has previously raised objections to the IRS's use of the term "review" in its notices, as opposed to the term "audit" because it leaves many taxpayers unaware that their return in being examined. As we have previously noted, "'review' or 'exam' may confuse taxpayers, but 'audit' is always clear." National Taxpayer Advocate 2011 Annual Report to Congress 84 (Study: An Analysis of the IRS Examination Strategy: Suggestions to Maximize Compliance, Improve Credibility, and Respect Taxpayer Rights).

⁵¹ Data obtained from SAMS (Nov. 2, 2012). Analysis was of SAMS submissions from January, 2011 through October, 2012. SAMS is a database of systemic tax issues and information submitted by IRS employees and the public.

⁵² Data obtained from Taxpayer Advocate Management Information System (TAMIS) (Nov. 1, 2012).

⁵³Id.

⁵⁴ IRS Compliance Data Warehouse AIMS FY 2012 (Nov. 2012).

⁵⁵ W&I response to TAS research request (Nov. 16, 2012). Of the $1.1 billion in adoption credit claims in tax year 2010 as a result of adoption credit audits, the IRS disallowed $115 million -- or ten percent -- in adoption credit claims. IMF, Transaction History File, Transaction Code 766 with a Credit Reference Number 261 for tax year 2010 returns processed in calendar year 2011 and tax year 2011 returns processed in calendar year 2012 from Compliance Data Warehouse (Nov. 2012).

⁵⁶ IMF, Transaction History File, Transaction Codes 770, 771, 772, 776, and 777 for FYs 2011 and 2012 Adoption Credit Audits in Project Codes 355 and 423 on AIMS from Compliance Data Warehouse (Nov. 2012). IRC § 6611. For a timely filed return, the IRS must pay any overpayment within 45 days from the due date of the return, or pay interest as established in IRC § 6621.

⁵⁷ IRS Compliance Data Warehouse AIMS FY 2012 Project Codes 355 and 423 (Nov. 2012); IRS, Data Book 2011 Table 9a Enforcement Coverage Page 22.

⁵⁸ GAO, GAO-12-98, Adoption Tax Credit (Oct. 2011). The 3.5 percent represents a total of 28 staff days. The IRS spent a total of 23,525 staff days on all correspondence exams in FY 2012. W&I response to TAS research request (Nov. 16, 2012) (extrapolation of 2,940.59 FTEs/Staff Years into staff days).

⁵⁹ GAO, GAO-12-98, Adoption Tax Credit 10 (Oct. 2011).

⁶⁰ IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (through Sept. 14, 2012). Includes late-filed 2010 returns as well as 2011 returns. IRS 7-day response (Nov. 29, 2012). W&I response to TAS research request (Nov. 28, 2012). Numbers shown are for tax year 2011 returns filed in 2012 (through Oct. 12, 2012), down slightly from 80 percent with missing, invalid, or insufficient documentation in TY 2010.

⁶¹ W&I response to TAS research request (Nov. 16, 2012).

⁶² GAO, GAO-12-98, Adoption Tax Credit 10 (Oct. 2011).

⁶³ H.R. Conf. Rep. No. 104-737, 104th Cong., 2nd Sess. 1996, sec. 1807, accompanying H.R. 3448, the Small Business Job Protection Act of 1996. The substantiation provisions, which have remained the same, were:

⁶⁵ This is a result of the IRS's enforcement efforts and is not a requirement of the statutory language. Some IRS examinations are conducted entirely by mail, and these examinations are known as correspondence exams. If the examination is conducted by mail, a letter is issued to the taxpayer asking for additional information about certain items shown on the tax return. Publication 3498 The Examination Process, (Nov. 2004).

⁶⁶http://www.irs.gov/Individuals/Adoption-Credit-Documentation-Requirements.

⁶⁷ National Taxpayer Advocate 2007 Annual Report to Congress 94-116 (Study: EIC Audits -- A Challenge to Taxpayers); National Taxpayer Advocate 2006 Annual Report to Congress 289-310 (Most Serious Problem: Correspondence Exams); National Taxpayer Advocate 2005 Annual Report to Congress 94-122 (Most Serious Problem: Earned Income Tax Credit Exam Issues); National Taxpayer Advocate 2002 Annual Report to Congress 47-54 (Most Serious Problem: EITC Eligibility Determination Can Be Made Less Burdensome); National Taxpayer Advocate 2002 Annual Report to Congress 75-80 (Most Serious Problem: The Length of EITC Audits Contributes to Taxpayers Concerns); National Taxpayer Advocate 2002 Annual Report to Congress 81-87 (Most Serious Problem: EITC Recertification Compounds Taxpayer Burden).

⁶⁸ GAO, GAO-12-98, Adoption Tax Credit 9 (Oct. 2011).

⁶⁹ IRS, IRS Earned Income Tax Credit (EITC) Initiatives, Addendum to the Report on Qualifying Child Residency, Certification, Filing Status, and Automated Underreporter Tests: Implementation of Alternative Approaches to Improving the Administration of EITC (2008); IRS, IRS Earned Income Tax Credit (EITC) Initiative: Final Report to Congress (Oct. 2005).

⁷⁰See IRS Earned Income Tax Credit (EITC) Initiatives: Report on Qualifying Child Residency Certification, Filing Status, and Automated Underreporter Tests 8, 14 (2008). TAS has also been working with the IRS on a three-year study related to third-party affidavits to demonstrate the residency of qualifying children during EITC audits. For more information on the 2005 pilot and a more recent TAS-IRS study on affidavits, see National Taxpayer Advocate 2011 Annual Report to Congress 304-305 (Most Serious Problem: The IRS Should Reevaluate Earned Income Tax Credit Compliance Measures and Take Steps to Improve Both Service and Compliance). While current audit procedures allow taxpayers to provide either official records or letters on official letterhead to document the residence of a child, this pilot program gives the taxpayer the option of using another type of documentation -- a third-party affidavit. This procedure allows third-parties with knowledge of the child's residency to fill out a standardized affidavit rather than write a letter. The affidavit would be signed under penalties of perjury and list the affiant's title, agency, and contact information. The affidavit would also contain a third-party contact notification alerting the taxpayer that the IRS may contact the affiant. When questionable claims arise, the IRS can contact the affiant to verify the accuracy of the information.

⁷¹ GAO, GAO-12-98, Adoption Tax Credit 8 (Oct. 2011).

⁷² See Tax Tips, available at http://www.irs.gov/uac/Tax-Tips-for-2012-1 (last visited Nov. 14, 2012).

⁷³ IRS, March 2012 Adoption Credit Phone Forums Questions and Answers, available at http://www.irs.gov/Individuals/Adoption-Credit-Phone-Forum-Questions-and-Answers (last visited Nov. 2, 2012).

⁷⁴ For a discussion of the National Taxpayer Advocate's concerns about the IRS approach to taxpayer education, see Most Serious Problem: The IRS Is Substantially Reducing Both the Amount and Scope of its Direct Education and Outreach to Taxpayers and Does Not Measure the Effectiveness of its Remaining Outreach Activities, Thereby Risking Increased Noncompliance, infra.

⁷⁵ IRS, On Earned Income Tax Credit Awareness Day, IRS and Partners Launch Outreach Campaign to Low- and Moderate-Income Workers, IR-2012-11 (Jan. 27, 2012).

⁷⁶ Washington State Department of Social & Health Services, Adoption Tax Credit Awareness Day, available at http://www.dshs.wa.gov/ca/fosterparents/newstaxcredit.asp (last visited Oct. 24, 2012).

⁷⁷ National Taxpayer Advocate 2011 Annual Report to Congress 687-689 (Case Advocacy: Policymakers Can Learn from the Implementation of the FTHBC); National Taxpayer Advocate Fiscal Year 2012 Objectives Report to Congress 28-32; National Taxpayer Advocate 2010 Annual Report to Congress 15 (Most Serious Problem: The IRS Mission Statement Does Not Reflect the Agency's Increasing Responsibilities for Administering Social Benefits Programs) (Case Advocacy: TAS Assists the IRS with the Administration of the First-Time Homebuyer Credit); National Taxpayer Advocate Fiscal Year 2011 Objectives Report to Congress 3, 37-43; National Taxpayer Advocate 2009 Annual Report to Congress 506-509; Hearing on Complexity and the Tax Gap: Making Tax Compliance Easier and Collecting What's Due, Hearing Before the S. Comm. on Finance, 112th Cong. (statement of Nina E. Olson, National Taxpayer Advocate) (June 28, 2011); Filing Season Update: Current IRS Issues: Hearing Before the S. Comm. on Finance, 111th Cong. (2010) (statement of Nina E. Olson, National Taxpayer Advocate) (Apr. 15, 2010); The National Taxpayer Advocate's 2009 Report on the Most Serious Problems Encountered by Taxpayers: Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and Means, 111th Cong. (2010) (statement of Nina E. Olson, National Taxpayer Advocate) (Mar. 16, 2010).

⁷⁸ National Taxpayer Advocate Fiscal Year 2012 Objectives Report to Congress 35-36; National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 46-47. GAO, GAO-12-98, Adoption Tax Credit (Oct.2011).

⁷⁹ Taxpayer Advocacy Panel, Adoption Credit Processing Recommendations (June 2012). The Taxpayer Advocacy Panel (TAP) was created in October 2002 with the expansion of the former Citizen Advocacy Panel, first established in 1998. The TAP reports to the Secretary of the Treasury, Commissioner of Internal Revenue, and the National Taxpayer Advocate with oversight and support of the program provided by the TAP Director and staff. The TAP acts as a two-way conduit between the public and IRS. The mission of the TAP is to listen to taxpayers, identify taxpayers' issues, and make suggestions for improving IRS service and customer satisfaction.

⁸⁰ National Taxpayer Advocate 2009 Annual Report to Congress 75 (Study: Running Social Programs Through the Tax System).

⁸¹ IRS Production Report, Adoption Credit Compliance Filters Report Through Cycle 2012-38 (through Sept. 14, 2012).

⁸²Id. Includes late-filed 2010 returns as well as 2011 returns. A single claim can trip more than one filter.

⁸³ National Taxpayer Advocate 2009 Annual Report to Congress 75 (Study: Running Social Programs Through the Tax System).

Steven T. Miller, Deputy Commissioner, Services and Enforcement

Faris Fink, Commissioner, Small Business/Self-Employed Division

Heather C. Maloy, Commissioner, Large Business and International Division

Peggy Bogadi, Commissioner, Wage and Investment Division

William J. Wilkins, Chief Counsel

DEFINITION OF PROBLEM

The Bank Secrecy Act (BSA) requires U.S. citizens and residents to report foreign accounts on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) so the government can better detect "bad actors" engaged in tax evasion, terrorism, and money laundering.¹ Beginning in 2009, the IRS initiated a series of offshore voluntary disclosure (OVD) programs to settle with taxpayers who had failed to report offshore income and file any related information return such as the FBAR: the 2009 Offshore Voluntary Disclosure Program (OVDP), 2011 Offshore Voluntary Disclosure Initiative (OVDI), and the open-ended 2012 OVDP.² As discussed in prior reports, these programs applied a resource-intensive, burdensome, punitive, one-size-fits-all approach designed for "bad actors" to "benign actors" who inadvertently violated the rules.³

While an estimated five to seven million U.S. citizens reside abroad, and many more U.S. residents have FBAR filing requirements,⁴ the IRS received only 741,249 FBAR filings in 2011, and as of September 29, 2012, it had received fewer than 28,000 OVD submissions from FBAR violators.⁵ Thus, significant FBAR filing compliance problems likely remain unaddressed.

In addition to problems identified in prior reports, the National Taxpayer Advocate is concerned that the IRS has:

• Increased the cost and burden of correcting past violations, as well as the IRS resources required to process these corrections, by continuing to require benign actors to opt in and opt out of OVD programs -- even though processing times are longer for those who opt out, averaging nearly 550 days for the 2009 program;

• Increased the burden of reporting foreign accounts in the future by requiring duplicative reporting on the FBAR and Form 8938, Statement of Specified Foreign Financial Assets; and

• Discontinued pilot programs to send information about the foreign account reporting requirements to people with foreign accounts.

As the IRS receives an increasing amount of information from foreign financial institutions that will enable it to identify more FBAR noncompliance, however, it may need to devote more enforcement resources to address this noncompliance; expand its outreach and self-correction options for benign actors; or ignore the noncompliance altogether. The IRS should promote voluntary compliance by reducing compliance burdens and expanding its targeted outreach and self-correction options for benign actors.

ANALYSIS OF PROBLEM

IRS OVD programs discouraged taxpayers from self-correcting errors, burdening taxpayers and draining IRS resources.

Taxpayers may normally correct their own inadvertent violations without significant penalties or burdens.

The maximum civil penalty applicable to a bad actor for "willfully" failing to report foreign accounts on an FBAR is severe -- the greater of 50 percent of the account or $100,000 per year.⁶ However, the IRS does not generally apply a significant penalty to benign actors who inadvertently fail to report accounts, particularly if they voluntarily correct the violation(s) before the IRS contacts them.⁷

In addition, those who failed to report income could normally avoid accuracy-related penalties by filing "qualified amended returns" before being contacted by the IRS.⁸ Thus, in the absence of any special IRS program, a taxpayer could correct a failure to report a foreign account and income from the account while avoiding most penalties by simply filing three (or six) years worth of returns (or amended returns) and FBARs.⁹ This approach encourages voluntary compliance and self-correction, which is the IRS's stated goal.¹⁰

The IRS OVD programs discourage self-correction.

The IRS "strongly encouraged" everyone with an FBAR violation and unreported income (including benign actors) to participate in its OVD programs and initially discouraged them from opting out.¹¹ For example, IRS FAQs indicated:

IRS OVD programs were burdensome for benign actors and drained IRS resources.

The OVD programs require benign actors to opt in and then opt out. OVD program participants must file (or amend) eight years of returns; wait for the IRS to process the applications; and then either (1) pay various penalties plus an "offshore" penalty equal to 20, 25, or 27.5 percent of their unreported offshore assets;¹⁵ or (2) "opt for an examination" by "opting out" and risk unreasonably large FBAR penalties.¹⁶

As shown below, OVD program processing times are longer for benign actors who opt out, averaging nearly 550 days for those opting out of the 2009 OVDP.

   TABLE 1.8.1, OVD Program Applications, Dispositions, and Processing Time

While benign actors would normally have made "quiet" corrections, rather than participate in the OVD programs, the IRS warned them not to do so. This approach left the taxpayers with no good options -- and discouraged voluntary compliance -- while committing the IRS to use limited enforcement resources to process a potentially large number of submissions.²¹

People with Canadian retirement plans faced additional burdens.

People with certain Canadian retirement plans who wanted to file late or amended U.S. tax returns, as required for participation in an OVD program, faced additional burdens. The IRS issued conflicting guidance about how to make a late election to exclude undistributed income from those plans.²² Under Revenue Procedure 2002-23, if taxpayers do not make these elections by attaching them to a timely-filed U.S. income tax return, they are late, and the IRS will not accept late elections unless the taxpayer obtains a private letter ruling (PLR).²³ Some taxpayers spent significant time and resources to obtain a PLR, as shown below.²⁴

  TABLE 1.8.2, PLR Requests Under Section 4.06 of Rev. Proc. 2002-23,

Pursuant to 2012 OVDP FAQ #54, the IRS recently provided entirely different instructions for making late elections. Although FAQ #54 may reduce burden for some, it will confuse others, as the IRS has issued three conflicting statements about how to make a late election. This confusion is compounded by the fact that neither the taxpayer-friendly IRM nor FAQ #54 represent formal guidance. Moreover, those who have already paid to prepare a PLR submission may incur additional fees to make a different submission pursuant to FAQ #54.³⁰

The IRS has recently reduced the burden of correcting errors for some taxpayers.

The IRS issued a "fact sheet," clarifying that nonresidents who opt out of the OVD programs will not always face penalties.

In December 2011, the IRS clarified that, for nonresidents, it would not always impose FBAR penalties if the taxpayer could establish a "reasonable cause."³¹ While this clarification was helpful, it provided little comfort to many with inadvertent violations, because establishing reasonable cause is sometimes difficult. For example, it is difficult to establish reasonable cause for failure to file an income tax return because the law assumes nearly every U.S. citizen knows about the obligation to file an income tax return.³² By contrast, the FBAR filing requirement was relatively unknown until recently, but the IRS fact sheet does not explicitly make it easier for taxpayers to establish reasonable cause for failure to file an FBAR. For example, the taxpayer does not necessarily have reasonable cause if tax preparation software or a tax preparer failed to ask the taxpayer about foreign accounts.³³ The government expects the taxpayer to review the tax return that references FBAR reporting, expects this review to cause the taxpayer to file an FBAR, and may even assume that any failure to file an FBAR is thus due to willful blindness.³⁴ Even if a preparer affirmatively advised the taxpayer not to report a foreign account or the income from it, the taxpayer is likely to have difficulty getting the preparer to sign a statement acknowledging the inaccurate advice.³⁵ However, the IRS may require such a signed statement before it will make a reasonable cause determination. Thus, some people with inadvertent violations may not be able to establish reasonable cause.

The IRS recently established a process to allow nonresidents to make self-corrections outside of the OVD programs.

Under a new program, beginning September 1, 2012, nonresident nonfilers have the option of filing three years of delinquent returns (and six years of FBARs) without triggering penalties (the "Streamlined Nonresident Filing Initiative").³⁶ If each return reports less than $1,500 in additional tax due and the IRS deems them "simple," absent "high risk factors," the returns will be classified "low risk" and will not be examined. Participants are ineligible for the 2012 OVDP.

Because the IRS has provided little guidance about what makes a return "high risk," participants may still be subject to a full examination and potentially severe penalties, making the new program less attractive. Moreover, the IRS has not provided any similar self-service options for benign actors who are U.S. residents or owe more than $1,500.³⁷ The IRS should increase the threshold and allow U.S. residents to participate.³⁸ Nonetheless, this program is likely to reduce the burden on many nonresidents as well as on the IRS.

New duplicative reporting requirements make compliance more burdensome, and "stack" penalties.

Beginning in 2012, those with certain foreign financial assets in excess of $50,000 must report foreign account information (and certain other foreign financial asset information) on IRS Form 8938, Statement of Specified Foreign Financial Assets.³⁹ Form 8938 is sometimes called the "Tax FBAR" or "Super FBAR" because, as the Government Accountability Office (GAO) has observed, it duplicates much of the information required on the FBAR, though it is due with the return rather than on June 30, the due date for the FBAR.⁴⁰ In addition, a taxpayer who fails to report a single account on both forms could face two sets of penalties -- the FBAR penalty under Title 31 and the Super FBAR penalty under Title 26.

Many benign actors still have not filed FBARs.

The IRS should be reducing (rather than increasing) the burden of correcting prior non-compliance and the burden of reporting foreign accounts in the future, given the existing compliance problem. While an estimated five to seven million U.S. citizens reside abroad and many U.S. residents also have FBAR filing requirements,⁴¹ the IRS received only 741,249 FBAR filings in 2011.⁴² In the face of what may be a serious FBAR compliance problem, the government opened only 3,220 civil FBAR examinations and 18 criminal investigations in calendar year (CY) 2011.⁴³

While the OVD programs attracted over 27,000 applications (perhaps less than one percent of those who did not file FBARs) and collected almost $5.5 billion, a more effective initiative could prompt significantly more taxpayers to come into compliance voluntarily.⁴⁴ The OVD programs may be prompting them to renounce U.S. citizenship instead. The number of people renouncing citizenship has risen to an all-time high -- nearly quadrupling over a four-year period -- from 470 in 2007 to 1,788 in 2011.⁴⁵

The IRS stopped sending letters to educate those with foreign accounts about the foreign account reporting requirements.

IRS officials generated significant publicity about the FBAR reporting requirements by giving speeches and posting information to the IRS website.⁴⁶ Perhaps as a result, FBAR filings have more than doubled between 2008 and 2011 -- from 349,667 in 2008 to 741,249 in 2011.⁴⁷ However, as noted above, this may still be only a fraction of the filings the IRS should receive.

In addition, the IRS has not conducted in-person presentations about the FBAR filing requirements in foreign countries, even in countries where it has a tax attaché and a significant number of residents are required to file.⁴⁸ This approach sends the message that the IRS will spend resources to punish, but not to educate, U.S. citizens abroad.

The IRS has also discontinued an FBAR Compliance Initiative Project to educate those with foreign bank accounts who are most likely to have FBAR violations.⁴⁹ While the Postal Service returned 22 percent of the project's letters as undeliverable, address research could help to reduce that problem.⁵⁰ In addition, the IRS has stopped work on an initiative to develop the FBAR Stop Filer Program.⁵¹ The Stop Filer Program would send letters to taxpayers who had filed an FBAR in the prior year, but not the current year, to remind them that they may still have a filing requirement. Thus, the IRS does not send letters to educate those for whom the requirements are the most relevant.

As information reporting on foreign accounts expands, a combination of targeted soft notices and expanded self-correction options could significantly improve voluntary compliance.

Over the next few years, foreign financial institutions will begin to report more foreign accounts to the IRS, enabling the IRS to identify many more FBAR violations.⁵² New Form 8938 filings may also allow the IRS to identify more taxpayers who should have filed an FBAR.⁵³ Yet, the IRS is unlikely to have additional resources to address FBAR violations using enforcement tools or its OVD programs. As a result, it will increasingly have to ignore violations that it can detect unless it expands the self-correction options available to benign actors. If the IRS reinstated and expanded its soft notice programs and its Streamlined Nonresident Filing Initiative to encourage more benign actors to correct inadvertent violations without draining IRS resources, it could create a win-win situation -- reducing the burden for them while freeing up IRS enforcement resources to address bad actors.

CONCLUSION

In conclusion, the National Taxpayer Advocate preliminarily recommends that the IRS:

Global tax enforcement is a top priority at the IRS, and we have made significant progress on multiple fronts, including groundbreaking international tax agreements and increased cooperation with other governments. In addition, the IRS and Justice Department have increased efforts involving criminal investigation of international tax evasion. This combination of efforts helped support the 2009 OVDP, the 2011 OVDI, and the ongoing 2012 OVDP. The goal of these programs is to get individuals back into the U.S. tax system and to turn the tide against offshore tax evasion. The programs have given U.S. taxpayers with undisclosed assets or income offshore an opportunity to get compliant with the U.S. tax system, pay their fair share, and avoid potential criminal charges. The programs have so far resulted in the collection of more than $5.5 billion in back taxes, interest, and penalties from approximately 38,000 applicants. In addition, the programs provided the IRS with a wealth of information on various banks and advisors assisting people with offshore tax evasion, which the IRS is using to continue its international enforcement efforts.

Throughout the programs, taxpayers have had the opportunity to opt out of the settlement structure and request an examination if the taxpayer disagrees with the result provided for under the program. The opt-out procedures and additional guidance issued on June 1, 2011, clarify that, depending on the facts and circumstances, it may be preferable for a particular taxpayer to opt out of one of the programs. In addition, the IRS added frequently asked questions to provide examples of circumstances in which taxpayers may want to consider opting out of the civil settlement structure and examples of when it might be a disadvantage to opt out. The IRS also advised employees working cases that taxpayers opting out should not be treated in a negative fashion merely because he or she opted out.

The IRS has taken a number of additional steps to assist taxpayers seeking to come into compliance. Last year, to address questions from international taxpayers, the IRS issued a fact sheet⁵⁵ to assist U.S. citizens and dual citizens residing outside the U.S. understand the federal tax return and FBAR filing requirements and return to compliance. More significantly, to address additional feedback from taxpayers and stakeholders, including practitioners and organizations representing taxpayers located overseas, the IRS provided a new option -- the Streamlined Filing Compliance Procedures -- effective September 1, 2012, to help some nonresident U.S. taxpayers who have not been filing tax returns come into compliance. The option provides certain taxpayers who have resided outside of the U.S. since January 1, 2009, with a chance to catch up with their federal tax filing obligations if they owe little or no back taxes.

Situations of taxpayers with offshore compliance issues vary widely given the complexities of this area of tax law. While taxpayers should consult with their professional tax advisor to determine which option is the most appropriate given a taxpayer's specific facts and circumstance, the IRS did identify a number of common situations and potential solutions on IRS.gov to assist taxpayers.⁵⁶

With regard to the recommendations in the report, the IRS notes the following.

As previously stated, in June 2012, the IRS announced new streamlined filing compliance procedures ("streamlined procedures"), effective September 1, 2012, for certain non-resident U.S. taxpayers who have failed to timely file U.S. federal income tax returns or FBARs but recently became aware of their filing obligations and now seek to come into compliance with the law. Under this program, taxpayers presenting low compliance risk will undergo an expedited review and the IRS will not assert penalties or pursue follow-up actions. In August 2012, the IRS issued streamlined procedural guidance, including submission instructions and a description of factors that, if present, suggest an increase in compliance risk level and therefore ineligibility for streamlined examination.⁵⁷ We will continue to evaluate the program and feedback received from taxpayers, practitioners, and other stakeholders to determine whether additional modifications to the program or guidance are necessary.

The IRS has taken a number of steps to educate persons with foreign accounts about the FBAR and Form 8938 reporting requirements. For example, the IRS created a comparison chart available on IRS.gov⁵⁸ to assist taxpayers in differentiating between FBAR and FATCA Form 8938 requirements. This chart has been publicized through several channels reaching U.S. filers located domestically and overseas, including the IRS Twitter account, communications by the IRS tax attachés located in U.S. consulates and embassies overseas with the assistance of the State Department, and the IRS National Public Liaison's practitioner email distribution list. The IRS will continue to share information with the public using IRS.gov and other communication vehicles to educate taxpayers regarding FBAR and FATCA filing requirements and will also continue to monitor whether additional outreach is appropriate.

In response to inquiries from taxpayers participating in one of the three voluntary disclosure programs with specified Canadian retirement plans, in June 2012, the IRS provided instructions for how taxpayers could make the retroactive deferral of income elections.⁵⁹ In addition, the new Streamlined Procedures incorporated instructions for addressing this issue in its submission requirements.⁶⁰ We will continue to review other available guidance to determine if additional clarification is necessary.

With respect to the perceived duplicate reporting required on Forms 8938 and TD F 90-22.1, it is important to recognize that there are two separate reporting requirements under the law with different requirements. The FBAR (TD F 90-22.1) is required under Title 31 for law enforcement purposes in addition to tax administration. As a consequence, different policy considerations apply to FBAR and other information reporting, such as the Form 8938. These are reflected in the law defining differing categories of persons required to file Form 8938 and the FBAR, different filing thresholds for Form 8938 and FBAR reporting, and differing assets (and accompanying information) required to be reported on each form. These differing policy considerations were recognized during the passage of the HIRE Act and the enactment of section 6038D, and Congress's intention to retain FBAR reporting notwithstanding the enactment of section 6038D was specifically noted in the technical explanation of the revenue provisions contained in Senate amendment 3310, The "Hiring Incentives to Restore Employment Act," Under Consideration by the Senate (Staff of the Joint Comm. On Taxation, JCX-4-10 (February 23, 2010)) (Technical Explanation) accompanying the HIRE Act. The Technical Explanation states that "[n]othing in this provision [section 511 of the HIRE Act enacting section 6038D] is intended as a substitute for compliance with the FBAR reporting requirements, which are unchanged by this provision." (Technical Explanation at p. 60.) The IRS is committed to ensuring that taxpayers understand the different reporting requirements and will continue to explore whether further coordination of the requirements is possible provided the existing legal framework.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate fully supports the IRS's goal to design initiatives and offer settlements to "get individuals back into the U.S. tax system and to turn the tide against offshore tax evasion." Its new Streamlined Nonresident Filing Initiative is a significant step in the right direction. The National Taxpayer Advocate commends the IRS for addressing tax evasion and for its web-based efforts to educate taxpayers about little-known FBAR reporting requirements that, if overlooked, can trigger massive and disproportionate civil penalties.

However, the combination of the FBAR statute and the way the IRS administers it creates the potential for such draconian penalties that many taxpayers agree to pay unwarranted amounts to avoid the possible risk of being bankrupted several times over (as described below).⁶¹ The IRS may believe that taxpayers have the choice to opt out of its OVD programs, but many do not feel that way.

Specifically, the FBAR statute authorizes a maximum penalty of up to 50 percent of the maximum balance in each overseas account for each year of non-reporting (or, if greater, $100,000 per violation).⁶² Because the statute of limitations period is six years, the maximum penalty for large accounts is essentially 300 percent of the maximum account balances (assuming a relatively constant balance).⁶³

Far from allaying taxpayer concerns about this statute, the IRS OVD programs magnify them. In general, the OVD programs attempted to entice taxpayers to make voluntary disclosures by offering to cap the FBAR penalty and other penalties for failure to file information returns at 20 percent (or 25 or 27.5 percent for the 2011 and 2012 OVD programs, respectively) of the highest account value during the past six years (called the "offshore penalty"). For taxpayers who believe the IRS can prove they deliberately violated the disclosure statute, this is a good deal. But what about other taxpayers for whom penalties would be negligible?

The existing FBAR statute offers such taxpayers a better deal, capping the maximum penalty at $10,000 per violation if the IRS cannot prove the violation was willful and eliminating the penalty altogether if the taxpayer can show "reasonable cause" for his or her failure to report the account(s).⁶⁵ As discussed in prior reports, 2009 OVDP FAQ #35 provided seemingly clear assurances that "[u]nder no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes."⁶⁶ So if a taxpayer makes a voluntary disclosure under the 2009 OVDP and argues that his failure was nonwillful or due to reasonable cause, the IRS will consider that. Right?

Not really. The IRS now says that, notwithstanding FAQ #35, those who seek to pay a lower penalty must opt out of the OVD programs and submit to a full-blown examination.⁶⁷ That examination could yield a lesser penalty -- but it also could yield a greater FBAR penalty, potentially the maximum.

A big disconnect exists between the way the IRS and taxpayers view the decision to opt out. From the IRS perspective, a taxpayer who believes his failure to report the account was nonwillful or subject to the reasonable cause exception can opt for an examination where he or she can demonstrate it. "If the taxpayer really has nothing to hide, why would the taxpayer hesitate?" the IRS reasons.

But that is not how many taxpayers react. Because of the IRS's aggressive statements and enforcement measures in the foreign bank account reporting area, many taxpayers start out scared to death about criminal prosecution and the possibility of losing 300 percent or more of the value of their accounts. Most are distrustful of the IRS and are not confident it will be reasonable.⁶⁸ The fact that the IRS seemed to say through FAQ #35 that it would consider lesser penalties within the 2009 OVDP regime and is now backtracking increases taxpayer concerns about whether they will get a fair shake if they opt out.

TAS has encountered some examiners who, seeking to close OVD cases, suggested that the taxpayer would likely pay more if he or she opted out. Such statements are believable because the OVD examiner -- the very same examiner who recommended against reducing the penalty within the OVD program -- is required to make an ex parte recommendation to the opt-out committee about how to resolve the case if the taxpayer opts out.⁶⁹ Moreover, some taxpayers in this position come from countries with totalitarian regimes, where the government often enforces its laws in arbitrary ways. Thus, even where taxpayers feel strongly that their FBAR noncompliance was due to reasonable cause or was not willful, faced with the choice of accepting the IRS's proposed penalty (which, in our example, comes to $200,000 or 20 percent of $1 million) or opting for a full examination -- with the hope of avoiding the penalty but with the knowledge that opting out could result in a potential penalty of far more than their net worth ($3 million in our example) -- many will not want to risk opting out.

From a taxpayer's perspective, this may feel like extortion. In the opinion of the National Taxpayer Advocate, it is a significant intrusion on taxpayer rights.

More broadly, the National Taxpayer Advocate is concerned extreme penalties are sometimes enacted to combat extreme abuses, but the penalties inadvertently affect "benign actors" whose actions technically fall within the over-broad definition of the extreme conduct. In 2004, for example, Congress enacted IRC § 6707A, which imposed a strict liability penalty for failing to report participation in specified "listed transactions."⁷⁰ The penalty amount was $100,000 per individual per year and $200,000 per entity per year.⁷¹ The penalty was intended to apply to those who engaged in egregious tax shelters. However, it soon became apparent that the penalties were affecting a range of small businesses, including some that created insurance programs to benefit their employees and did not know the transactions fit within the technical definition of a particular listed transaction. In some cases, individuals operated their businesses through wholly owned Subchapter S corporations, meaning that they were subject to penalties of $300,000 per year ($100,000 at the individual level and $200,000 at the entity level). After the National Taxpayer Advocate and others raised concerns that the penalty was both disproportionate and applicable to a much wider swath of taxpayers than intended, Congress reduced the penalty.⁷²

A similar situation arises here. The FBAR penalties generally are designed to apply to taxpayers who are intentionally evading U.S. tax by hiding significant untaxed assets in offshore accounts (the "bad actors"). But they are also affecting taxpayers with modest account balances and/or who did not intentionally evade tax, including those with assets in higher-tax jurisdictions where no tax evader would reasonably plan to hide assets. In administering this law, the IRS needs to do a better job of recognizing the distinction, and a key part of what is needed is to remove the fear of opting out of the OVD programs.

The National Taxpayer Advocate has suggested a three-category approach to improving the OVD programs to encourage voluntary compliance among those who failed to file FBARs and similar information returns. To encourage voluntary compliance, these taxpayers, who are coming forward before being contacted by the IRS, should be given reasonable options for correcting violations without having to opt out and risk disproportionate penalties.⁷³

Category 1. Full relief from FBAR and information reporting penalties. Taxpayers whose underpayment is below a reasonable threshold amount -- such as the IRC § 6662(d) threshold (i.e., the greater of $5,000 or ten percent of the tax required to be shown) -- should be permitted to file delinquent returns without penalty, regardless of whether they are residents.⁷⁴ They should not be subject to the threat of being deemed "high risk" and potentially hit with the maximum penalties, as is the case under the new Streamlined Nonresident Filing Initiative.⁷⁵

Category 2. Taxpayers who have reasonable cause or who acted non-willfully. Taxpayers whose underpayment is greater than the threshold, but who believe they have reasonable cause or who acted non-willfully should provide an explanation of their circumstances, file delinquent returns, pay tax due, interest, accuracy-related penalties, and Title 26 information reporting penalties. Depending on the circumstances and explanation, these taxpayers should be required to pay either the non-willful FBAR penalty or no penalty under the reasonable cause exception.⁷⁶ Because they are required to cooperate, the IRS should have little difficulty evaluating their circumstances without requiring them to opt out.

Category 3. Taxpayers not included in Category 1 or 2. Taxpayers who do not assert that their violations were nonwillful but still voluntarily come forward to correct them should be required to file delinquent or amended returns, and pay tax, interest, accuracy-related penalties, and the offshore penalty, as currently required under the OVD programs.

With regard to Category Two, in order to determine whether there are valid arguments to claim a reasonable cause exception, the facts and circumstances involving non-compliance would have to be carefully reviewed by practitioners. Anti-abuse rules could discourage Category Three taxpayers from self-selecting into Category Two. This reasonable three-category approach could prevent the IRS from being viewed as extorting unjustified penalties from innocent taxpayers and ultimately improve voluntary compliance. As the Internal Revenue Manual acknowledges,

In addition, the IRS comments do not fully address the National Taxpayer Advocate's preliminary recommendations.

• The IRS has not stated whether it might implement the National Taxpayer Advocate's preliminary recommendation to expand the OVD programs and the Streamlined Nonresident Filing Initiative to prevent its procedures from collecting the proceeds of what many are likely to view as extortion.

• The IRS has not addressed whether it will send letters to people who have likely overlooked the information reporting requirements.

• The IRS does not dispute that it has provided and continues to provide beneficiaries of Canadian retirement plans with conflicting information about how they can file a late return that excludes undistributed income from the plan. As noted above, Revenue Procedure 2002-23, 2002-1 C.B. 744 (requiring a PLR), and IRM 21.5.3.4.9.1 (Aug. 4, 2009) (instructing employees to process late elections) both remain in force and conflict with 2012 OVDP FAQ #54 (requiring a submission to an examiner) and the instructions to the Streamlined Nonresident Filing Initiative. Yet, the IRS does not commit to combine or clarify this conflicting guidance.

• The IRS does not dispute that it is difficult for taxpayers to determine whether their violations are nonwillful or qualify for the reasonable cause exception, or that taxpayers cannot rely on statements on the IRS website. Yet, it does not commit to provide any clarifying guidance.

Recommendations

The National Taxpayer Advocate recommends the IRS take the following actions:

² IRS, Voluntary Disclosure: Questions and Answers, http://www.irs.gov/uac/Voluntary-Disclosure:-Questions-and-Answers (first posted May 6, 2009) [hereinafter "2009 OVDP FAQ"]; IRS, 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers, http://www.irs.gov/Businesses/International-Businesses/2011-Offshore-Voluntary-Disclosure-Initiative-Frequently-Asked-Questions-and-Answers (first posted Feb. 8, 2011) [hereinafter "2011 OVDI FAQ"]; IRS, Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers (first posted June 26, 2012) [hereinafter "2012 OVDP FAQ," or collectively the "OVD programs"].

³ National Taxpayer Advocate 2011 Annual Report to Congress 191-205; Id. at 206-72; National Taxpayer Advocate 2013 Objectives Report to Congress 7-8; Id. at 21-29. See also Taxpayer Advocate Directive 2011-1 (Aug. 16, 2011).

⁴ National Taxpayer Advocate 2009 Annual Report to Congress 144.

⁵ IRS response to TAS information request (July 27, 2012); IRS response to TAS information request (Sept. 23, 2012).

⁶ 31 U.S.C. § 5321(a)(5)(C).

⁷See, e.g., IRM 4.26.16.4.7 (July 1, 2008). Unlike citizens of most other countries, U.S. citizens with income above certain thresholds are required to file returns with the IRS even if they reside abroad and have no net U.S. tax liability. See, e.g., IRC § 6012(a)(flush) and (c). The FBAR and the new Form 8938 may help the government to detect potentially unreported income deposited in foreign accounts.

⁸See Treas. Reg. § 1.6664-2. Certain deductions and credits may be denied if returns from individuals who are not U.S. residents or citizens are more than 16 months late or if returns from foreign corporations are more than 18 months late, provided the taxpayer does not demonstrate reasonable cause for the delay. See IRC §§ 874(a) (applicable to individuals) and 882(c)(2) (applicable to corporations); Treas. Reg. §§ 1.874-1 and 1.882-4.

⁹ The statutory period for assessing additional tax is generally limited to three or six years from the date the return is filed. See IRC § 6501.

¹⁰ IRS Policy Statement 6-11 (Nov. 4, 1977) ("[A]dministrative procedures and forms will be designed to promote voluntary compliance."); IRS Policy Statement 20-1 (June 29, 2004); H.R. Conf. Rep. No. 101-386 at 661 (1989) ("the IRS should develop a policy statement emphasizing that civil tax penalties exist for the purpose of encouraging voluntary compliance.").

¹¹ 2009 OVDP FAQ #10; 2011 OVDI FAQ #15; 2012 OVDI FAQ #12.

¹²See, e.g., National Taxpayer Advocate 2011 Annual Report to Congress 238-41.

¹³See Memorandum for National Taxpayer Advocate from Deputy Commissioner for Services and Enforcement, Taxpayer Advocate Directive 2011-1 (Oct. 14, 2011); Memorandum for Commissioner of Internal Revenue from National Taxpayer Advocate, Recommendations Regarding Taxpayer Advocate Directive 2011-1 (Sept. 26, 2011). For further discussion of this issue, see National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 8-9.

¹⁴See e.g., Alison Bennett, Tax Evasion: Taxpayers Fear Disclosing Offshore Assets As Deadline Approaches, Practitioners Say, 157 DTR GG-1, 2011 (Aug. 15, 2011); Robert Wood, Should You File FBAR for the First Time?, Forbes (June 14, 2011), http://www.forbes.com/sites/robertwood/2011/06/14/should-you-file-fbar-for-the-first-time/; Steven Mopsick, Tax Justice for Americans Abroad: No Penalties for Prospective Compliance, 136 Tax Notes 189 (July 9, 2012).

¹⁵ Certain taxpayers could qualify for an offshore penalty rate of 5 percent or 12.5 percent. 2011 OVDI FAQ #52 and #53; 2012 OVDP FAQ #52 and #53.

¹⁶See 2011 OVDI FAQ #42; 2012 OVDP FAQ #42; 2009 OVDP FAQ #34. But see Memorandum from Deputy Commissioner for Services and Enforcement, Guidance for Opt Out and Removal of Taxpayers from the Civil Settlement Structure of the 2009 OVDP and the 2011 OVDI (June 1, 2011) ("the taxpayer should not be treated in a negative fashion merely because he or she chooses to opt out . . ."; 2012 OVDP FAQ #51 (same).

¹⁷ IRS response to TAS information request (Oct. 23, 2012).

¹⁸ The number shown for the 2009 OVDP and the 2011 OVDI counts an application from a husband and wife as one application, but the number shown for the 2012 OVDP counts them as two.

¹⁹ IRS response to TAS information request (Oct. 23, 2012) (noting that $1,255,567 in willful and nonwillful penalties plus $1,671,518 in negligence penalties were assessed against taxpayers who opted out of the 2009 OVDP in 186 closed cases). Moreover, a small number of taxpayers could account for most of these penalties.

²⁰Id.

²¹ Although the IRS has not processed very many opt out requests, the average civil FBAR penalty assessed against those opting out of the 2009 OVDP is only $15,737 ($1,255,567 in willful and nonwillful penalties plus $1,671,518 in negligence penalties, divided by 186 closed cases). IRS response to TAS information request (Oct. 23, 2012). Moreover, the IRS has not initiated any criminal prosecutions against those who opted out. Id.

²²See Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.

²³ Rev. Proc. 2002-23, 2002-1 C.B. 744.

²⁴ To put these figures in context, a Westlaw search revealed the IRS issued only 1,487 PLRs in 2011.

²⁵ IRS response to TAS information request (July 25, 2012).

²⁶ Processing time reflects the days in inventory for rulings issued during the year.

²⁷ One PLR request was returned because it was not necessary.

²⁸ The open cases were suspended pending resolution of consistent treatment under the OVDI program. We understand the IRS is returning the user fees.

²⁹ Rev. Proc. 2002-23, §§ 4.01 and 4.06, 2002-1 C.B. 744; Treas. Reg. §§ 301.9100-1 and -3; IRM 21.5.3.4.9.1 (Aug. 4, 2009) ("For retroactive elections . . . Process the amended return as normal."). The IRS does not track the number of Form 8891 submissions or the number processed late. IRS response to TAS information request (July 27, 2012).

³⁰See Marie Sapirie, Frustration Grows for Canadians in OVDI, 2012 TAX NOTES TODAY 169-1 (Aug. 29, 2012).

³¹ IRS, FS-2011-13, Information for U.S. Citizens or Dual Citizens Residing Outside the U.S. (Dec. 2011), http://www.irs.gov/uac/Information-for-U.S.-Citizens-or-Dual-Citizens-Residing-Outside-the-U.S.

³²See, e.g., United States v. Boyle, 469 U.S. 241 (1985).

³³ "Factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause include reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account, that the unreported account was established for a legitimate purpose and there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and that there was no tax deficiency (or there was a tax deficiency but the amount was de minimis) related to the unreported foreign account." IRS, FS-2011-13, Information for U.S. Citizens or Dual Citizens Residing Outside the U.S. (Dec. 2011) [emphasis added]; Treas. Reg. § 1.6664-4 (reliance on tax advisor not reasonable if the taxpayer "fails to disclose a fact that it knows, or reasonably should know, to be relevant to the proper tax treatment of an item").

³⁴ IRM 4.26.16.4.5.3 (July 1, 2008).

³⁵ A benign actor with nothing to hide might have been less likely to question a preparer's advice or ask for a contemporaneous written opinion about the FBAR filing requirement.

³⁶ IRS, New Filing Compliance Procedures for Non-Resident U.S. Taxpayers (first posted June 28, 2012), http://www.irs.gov/Individuals/International-Taxpayers/New-Filing-Compliance-Procedures-for-Non-Resident-U.S.-Taxpayers.

³⁷ For a description of some benign actors who are U.S. residents, see for example, Steve Mopsick, Tax Justice II: No FBAR Penalties For Otherwise Compliant Recent Immigrants to the United States (Aug. 2, 2012), http://mopsicktaxlaw.blogspot.com/2012/08/tax-justie-ii-no-fbar-penalties-for.html.

³⁸ The National Taxpayer Advocate previously recommended increasing the $1,500 threshold to the "substantial understatement" threshold. National Taxpayer Advocate 2013 Objectives Report to Congress 24. Individuals who owe less than the greater of 10 percent of the tax required to be shown on the return or $ 5,000 may not have a "substantial understatement," and thus, may not be subject to an accuracy-related penalty, particularly if a negligence penalty does not apply. IRC § 6662(d). When the substantial understatement penalty applies due to an undisclosed foreign financial asset, the penalty rate increases from 20 to 40 percent. See IRC § 6662(j). Thus, there is precedent for using the combination of a substantial understatement and nondisclosure to distinguish minor omissions from those that may warrant more significant sanctions. Of course, we would still need to consider how to handle those who had not filed returns, as they would not have a substantial understatement.

³⁹ IRC §§ 6038D and 1298(f); Notice 2011-55, 2011-29 I.R.B. 53 (July 18, 2011). An FBAR is due on June 30 if the aggregate value of the foreign accounts exceeded $10,000 during the prior calendar year. 31 C.F.R. § 1010.306(c).

⁴⁰ GAO, GAO-12-403, Reporting Foreign Accounts to the IRS, Extent of Duplication Not Currently Known, but Requirements Can Be Clarified 2, 18 (Feb. 2012). Although the IRS met with GAO and provided technical information, neither the Financial Crimes Enforcement Network (FinCen) nor the IRS responded to GAO's recommendation to revise the Form 8938 and FBAR to address duplicative reporting. Id. at 3.

⁴¹ IRS website, Reaching Out to Americans Abroad (Apr. 2009), http://www.irs.gov/Businesses/Reaching-Out-to-Americans-Abroad; W&I Research Study Report, Understanding the International Taxpayer Experience: Service Awareness, Use, Preferences, and Filing Behaviors (Feb. 2010) (citing U.S. Department of State data). This number does not include U.S. troops stationed abroad. Moreover, the tax gap associated with offshore accounts could be significant. See, e.g., James Henry, Tax Justice Network, The Price of Offshore Revisited 5 (July 2012), http://www.taxjustice.net/cms/upload/pdf/Price_of_Offshore_Revisited_120722.pdf ("at least $21 to $32 trillion" may be "invested virtually tax-free through . . . more than 80 'offshore' secrecy jurisdictions").

⁴² IRS response to TAS information request (July 27, 2012).

⁴³Id. This figure does not include OVD "certifications," but it does include "examinations" resulting from OVD submissions.

⁴⁴Id. (reporting the dollar amount); IRS response to TAS information request (Sept. 23, 2012) (reporting the number of applications).

⁴⁵ The figures above reflect the number of names of expatriates published in the Federal Register.

⁴⁶ IRS response to TAS information request (July 27, 2012). The IRS also recently reorganized materials on its website.

⁴⁷Id. For a graphic representation of the dramatic rise in Internet searches for the term "FBAR" after 2009, see http://www.google.com/trends/?q=FBAR (last visited, Sept. 21, 2012).

⁴⁸ IRS response to TAS information request (Aug. 17, 2012). Nor does it plan to do so. IRS response to TAS information request (July 27, 2012). For additional discussion of this issue, see Most Serious Problem: Challenges Persist for International Taxpayers as the IRS Moves Slowly to Address Their Needs, supra/infra; National Taxpayer Advocate 2011 Annual Report to Congress 137-272 (Most Serious Problems: Foreign Taxpayers Face Challenges in Fulfilling U.S. Tax Obligations), 166-75 (Most Serious Problem: Small Businesses Involved in International Economic Activity Need Targeted IRS Assistance).

⁴⁹ U.S. Department of the Treasury, A Report to Congress in Accordance With § 361(B) of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 5 (CY 2009) ("the project remains viable . . . [but] is currently closed."). Many foreign accounts are reflected in the Web-CBRS database. Id. at 5.

⁵⁰ In response to 117 letters, 26 were returned as undeliverable, but the IRS received 73 responses and 15 FBAR filings. IRS response to TAS information request (Nov. 2, 2012). For suggestions to reduce undeliverable mail, see Status Update: Underfunding of IRS Initiatives to Modernize Its Correspondence Systems Undermines Taxpayers' Statutory Rights and Impedes Efficient Resource Allocation, infra.

⁵¹ IRS response to TAS information request (Aug. 8, 2012).

⁵² Foreign financial intermediaries will soon be required to report more foreign accounts to the IRS. See generally IRC §§ 1471-1474; Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities, 77 Fed. Reg. ¶ 9022 (Feb. 15, 2012) (notice of proposed rulemaking).

⁵³See IRC §§ 6038D and 1298(f).

⁵⁴ The National Taxpayer Advocate previously recommended increasing the FBAR filing threshold to make it consistent with the Form 8938 filing threshold. See National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 25 (noting the government could amend regulations under 31 C.F.R. § 1010.306(c) and/or change the FBAR form). She also recommended abating the penalty for the failure to file Form 8938 during the first year. Id. at 26. In addition, the IRS might reduce duplicative reporting by adding items reported on an FBAR to the existing list of items that taxpayers do not have to report on Form 8938. See Treas. Reg. § 1.6038D-7T.

⁵⁵http://www.irs.gov/uac/Information-for-U.S.-Citizens-or-Dual-Citizens-Residing-Outside-the-U.S.

⁵⁶ http://www.irs.gov/Individuals/International-Taxpayers/Options-Available-to-Help-Taxpayers-With-Offshore-Interests.

⁵⁷ http://www.irs.gov/uac/Instructions-for-New-Streamlined-Filing-Compliance-Procedures-for-Non-Resident-Non-Filer-US-Taxpayers.

⁵⁸http://www.irs.gov/Businesses/Comparison-of-Form-8938-and-FBAR-Requirements.

⁵⁹See 2012 OVDP FAQ 54 at http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers.

⁶⁰See instruction 7 at http://www.irs.gov/uac/Instructions-for-New-Streamlined-Filing-Compliance-Procedures-for-Non-Resident-Non-Filer-US-Taxpayers.

⁶¹ Research suggests the IRS's current approach may be more likely to reduce voluntary compliance and increase tax evasion. See e.g., TAS Research Study, Factors Influencing Voluntary Compliance by Small Businesses: Preliminary Survey Results, vol. 2, infra (finding a correlation between tax compliance and trust in government and the views of other members of local organizations toward the IRS and the U.S. tax system).

⁶² 31 U.S.C. § 5321(a)(5)(C).

⁶³ A six-year statute of limitations applies to the civil FBAR penalty. See 31 U.S.C. § 5321(b)(1). Criminal penalties of up to $500,000 and 10 years in prison may also apply. 31 U.S.C. §§ 5321(a)(5)(C) and 5322; 31 C.F.R. § 1010.840(b).

⁶⁴See Steven Toscher and Barbara Lubin, When Penalties Are Excessive -- The Excessive Fines Clause as a Limitation on the Imposition of the Willful FBAR Penalty, J. TAX PRAC. & PROC. 69-74 (Jan. 2010).

⁶⁵ 31 U.S.C. § 5321(a)(5)(B).

⁶⁶ National Taxpayer Advocate 2011 Annual Report to Congress 191-205; Id. at 206-72; National Taxpayer Advocate 2013 Objectives Report to Congress 7-8; Id. at 21-29. See also Taxpayer Advocate Directive 2011-1 (Aug. 16, 2011).

⁶⁷ IRS guidance says it will consider accepting a lower penalty inside the 2009 OVDP if "discussions concerning the assertion of an offshore penalty lower than 20 percent have taken place with a TA, Territory Manager, Group Manager, Counsel, or member of the national team (i.e. during a case assistance visit) and the discussions have been documented in the agents case file prior to Feb 8, 2011." Memorandum from Director, SB/SE Examination, and Director, International Individual Compliance, for all OVDI Examiners, Use of Discretion on 2009 OVDP Cases (Mar. 1, 2011), http://www.irs.gov/pub/irs-drop/ovdi_memo_use_of_discretion_3-1-11.pdf. When the IRS does consider a lower penalty under FAQ #35, however, it reverses the burden of proof -- requiring the taxpayer to prove nonwillfulness before considering the nonwillful penalty. Moreover, in TAS's view, even when a taxpayer proves nonwillfulness inside the 2009 OVDP, in some cases the IRS does not actually consider the facts they have presented. Rather, it asserts, without providing any explanation, that the taxpayer has not proved nonwillfulness and must opt out before the IRS will consider the facts.

⁶⁸ As the IRS's own characterization of these taxpayers in its response suggests, it starts with the misperception that it is giving people a great deal because it assumes it is giving people "an opportunity to get compliant with the U.S. tax system, pay their fair share, and avoid potential criminal charges." Most taxpayers who make inadvertent mistakes would not view the IRS offer as a good deal because they would not be subject to penalties at all. Rather, they would be alarmed by the implication that the IRS considers them potential targets of a criminal prosecution for inadvertently failing to file an information return. As discussed above, nobody who has opted out has been subject to criminal prosecution.

⁶⁹ Memorandum for Commissioner, LB&I Division and Commissioner, SB/SE Division, from Deputy Commissioner for Services and Enforcement, Guidance for Opt Out and Removal of Taxpayers from the Civil Settlement Structure of the 2009 OVDP and the 2011 OVDI (June 1, 2011), http://www.irs.gov/pub/newsroom/2011_ovdi_opt_out_and_removal_guide_and_memo_june_1_2011.pdf.

⁷⁰ American Jobs Creation Act, Pub. L. No. 108-357, § 811(a), 118 Stat. 1418 (2004); H.R. Rep. No. 108-548, pt. 1, at 261 (2004).

⁷¹See id.

⁷²See National Taxpayer Advocate 2008 Annual Report to Congress, vol. 2, 24 (recommending legislation to make the penalty proportional to the decrease in tax, establish a "reasonable cause" exception, and to eliminate the potential for stacking); National Taxpayer Advocate 2008 Annual Report to Congress 419, 422 (same). Congress subsequently changed the law. See Creating Small Business Jobs Act of 2010, Pub. L. No. 111-240, Title II, § 2041(a), 124 Stat. 2506, 2560 (2010) (limiting the penalty to 75 percent of the decrease in tax shown on the return as a result of such transaction). For an analysis of continuing problems with the penalty, including the lack of a reasonable cause exception, see Toni Robinson and Mary Ferrari, Congress Eases a Penalty, but Squanders Reform Opportunity, 2011 TAX NOTES TODAY 13-7 (Jan. 17, 2011).

⁷³See National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 23-25.

⁷⁴ Under the 2009 OVDP FAQ #9, persons who failed to file FBARs and did not report all of their income are required to pay the offshore penalty, even if they have no tax liability. Under 2011 OVDI FAQ #18 and FAQ #19, those with no unreported tax liability for periods before 2011 were permitted to file corrected returns outside of the program without penalty. Under 2012 OVDP FAQ #18, those with no unreported tax liability are permitted to file corrected returns outside of the program without penalty.

⁷⁵ Those who owe more than $1,500 per year or are U.S. residents are ineligible for the Streamlined Nonresident Filing Initiative. IRS, Instructions for New Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers (Aug. 31, 2012), http://www.irs.gov/uac/Instructions-for-New-Streamlined-Filing-Compliance-Procedures-for-Non-Resident-Non-Filer-US-Taxpayers. Moreover, those deemed "high risk" may still be subject to a full examination and maximum penalties, even if they otherwise qualify. Id.

⁷⁶ The IRS should publish guidance to expressly define what constitutes "reasonable cause" for the purposes of FBAR and provide examples about the difference between willful and nonwillful violations, based on the taxpayer's background, education level, cultural concerns, etc. In developing a broader "reasonable cause" standard to apply to FBAR violations, the Ratzlaf standard of "a voluntary intentional violation of a known legal duty" is a good starting point. See Ratzlaf v. U.S., 510 U.S. 135 (1994) (U.S. Supreme Court case discussing Bank Secrecy Act violations; however, not dealing with FBAR directly). The Ratzlaf analysis involves both the "knowledge of the reporting requirement" and a "specific intent," i.e., "a purpose to disobey the law." Ratzlaf, 510 U.S. at 141 (internal citations omitted). See also Cheek v. U.S., 498 U.S. 192 (1991) (holding that an airline pilot did not have the requisite "willfulness" for criminal tax evasion because he had a sincere belief that his income was not taxable, no matter how unreasonable that belief might be).

⁷⁷ IRM 4.26.16.4(4)-(5) (July 1, 2008).

⁷⁸ JCT, JCX-4-10, Technical Explanation of the Revenue Provisions Contained in Senate Amendment 3310, The "Hiring Incentives to Restore Employment Act," Under Consideration by the Senate 60-61 (Feb. 23, 2010).

⁷⁹ The IRS might reduce duplicative reporting by adding items reported on an FBAR to the existing list of items that taxpayers do not have to report on Form 8938. See Treas. Reg. § 1.6038D-7T.

Peggy Bogadi, Commissioner, Wage and Investment Division

DEFINITION OF PROBLEM

Any individual who has a tax return filing obligation but is not eligible to obtain a Social Security number (SSN) must apply to the IRS for an Individual Taxpayer Identification Number (ITIN).¹ ITINs may also appear on credit histories and bank records to meet requirements of backup withholding and the Bank Secrecy Act.² For almost a decade, the National Taxpayer Advocate has raised concerns about ITIN policies and procedures, including the recurring bottlenecks of ITIN applications during the peak tax season and the associated strain on IRS resources, inhibiting an ability to timely detect and deter fraud.

Instead of conducting a comprehensive and strategic analysis of the problems associated with its ITIN program, the IRS has consistently adopted a reactive approach. Thus, on June 22, 2012, in response to a Treasury Inspector General for Tax Administration (TIGTA) report, the IRS abruptly announced interim changes to ITIN procedures, requiring applicants to submit only original documents or documents certified by the issuing agency, and suspending the certifying acceptance agent program.³ This policy change exacerbated long-standing taxpayer service and compliance concerns present in ITIN operations, including:

• The unprecedented burden on ITIN applicants, imperiling their future tax compliance as well as their personal welfare and safety in the U.S. and abroad;

• The bottlenecks caused by seasonal processing of most ITIN applications, contributing to the proliferation of refundable credit schemes;

• The use of outdated processes in ITIN operations;

• The potential abrogation of the U.S. government's commitments under the 1961 Hague Apostille Convention;⁴ and

• The lack of adequate oversight of the certifying acceptance agent program.

Background

The IRS established the ITIN program in 1996 to facilitate tax return filing by individuals who have U.S. tax filing obligations and are ineligible for SSNs.⁵ These individuals can fall into one of two categories:

• U.S. resident aliens taxable on their worldwide income; and

• Nonresidents taxable on certain U.S.-source income.⁶

Although tax return filing is the most common use for ITINs, certain taxpayers are required to furnish ITINs for other legitimate tax administration purposes. For example, an ITIN may be used to report income associated with a bank account,⁸ for information reporting,⁹ or for withholding on the income of foreign investors.¹⁰ An ITIN does not authorize an alien to work in the United States, grant an immigration status, or qualify the alien for the Earned Income Tax Credit (EITC) or Social Security benefits.¹¹

Of 21 million ITINs assigned from the inception of the program in 1996 through August of processing year (PY) 2012, about 19.8 million (or about 94.4 percent) showed up on tax returns or information returns (Forms W-2, 1099, W-4, W-8, W-9, 8288, 1042), as shown on Figure 1.9.1 below.¹² For example, between the inception of the ITIN program and February 2009, of all ITINs associated with returns, about 33 percent appeared as primary, 18 percent as secondary, and 40 percent as those of dependent taxpayers, with the remaining nine percent associated with information returns.¹³

 

FIGURE 1.9.1, ITINs Used for Tax Administration Purposes Compared

 

to Total ITINs Issued from 1996 through October 27,

 

2012¹⁴

 

 

 

 

FIGURE 1.9.2, All ITINs Issued by Country of Citizenship in PY

 

2012 (through August 2012)¹⁵

 

 

 

In 2011, the last full processing year, the IRS assigned 1.7 million ITINs, of which approximately 270,000 went to non-resident aliens.¹⁹ In PY 2011, an average ITIN filer received a refund of $2,126 (including refundable credits) compared to an average of $2,913 for the general U.S. taxpayer population, as shown below.²⁰

 

FIGURE 1.9.3, Average ITIN Refunds Are Smaller Than Average U.S.

 

Taxpayer Refunds

 

 

 

The IRS's Policy Change to Require Applicants to Submit Only Original Documents or Documents Certified by the Issuing Agency Imposes an Onerous Burden on Taxpayers and May Irreversibly Harm Compliance and Endanger Taxpayers.

On June 22, 2012, the IRS abruptly and unilaterally changed ITIN application procedures without discussing these changes with internal and external stakeholders.²³ The IRS eliminated the option of providing a notarized copy of required identification documents, such as passports and birth certificates, with the Form W-7, Application for IRS Individual Tax Identification Number. Individuals applying for an ITIN must now either mail their original passports or other acceptable government-issued identification documents (or certified copies of these documents obtained from the original issuing agency) to the IRS Austin Service Center with their Forms W-7. The IRS indicated that it might take 60 days or longer to return these original documents to the applicant via standard U.S. mail.²⁴ The IRS did not authorize its walk-in sites to verify original documentation presented by ITIN applicants but instead instructed the sites to forward the original documentation to the centralized processing unit in Austin.

The IRS also immediately stopped issuing ITINs for applications submitted through certifying acceptance agents (CAAs) unless they include original documentation or copies of original documents certified by the issuing agency. Prior to this change, ITIN applicants using CAAs could present their original documents to the CAA for verification without having to submit notarized copies to the IRS.²⁵

These changes imposed a significant burden on ITIN applicants. Numerous stakeholders, including Low-Income Taxpayer Clinics (LITCs), colleges and universities, Volunteer Income Tax Assistance (VITA) sites, and tax practitioners complained about the extreme and unnecessary burden of these new interim procedures on taxpayers, and the harm to future compliance and the U.S. economy. Some commented that the policy has such a chilling effect on compliance that the affected taxpayers may stop filing returns altogether.²⁶ One LITC that conducts English as a Second Language (ESL) outreach for low income taxpayers complained that it had to cancel a scheduled workshop in September 2012 for ITIN applicants because no one appeared.²⁷ The clinic believes the applicants are not coming because they are reluctant to give up original identification documents. As the chart below shows, the number of ITIN applications significantly decreased in the months following the June 22, 2012 policy change compared to the same period in PY 2011.²⁸ At the same time, the number of rejected applications significantly increased.

 

FIGURE 1.9.4, Received and Rejected ITIN Applications in Second

 

Quarters of Processing Years 2011 and 2012

 

 

 

The requirement to provide original documents or copies certified by the issuing agency imposed a significant burden on many groups of taxpayers, including foreign students and businesspeople:

• Foreign students²⁹: Hundreds of thousands of foreign students bring more than $20 billion into the U.S. economy every year.³⁰ In FY 2011, the United States granted about 850,000 visas in student visa categories.³¹ As of April 2, 2012, there were about 1.2 million students, exchange visitors, and their dependents in active visa status.³² All these students are in the country legally under the Student and Exchange Visitor Program (SEVP).³³ The Department of Homeland Security (DHS) has authorized Designated School Officials (DSOs) of the 9,888 SEVP-member schools and Responsible Officers (ROs) of the 1,426 exchange visitor program sponsors to verify students' or visitors' documentation and certify extensions of visas on Forms I-20 and DS-2019.³⁴

• Foreign businesspeople and investors: Foreign individuals who have a U.S. filing obligation need ITINs to file a return, to make an election, claim an exemption from withholding, or submit a form to a partnership or a corporation that conducts business

The IRS's policy change created a tremendous burden on these taxpayers, including:

• The extended time (from one to three months, not including the IRS processing time of at least 60 days) without a passport. For students, this limited their ability to timely leave the country after the authorized period of stay or to travel in emergencies. For businesspeople, this can cause substantial damage to their business activities, preventing travel until the IRS returns their passports.

• The inability to submit documents certified by an apostille, which violates the U.S. government's obligations under the Hague Convention.³⁷

• Violation of prohibitions against sending original passports by mail in certain countries.³⁸

• The inability to obtain a certified copy from certain country embassies or a copy of a U.S. visa certified by the Department of State.³⁹

• The extended period of time (often many months) and associated costs required to obtain a duplicate, if the passport is lost.

• The inability to apply for required driver's licenses for taxpayers who are considered temporary state residents.⁴⁰

Outside stakeholders, LITCs and TAS case advocates have reported the policy change will cause foreign individuals who are U.S. residents for tax purposes to experience the following burdens, which may irreversibly harm them and their filing compliance:⁴⁴

• Taxpayers in several states risk being detained for an extended time (for example, incident to a routine traffic stop) for not having identification documents that they sent to the IRS.⁴⁵ As a result, some taxpayers, whether in the U.S. legally or not, who may feel threatened by the "show me your papers" laws, could choose a path of least resistance and decide not to file taxes at all, costing the government reductions in voluntary compliance and tax revenue.⁴⁶

• Some countries require citizens to carry identification documents at all times. The IRS's interim rule puts taxpayers' spouses and dependents who are not even present in the U.S. at risk of detention in those countries.⁴⁷

• Depending upon the taxpayer's location in the U.S., it may not be possible or practical to appear in person at the consular office.

• Some prospective ITIN applicants have been advised by their home countries' consulates that they do not issue certified copies of passports.⁴⁸

• Some countries, e.g., the United Kingdom and the Commonwealth countries, will not issue a certified copy of a passport at all -- even if the applicant is present in the home country. The only way to have the government stamp a copy is via the apostille process.⁴⁹

• Some countries do not provide any type of certification process for these documents, making it impossible for taxpayers to secure an ITIN.⁵⁰

• In order to file timely returns, some taxpayers must forego a joint return and any exemptions because their spouses and dependents cannot obtain ITINs before the return filing date. As a result, they could be made to pay more in taxes than they legally owe.⁵¹

• Some unbanked taxpayers, many of whom are low income, cannot cash checks until their original documents are returned.⁵²

• Taxpayers who are low income and therefore transient are at greater risk of losing their documents in the mail or at the IRS, and of becoming victims of identity theft and associated fraud.

TAS case advocates and LITCs note that the original documents sent by regular mail to applicants are often lost.⁵³ The IRS normally returns originals by regular mail within 60 days of receipt.⁵⁴ If these documents are returned to the IRS as undeliverable, IRS procedures do not require a personal contact with the taxpayer over the phone.⁵⁵ Instead, if the IRS does not detect a better address, it mails the original passports to embassies of issuing countries and destroys other items.⁵⁶ Many ITIN applicants are low income and transient.⁵⁷ However, given the high percentage of cell phone usage in this country, most applicants probably do have a contact phone number that they retain for a long time.⁵⁸ The IRS should change the Internal Revenue Manual (IRM) to require ITIN employees to contact the applicant if a document is returned as undeliverable. The IRS should also send the original documents by trackable mail service, such as certified, registered, or priority mail, and allow applicants who need their documents back more quickly the option of including a prepaid Express Mail or Courier envelope.⁵⁹ In addition, we recommend the IRS revise its Form W-7 to allow applicants to provide contact information of a third party designee for limited purposes of discussing Form W-7 processing issues with the designated third party, similar to a third party designee box on a tax return.⁶⁰

The IRS Should Have Focused Specifically on Refund Schemes Instead of Establishing Prohibitive Requirements for the Entire ITIN Population.

The IRS changed its procedures in response to a recent TIGTA report that identified certain tax refund fraud connected to refundable credits and exemptions.⁶¹ However, it is unclear how receipt of an original passport or other identification provides the IRS with any more certainty that the applicant is actually the owner of the document or shows that the applicant is eligible for any refundable credits claimed. For example, for the taxpayer to claim a CTC or Additional CTC, his or her child must satisfy certain requirements not substantiated by the claimant's documents.⁶²

Generally, to claim exemptions for spouses and dependents, the ITIN taxpayer must be a U.S. resident alien for tax purposes, a resident of Canada or Mexico, or a resident of India or the Republic of Korea meeting certain requirements.⁶³ While the IRS may have a legitimate reason to scrutinize ITIN applications from nationals of these countries, it does not have justification for imposing undue burden on all ITIN applicants.⁶⁴ Its one-size-fits-all approach to documents does not resolve concerns about dependency exemptions and the CTC and harms generally compliant taxpayer groups.

Seasonal Processing of Most ITIN Applications and the Absence of Revocation Procedures Exacerbates the IRS's Inability to Timely Detect and Deter Fraud.

For several years, the National Taxpayer Advocate has criticized the IRS policy of processing ITIN applications only with paper tax returns during the filing season, on the grounds that it creates seasonal bottlenecks affecting over one million tax returns and associated refunds annually.⁶⁵ The policy is in response to the fear that the bulk of ITIN applications are submitted by resident aliens employed in the U.S. illegally who seek ITINs for non-tax purposes, such as for obtaining a driver's license.⁶⁶ However, as discussed above, over 94.4 percent of issued ITINs appear on tax returns.⁶⁷ In addition, most states do not require an applicant for a driver's license or a state ID card to provide an SSN, removing an incentive for ITIN holders to use ITINs for non-tax purposes.⁶⁸

The requirement that ITIN applications be submitted along with tax returns strains IRS resources during the filing season, condensing a 12-month ITIN workload into four months. This process does not allocate sufficient time or resources to verify the existence of wage income or the tax filing need for those claiming exemptions and credits.

Allowing taxpayers to obtain ITINs throughout the year would enable the IRS to build in additional time for analyzing trends and verifying wage and withholding amounts before the filing season begins.⁶⁹ To reduce the improper use of ITINs, the IRS should develop a process to revoke the numbers that are no longer used for tax purposes, after notifying the taxpayer; for example, in situations when the taxpayer leaves the country (as would a student) or receives an SSN.

The IRS Should Apply Existing Processes to Timely Identify and Prevent Potential Fraud Schemes Involving ITIN Applicants.

Unlike the Questionable Refund Program (QRP) and its successor, the Accounts Management Taxpayer Assurance Program (AMTAP), the ITIN program was not designed to select and examine returns suspected of fraud. The ITIN program does not have electronic applications or filters to screen, score, and select returns for review.⁷⁰ The inability of the ITIN operation to screen returns is exacerbated by the IRS's insistence on processing the bulk of ITIN applications attached to paper returns during the peak filing season as discussed above. Thus, efforts to detect fraud when processing ITIN applications are necessarily unwieldy, ineffective, and subjective. If ITINs were assigned before the filing season, the returns associated with them would be subject to all fraud detection filters the IRS uses for all other returns claiming refunds. As further illustration of the ITIN program's deficiencies, the IRS has identified multiple fraud schemes, e.g., thousands of returns filed from the same address, same return information, same CAA, etc.⁷¹ However, it failed to take timely enforcement actions against perpetrators. Yet these returns have precisely the kind of characteristics that the IRS's regular return processing routinely catches and stops.

The IRS also misses the opportunity to use the recently adopted Preparer Tax Identification Number (PTIN) regulations to address potential ITIN-related fraud by tax preparers.⁷² If it requires preparers to provide a PTIN on an ITIN application (Form W-7) the IRS will be able to link questionable or potentially fraudulent applications to a preparer and take appropriate action, including a referral to the IRS Criminal Investigation (CI) division, the Return Preparer Office, or the Office of Professional Responsibility, and a referral to the U.S. Department of Justice for a court injunction against the preparer.⁷³

TAS Visit to ITIN Operation Confirmed the Need for Modernization of the Technologically Obsolete Paper Process.

On September 18 and 19, 2012, TAS representatives visited the ITIN unit in Austin, TX. The visit showed that the employees do not use modern technology to process applications and detect potential fraud, instead manually verifying and processing a large number of paper files. Most ITIN examiners do not even have access to a telephone or IRS systems, other than the Real-Time System (RTS) for entering information about ITIN applications. The RTS itself is an outdated system that does not have fields for numbers, countries of issuance, and types of taxpayer documents proving identity, foreign status, or U.S. residency for tax purposes. For example, an ITIN examiner cannot enter the number or the date and the country of issuance of a passport for electronic screening of subsequent applications. Nor can he or she use face recognition software to identify multiple applications using the same photo identification. Further, RTS is an offline system that cannot communicate with other federal and state government databases to verify the taxpayer's identity.

To detect and deter fraud in the ITIN program, the IRS should modernize its processing technology to permit:

• Scanning and barcoding of incoming applications for future reference;

• Use of face recognition software and matching technology for screening applications, pictures, and signatures and comparing them with applications already in the database; and

• Automatic electronic verification with other federal, state, and foreign government agencies.⁷⁴

The IRS Should Address Unique Characteristics of Different Groups of ITIN Filers in Drafting New ITIN Rules.

As discussed above, the IRS's sweeping policy change based on a one-size-fits-all approach has imposed an unnecessary burden on different groups of ITIN applicants and may have had a chilling effect on filing compliance, as well as putting taxpayers at personal risk. Many taxpayer groups are not eligible for child tax credit and dependency exemptions and pose little or no risk of noncompliance. The IRS should take the demographics of taxpayer return claims into account and craft discrete exceptions for different groups of ITIN filers.

Foreign Students, Researchers, Trainees, and Exchange Visitors

This group of taxpayers should be able to file W-7 applications throughout the year for themselves, their spouses, and dependents by attaching copies of identity and foreign status documents certified by a SEVP-approved school or organization. The National Taxpayer Advocate is pleased with the collaboration between TAS and the IRS on this issue. On October 2, 2012, in response to the National Taxpayer Advocate's and stakeholders' concerns, the IRS stated that taxpayers with a SEVIS record can submit copies of their documents proving identity and foreign status when certified by a SEVP-designated official.⁷⁵ However, ITIN applications from these taxpayers must still accompany a paper return unless they meet an exception.⁷⁶ Because these taxpayers pose little or no risk of using ITINs for a non-tax purpose, they should be allowed to apply for and obtain ITINs throughout the year, in advance of the filing season. This would allow them to file electronically and therefore significantly reduce their burden. It would also enable their returns to run through the IRS's regular refund fraud detection procedures, further mitigating risk of tax fraud.

Alien Taxpayers Submitting Copies of Public Documents Certified by an Apostille.

As a signatory to the Hague Convention, the United States agreed to recognize public (including notarized) documents issued by other signatory countries if those public documents are authenticated by the attachment of an internationally recognized form of authentication known as an apostille.⁷⁷ The apostille procedure allows public documents issued in one signatory country to be recognized as valid in another.⁷⁸ Apostilles may be issued only by a designated Competent Authority of a signatory country. Each Competent Authority is required to keep a register of apostilles it has issued that any interested person can access as an essential tool to combat fraud and verify the origin of an apostille in case of doubt.⁷⁹

In January 2012, the Hague Conference on Private International Law (HCCH) and the National Notary Association of the United States of America (NNA) officially adopted the electronic Apostille Program (e-APP), a secure software that provides for the issuance of electronic apostilles (e-Apostilles) and verification of paper and electronic apostilles (e-Registers).⁸⁰ The e-APP (the e-Apostille and/or e-Register component) has been implemented in at least 14 countries, including the United States and Mexico, with other countries actively pursuing or considering implementation.⁸¹ The IRS should immediately rescind its ITIN policy change, which effectively denies recognition of copies of public documents certified by an apostille (and violates the U.S. obligations under the Hague Convention), and find a way to routinely verify the validity of apostilles. With the majority of ITIN applications submitted by Mexican nationals, the IRS may be interested in developing an electronic tool to systemically verify the validity of Mexican apostilles through the e-APP process.⁸²

Proper Oversight of the Certified Acceptance Agent Program Would Ensure the Validity of Foreign Documents and Alleviate Burden for ITIN Applicants.

According to Treasury Regulations and the controlling revenue procedure, other federal agencies, financial institutions, colleges and universities, and other authorized persons (including foreign persons) can certify copies of documents for ITIN applications.⁸³ As stated above, on June 22, 2012, the IRS stopped accepting copies of documents certified by CAAs, reacting to evidence of fraud by several "bad actors" identified in the TIGTA report.⁸⁴ Many stakeholders complained that instead of taking a timely enforcement action against unscrupulous CAAs, the IRS essentially ended the CAA program, creating undue burdens for honest taxpayers and compliant CAAs.⁸⁵

The following persons, if authorized as CAAs, pose little or no risk for the integrity of the ITIN program:

• Colleges and universities (as described above);

• Other federal agencies, e.g., the Social Security Administration or the United States Postal Service (which currently accepts U.S. passport applications);

• Financial institutions (broadly defined to include securities dealers, money services businesses, telegraph companies, etc.) that are required by law to verify and record the identity (name and address) and the TIN of the customer, e.g., the passport number and the country of issuance for a foreign national;⁸⁶

• Low Income Taxpayer Clinics;⁸⁷

• Volunteer Income Tax Assistance sites that provide free services and lack a financial incentive to commit or aid and abet fraud;

• Attorneys and Certified Public Accountants (CPAs) who are governed by their state licensing authorities and bound by ethical standards;⁸⁸

• Enrolled Agents;⁸⁹ and

• Certain state government agencies, e.g., Departments of Motor Vehicles, Departments of Social Services, and Boards of Education that have substantial experience in verifying the foreign persons' identity for state purposes.⁹⁰

The IRS should significantly revamp its CAA program to provide accurate and periodic training to CAAs, require all CAAs to take an annual competency examination like the return preparation exam administered to VITA volunteers, and require a due diligence statement regarding the accuracy of the ITIN application as well as any claims for the dependency exemption and CTC similar to IRS Form 8867, Paid Preparer's Earned Income Credit Checklist.⁹⁵ The IRS should also expand the program to include attorneys, CPAs, LITCs, VITA sites, and state government agencies. The program also would benefit from a process for electronic verification of CAA certifications where possible, and increased enforcement efforts against "bad actors."

CONCLUSION

Regardless of a taxpayer's immigration status or country of origin or residence, an efficient and equitable tax system does not distinguish between alien and other taxpayers with respect to taxpayer protection or customer service. The IRS should use a proactive approach to the ITIN application process, facilitating voluntary compliance and taking timely enforcement actions against perpetrators of fraud. While the National Taxpayer Advocate is pleased that the IRS now actively collaborates with TAS on ITIN issues, the IRS should consider inside and outside stakeholders' perspectives before significantly changing ITIN application procedures. Instead of employing a one-size-fits-all approach that harms future compliance by ITIN taxpayers, the IRS should specifically address refundable credit issues and CAA schemes identified in the TIGTA report.

The National Taxpayer Advocate preliminarily recommends that the IRS:

The IRS issued interim changes on June 22, 2012 to strengthen the procedures for issuing ITINs. Designed specifically for tax administration purposes, ITINs are only issued to people who are not eligible to obtain a Social Security number. After careful consideration, the IRS implemented these changes to protect the integrity of the application process while minimizing burden for applicants.

During the interim period, the IRS only issued ITINs when applications included original documentation, such as passports and birth certificates, or certified copies of these documents from the issuing agency. ITINs were not issued based on applications supported by notarized copies of documents. In addition, ITINs were not issued based on applications submitted through certifying acceptance agents unless they attached original documentation or copies of original documents certified by the issuing agency.

Some categories of applicants were not impacted by the interim changes including military spouses/dependents and nonresident aliens applying for ITINs for the purpose of claiming tax treaty benefits. The IRS also established exceptions to the interim procedures for certain types of applicants. On October 2, 2012, the IRS announced special instructions for the Student and Exchange Visitor Program (SEVP) and non-citizens with approved TY 2011 extensions. The original document requirement did not apply to these groups of taxpayers.

During the summer and fall of 2012, the IRS gathered feedback from stakeholders and interested groups on how to best safeguard the integrity of the ITIN program and improve applicant procedures.

Based on an extensive review of the ITIN application process along with feedback gathered from a variety of stakeholders, the IRS developed procedures for the 2013 filing season that will strengthen controls over the ITIN process. The IRS is also continuing this dialogue as we move forward in implementing these procedures. The IRS will maintain its new and stronger standard for issuing ITINs. ITIN applications will require original documentation, such as passports, birth certificates, or certified copies of these documents from the issuing agency. In addition, the IRS finalized its earlier decision of no longer accepting notarized copies of documents for ITINs to protect the integrity of the application process. The IRS recognizes the burden this may cause taxpayers and has identified exceptions and alternate methods to secure an ITIN without sending original documentation to the IRS. Though many of the interim guidelines from the summer were made permanent, others were modified based on feedback from key stakeholders. The changes will provide additional flexibility for people seeking ITINs while maintaining the stronger protection measures.

The IRS acknowledges there may be some additional burden with the IRS's policy change to require applicants to submit only original documents or documents certified by the issuing agency. The IRS is taking steps to relieve taxpayer burden while maintaining the integrity of the ITIN process. In addition to direct submission of documents to the IRS ITIN centralized site or use of Certifying Acceptance Agents, ITIN applicants will have several other avenues for verification of their documents. These options include providing full-service assistance for primary and dependent taxpayers at some key IRS Taxpayer Assistance Centers and our U.S. Tax Attachés in London, Paris, Beijing, and Frankfurt. In addition, Certifying Acceptance Agents, including those at the Low Income Taxpayer Clinics (LITCs) and Volunteer Income Tax Assistance (VITA) centers, may certify the original documentation of primary and secondary taxpayers. We have also retained the exception announced on October 2, 2012 for foreign students at educational institutions to be certified through the SEVP.

The Most Serious Problem suggests that the IRS is in violation of the Hague convention by requiring original documents. The IRS disagrees with this assertion. If the IRS generally accepted notarized copies of documents, then the IRS would be bound to accept notarized apostille copies from international sources under the Hague convention. Since the IRS no longer accepts notarized copies of documents, there is no requirement to accept apostille copies from international sources under the Hague convention.

Certified Acceptance Agents are an important intermediary in the ITIN application process. For processing year 2013, CAAs will be able to review original or certified copies from the issuing agency of identification documents from applicants and certify to the IRS that they verified the authenticity of the documents supporting the ITIN application. These face-to-face interviews of the primary and secondary applicants will help improve the integrity of the program while minimizing burden for applicants. ITIN applications for dependents submitted to the IRS by CAAs will continue to require original documents or copies certified by the issuing agency.

The application process for CAAs and AAs remains unchanged; however, there are new eligibility requirements for CAAs. The acceptance agent must be a U.S. or foreign person covered under Circular 230, and not under suspension or disbarment from practice before the IRS. This will include individuals who are attorneys admitted to the practice before the bar, Certified Public Accountants (CPA), Enrolled Agent (EA) and registered tax return preparers. The IRS recognizes that there are unique situations where it is not necessary to require a person to meet the Circular 230 eligibility requirements. IRS has granted exceptions to approved financial institutions, colleges, and universities, gaming industry, LITCs, and VITA centers.

As part of the application process, CAAs are required to complete an online course. Additionally, CAAs are required to successfully complete a forensic document identification training course. The IRS will increase compliance reviews using risk-based selection criteria. Infractions are identified and classified as minor and major. Stricter penalties will apply to major infractions, and CAAs will be removed from the program for one year.

The IRS recognizes there is a need to keep tighter control over ITINs to prevent misuse of the numbers once assigned. Changes were made to ensure they are being used for legitimate tax purposes. A key change is that, for the first time, new ITINs will expire after five years. Taxpayers who still need an ITIN will be able to reapply at the end of the expiration period. This step will provide additional safeguards to the ITIN program to help ensure only people with legitimate tax purposes are using the numbers. In addition, the IRS will explore options, through engagement with interested stakeholder groups, for deactivating or refreshing the information relating to previously issued ITINs. The IRS agrees with the recommendation of the National Taxpayer Advocate that the IRS should develop a process to retire ITINs that are no longer used for tax purposes.

In addition to changes in the ITIN program, there will be further compliance checks on claims for credits including the Additional Child Tax Credit. For PY 2013, there will be a requirement to attach Form 8812, Additional Child Tax Credit, to the Form 1040 tax return. The Form 8812 will include statements about the residency of dependent children with ITINs. The IRS is also adding pre-refund compliance checks based on referrals from the ITIN employees and additional filters to identify fraud. There are steps in place during tax return processing to identify fraud, such as "funny box" procedures, the Electronic Fraud Detection System (EFDS), Accounts Management Taxpayer Assurance Program (AMTAP), and Dependent Database (DDb) filters. The IRS efforts to prevent fraud and ID theft within the ITIN program are balanced with the accessibility of an obtaining an ITIN for those taxpayers filing tax returns.

With respect to the recommendation that the IRS allow filing of ITIN applications throughout the taxable year with proof of taxable income and a filing need, the IRS position remains unchanged. As mentioned in response to Most Serious Problem #8 in the 2010 Annual Report, the procedure of requiring a valid tax return with the Form W-7 application was designed to ensure that the ITIN assigned is used for its proper tax administration purpose. Associating the issuance of the ITIN with the filing of a tax return is still the only reliable method for the IRS to verify the number is being requested and properly used for tax administration purposes. As a result, ITINs are no longer issued solely based upon a statement that an applicant requires an ITIN in order to file a return without proof that the individual in fact needs the number to do so.

The IRS plans to make improvements in the following three areas noted in the draft Most Serious Problem: 1) making telephone contact with ITIN applicants, 2) returning documents by other than regular mail and 3) upgrading the RTS system. These are detailed more specifically in the following paragraphs.

With respect to the recommendation that ITIN employees contact the ITIN applicant if a document is returned undeliverable, the IRS agrees to do a study on undelivered ITIN mail. Under consideration is a procedure requiring ITIN Tax Examiners to research the Integrated Data Retrieval System (IDRS) for a good mailing address. If none is found, the employee will send an email to the Entity function in Austin with the taxpayer's telephone number. An Entity employee will then call the taxpayer to identify a good mailing address. The study will track how many applications do not have telephone numbers and the successful and unsuccessful attempts by the Entity to reach the taxpayer by telephone. At the end of six months, the IRS will evaluate the results and determine whether to continue the procedure.

The IRS appreciates the recommendation of the National Taxpayer Advocate regarding the use of certified, registered, or priority mail to return original documents. The Form W-7 instructions will be updated with a note that applicants are permitted to include a prepaid Express Mail or courier envelope for faster return delivery of their documents. The IRS would then return the documents in the envelope provided by the taxpayer. This option will permit applicants to obtain an expedited level of mail service provided they are willing to bear the associated cost.

The National Taxpayer Advocate has also recommended that the IRS invest in modernization of the ITIN operation, including an update of the RTS software. The RTS is a web-based application designed as an inventory system. It currently captures the document number and country of issuance of documents submitted with Form W-7. The IRS agrees to evaluate the feasibility of an automated process to scan and electronically verify documents. If feasible, the IRS will take the necessary steps to request the required system architecture. System upgrades and enhancements are subject to funding and resource prioritization processes.

The IRS will continue to elevate the feedback of National Taxpayer Advocate, as well as all other stakeholders, as we determine if additional program improvements are needed in the future.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS has acknowledged the burden imposed on ITIN applicants by the interim ITIN application rules. We applaud the IRS's efforts to increase and improve its compliance checks on questionable claims for tax credits, including the Additional Child Tax Credit, recognizing that these return issues are separate and distinct from the application for the ITIN. We also appreciate the IRS's efforts to strengthen and improve the oversight of the Certifying Acceptance Agent program, including the requirement (with exceptions) for the CAA to be a regulated Circular 230 practitioner, to complete an online course, and to complete forensic training. Nonetheless, we encourage the IRS to provide periodic training to CAAs and develop and administer an annual competency examination for these agents.

The National Taxpayer Advocate remains concerned about the disproportionate burden imposed on families with dependents applying for ITINs. The new permanent ITIN rules issued on November 30, 2012 provide limited alternatives to the requirement to submit either original documents or copies certified by the issuing agency to the ITIN processing operation in Austin.⁹⁶ While the IRS has allowed CAAs to certify primary and secondary ITIN applicants' documents after an in-person appearance by the applicant, this option is not available for dependent applicants, as CAAs must collect and mail originals or copies certified by the issuing agency. For dependents, the only alternative to mailing original documents is to appear at "participating IRS Taxpayer Assistance Centers (TACs)," which are only authorized to certify copies of passports or national identification cards.⁹⁷ This is impossible for taxpayers with dependents residing abroad, while taxpayers in the United States with young children may be required to travel extensively if there is no TAC in their area.⁹⁸ In addition, many TACs require a valid U.S.- issued ID just to enter the building, which makes this option unavailable for many.⁹⁹ For taxpayers with dependents residing abroad, whose only option for presenting original documents in person is to appear at one of four U.S. tax attaché offices, there is simply no alternative but to mail documents to the IRS.

As discussed above, the requirement to submit original documents or copies certified by the issuing agency imposes a significant burden on families with dependents, who now comprise more than two thirds of all ITIN applicants, while at the same time reducing filing compliance.¹⁰⁰ Because of these new permanent rules, many dependents cannot travel with their families, as they wait more than two months -- according to the IRS's own estimates -- for the IRS to return their passports. As Figure 1.9.5 below shows, the volume of ITIN applications submitted with tax returns and the number of assigned ITINs substantially decreased from June 22, 2012, when the IRS announced the policy change, through December 1, 2012, compared to the same period in processing year 2011.¹⁰¹ At the same time, the number of rejected applications increased significantly.

 

FIGURE 1.9.5, ITIN Application Receipts, Assignments,

 

and Rejects

 

 

 

In addition, the IRS could accept copies of foreign documents certified by an apostille. The IRS does not acknowledge its responsibility to accept apostilles as valid certifications of original documents under the Hague Convention, rationalizing that the apostille is a mere notarization. This interpretation is both inaccurate and unproductive for the IRS's own purposes, because it ignores the definition and purpose of the apostille as a state certification of authenticity.¹⁰² We submit that the state that issued the document is in the best position to authenticate its validity. The validity of an apostille can be easily verified by any interested person by accessing the apostille register maintained by a competent authority of each signatory country. Thus we recommend that the IRS reconsider its responsibilities regarding apostilles under the Hague Convention.¹⁰³

While the National Taxpayer Advocate is pleased by the IRS's commitment to develop a process to retire ITINs not used for tax purposes, she is disappointed with the IRS's refusal to accept and process ITIN applications throughout a taxable year with proof of earned income. In addition to the automatic five-year expiration rule for newly assigned ITINs, the IRS should be able, after communicating with the taxpayer, to retire numbers that are no longer used for tax purposes, for example, where the taxpayer leaves the country (as would a student) or receives an SSN. If the IRS can deactivate an ITIN not used for a valid tax administration purpose, it has no basis for requiring concurrent filing of paper tax returns with paper ITIN applications.

More importantly, the IRS mischaracterizes the National Taxpayer Advocate's position with respect to accepting ITIN applications throughout the year. The National Taxpayer Advocate is not recommending that the IRS issue ITINs "solely based upon a statement that an applicant requires an ITIN in order to file a return without proof that the individual in fact needs the number to do so." Rather, the National Taxpayer Advocate has consistently recommended that the IRS allow taxpayers to submit ITIN applications throughout the year so long as they are accompanied by proof that the taxpayer has a filing requirement.¹⁰⁴ This proof can consist of multiple paystubs showing withholdings, an employment agreement, or other such documents. The IRS's refusal to eliminate procedures that create a bottleneck and prevent e-filing is also inconsistent with the IRS's own plans to consider the Form W-7 as a "candidate" for electronic filing.¹⁰⁵ The IRS should reconsider its position and allow filing of ITIN applications throughout the taxable year with proof of taxable income and a filing need. We note that when ITIN returns are e-filed, they pass through IRS screens for identity theft and fraud protection. Thus, under our recommendation there would be no need for manual work-arounds.

We commend the IRS for initiating a study of undelivered mail to ITIN applicants and for its plans to revise procedures for telephone contact with applicants and return of documents by trackable mail service. We are also pleased that the IRS plans to enhance the RTS system, including an automated process to scan and electronically verify documents. We are looking forward to the IRS establishing a timeline for these changes. The IRS should not limit its provision of verifiable document returns to situations where taxpayers provide prepaid courier envelopes. It should return all documents via trackable mail service such as certified, registered, or priority mail. The IRS also should revise Form W-7 to include a field for contact information of a third party for limited processing questions, similar to a field on a tax return, and a PTIN of the paid preparer (if any).

Recommendations

The National Taxpayer Advocate recommends that the IRS:

²See generally Bank Secrecy Act, 31 U.S.C. §§ 5311-5314, 5316-5322; 12 U.S.C. § 1829(b); USA PATRIOT ACT, § 326, Pub. L. No. 107-56, 115 Stat. 307 (2001); 31 C.F.R. §§ 1010.410, 1010.620, 1022.400.

³ IR-2012-62 (June 22, 2012); TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications 29 (July 16, 2012).

⁴ The 1961 Hague Convention Abolishing the Requirement of Legalization for Foreign Public Documents (Hague Apostille Convention) (entered into force in the United States on Oct. 15, 1981), available at http://www.hcch.net/index_en.php?act=conventions.text&cid=41 (103 signatory countries) (last visited Dec. 20, 2012). See 33 U.S.T. 883, 527 U.N.T.S. 189, T.I.A.S. 10072, 94th Cong. 2d Sess. (1976) (with message and report, and text of Convention). See also Fed. R. Civ. P., Rule 44(a)(2) (notes).

⁵ Certain persons are required to file U.S. income tax returns and pay U.S. income tax regardless of their immigration or residence status. See generally IRC §§ 7701, 864, 871; Treas. Reg. §§ 301.7701(b)-1; 864(c)(1)-(4). To be eligible for an SSN, a taxpayer generally must be a U.S. citizen, legal permanent resident (green card holder), or be in work-authorized immigration status. See U.S. Social Security Administration (SSA), ssa.gov (last visited Dec. 20, 2012). Examples of individuals who need ITINs include non-resident aliens filing a U.S. tax return and not eligible for an SSN, U.S. resident aliens (based on days present in the United States) filing a U.S. tax return and not eligible for an SSN, dependents or spouses of a U.S. citizen/resident alien; and dependents or spouses of non-resident alien visa holders.

⁶See generally IRC § 7701. See also IRC §§ 1, 11, 61, 861, 862, 864, 871, 881, 882, and 1441-1446.

⁷ To become a resident for tax purposes, an individual must be present in the U.S. on at least 183 days during a three year period that includes the current year. See generally Treas. Reg. § 301.7701(b)-1(c).

⁸See Form W-9, Request for Taxpayer Identification Number and Certification. See also Forms W-8BEN, W-8ECI, W-8EXP, and W-8IMY.

⁹ Forms W-2 and 1099 and its progeny (e.g., 1099-DIV, 1099-INT, and 1099-OID).

¹⁰See generally IRC §§ 897, 1441-1445. See also, e.g., Forms 8288, 1042, and 1042-S.

¹¹ IRM 3.21.263.1(6) (Jan. 1, 2011).

¹² IRS, ITIN Production Reports (Dec. 31, 2008 - Oct. 27, 2012); National Taxpayer Advocate 2008 Annual Report to Congress 127.

¹³ IRS Compliance Data Warehouse (CDW), Individual Returns Transaction File (IRTF), TYs 1996-2007, and Information Returns Master File (IRMF), TYs 2000-2006 (data drawn Feb. 2009).

¹⁴ Processing year means the year in which the ITIN application was assigned and is based on a calendar year. Taxable year generally means a calendar year for individuals.

¹⁵ IRS response to TAS information request (Sept. 17, 2012).

¹⁶ An individual may generally deduct a dependency exemption amount for a child (or younger descendant or that of a sibling or step-sibling) under 19 (24 if a full-time student) sharing his or her home for over half the year who is a U.S. citizen or national, or a resident of the U.S., Canada, or Mexico. See IRC §§ 151(c), 152(b), (c). Different rules apply to dependents residing in Korea and India. See U.S.-Republic of Korea Income Tax Convention, Art. 4(7); U.S.-India Income Tax Convention, Art. 21(2).

¹⁷See IRC § 24(a), (c), and (d). With income below certain phase-outs, the primary taxpayer may claim a $1,000 CTC for a child under 17 who is a citizen, national, or resident of the U.S. for tax purposes. If the individual earns income below certain thresholds, ACTC in excess of tax owed is refundable. See also Legislative Recommendation: Simplify the National Status and Related Requirements for Qualifying Children, infra.

¹⁸ Reports by the Treasury Inspector General for Tax Administration (TIGTA) have attracted headlines with the insinuation that the IRS paid billions of dollars in invalid and fraudulent ACTC claims, i.e., those with ITINs rather than SSNs. See TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the ITIN Program to Detect Fraudulent Applications, (July 16, 2012); TIGTA, Ref. No. 2009-40-057, Actions Are Needed to Ensure Proper Use of ITINs and to Verify or Limit Refundable Credit Claims (Mar. 31, 2009).

¹⁹ IRS, ITIN Production Report (Dec. 31, 2011). The IRS assigned 1,740,490 ITINs in 2011. Processing year is the calendar year in which ITIN applications were processed. TAS Research, CDW, IMF_TC150_HISTORY table (data drawn Aug. 27, 2012).

²⁰Cf. TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications 29 (July 16, 2012) and IRS, Filing Season Statistics -- Dec. 31, 2011, available at http://www.irs.gov/uac/Filing-Season-Statistics----Dec.-31,-2011 (last visited Sept. 2, 2012).

²¹See SSA Performance and Accountability Reports (PAR), fiscal years (FYs) 2006-2011. As of October 2010, the ESF had accumulated approximately 305 million wage items and about $921 billion in wages for TYs 1937-2008. SSA FY 2011 PAR, at 176.

²² SSA FY 2010 PAR, at 176. From TY 2000 to TY 2008, the ESF grew from 3.8 percent of total reported wage items to 4.3 percent of all wages. SSA FY 2010 PAR, at 178.

²³ IR-2012-62 (June 22, 2012). The IRS announced that the procedures were in effect through the end of TY 2012. Although the IRS notified the National Taxpayer Advocate that it would be changing its ITIN procedures, it did not share with her the actual interim procedures prior to publication.

²⁴ IRS, 2012 ITIN Review Frequently Asked Questions, available at http://www.irs.gov/uac/2012-ITIN-Review-Frequently-Asked-Questions-1 (last visited Nov. 2, 2012).

²⁵See Rev. Proc. 2006-10, 2006-1 C.B. 293.

²⁶ TAS Teleconferences with the ABA Commission on Immigration and the Section of Taxation (Aug. 30, 2012); ABA Section of Litigation, Immigration Litigation Committee (Aug. 30, 2012); Low Income Taxpayer Clinics (Aug. 27, 2012); National Community Tax Coalition (Aug. 23, 2012).

²⁷ National Taxpayer Advocate and IRS teleconference with LITCs (Sept. 27, 2012).

²⁸ IRS, Real-Time System (RTS) reports (Sept. 22, 2012). The decline in ITIN receipts before June 22, 2012 constitutes 0.6 percent compared to the same period of TY 2011, while the decline in ITIN receipts after June 22 is 21.6 percent.

²⁹See e.g., Community Colleges for International Development, Inc. letter to the National Taxpayer Advocate (July 23, 2012).

³⁰ USA Today, More foreign students studying in USA, Nov. 14, 2011, available at http://www.usatoday.com/news/education/story/2011-11-13/foreign-students-boost-usa-economy/51188560/1 (last visited on Sept. 19, 2012). While some of these taxpayers who are authorized to work in the United States are eligible for an SSN, many others have taxable income and need an ITIN to comply with their U.S. tax filing requirements.

³¹ U.S. Dept. of State, Nonimmigrant Visas Issued FY 2011.

³² U.S. Dept. of Homeland Security, The Student and Exchange Visitor Program (SEVP) Quarterly Review (Apr. 2, 2012). Since the inception of the program in 2003, the number of visa holders increased to approximately 9.5 million.

³³ SEVIS, http://www.ice.gov/sevis/. This web-based system collects real-time information on nonimmigrant students, exchange visitors, approved schools, and program sponsors.

³⁴ U.S. Dept. of Homeland Security, The Student and Exchange Visitor Program (SEVP) Quarterly Review (Apr. 2, 2012).

³⁵ For a taxpayer to be considered a U.S. resident for tax purposes, he or she must meet either the green card or the substantial presence test for the calendar year. Under the substantial presence test, a taxpayer should be physically present in the United States on at least 31 days during the current year, and 183 days during the past three years, calculated according to a special formula. For a detailed discussion of the contiguous country rule for dependency exemptions, see Legislative Recommendation: Simplify the National Status and Related Requirements for Qualifying Children, infra.

³⁶ IRS Office of Research, Forecasting and Statistics, Document 6187 (Sept. 2010 and July 2012), Tables 1B. See also National Taxpayer Advocate 2011 Annual Report to Congress 137-150.

³⁷ As a signatory to the Hague Convention, the United States agreed to recognize public (including notarized) documents issued by other signatory countries if those public documents are authenticated by the attachment of an internationally recognized form of authentication known as an apostille. See Hague Apostille Convention, available at http://www.hcch.net/index_en.php?act=conventions.text&cid=41 (103 signatory countries) (last visited Dec. 20, 2012).

³⁸ For example, Algeria, India, Lithuania, Russia, Tunisia, and Ukraine prohibit mailing passports across borders. See, e.g., Indian Embassy in the United States, available at http://www.indianembassy.org/index.php?option=com_faqs&task=detail=2 (last visited Dec. 20, 2012); FedEx web site, available at http://www.fedex.com/ru_english/shippingguide/exportguidelines/ (last visited Dec. 20, 2012); United States Postal Service (USPS), available at http://pe.usps.com/text/imm/tz_016.htm (last visited Dec. 20, 2012). Interestingly, the U.S. consulate in Nogales, Mexico does not permit the mailing of documents of citizenship, see U.S. Consulate in Nogales, Mexico, available at http://spanish.nogales.usconsulate.gov/non_em_svcs2.html ("El Consulado Estadounidense en Nogales, Sonora no permite el envío/recibo por correo de documentos de Ciudadanía.") (last visited Sept. 25, 2012).

³⁹ AICPA Comments Regarding the Internal Revenue Service's (IRS's or Service's) June 22, 2012 Interim Policy Changes Involving the Individual Taxpayer Identification Number (ITIN) Application Process to the National Taxpayer Advocate (Oct. 16, 2012); TAS and IRS teleconferences with U.S. college and university representatives (Aug. 23, 2012 and Sept. 13, 2012).

⁴⁰ Community Colleges for International Development, Inc. letter to the National Taxpayer Advocate (July 23, 2012); TAS and IRS teleconferences with U.S. college and university representatives (Aug. 23, 2012 and Sept. 13, 2012); National Taxpayer Advocate email to the Deputy IRS Commissioner for Services and Enforcement (July 25, 2012).

⁴¹See, e.g., IRC § 83(b); Treas. Reg. § 1.83-2(e)(1) (a taxpayer identifying number (TIN) is required to make an election to treat the receipt of stock as income when received; the election must be made within 30 days of the transfer of property; no extensions are permitted); IRC § 7701(b); Treas. Reg. § 301.7701-3 (to obtain an EIN for a foreign entity in order to make an entity classification election, its principal officer must have a TIN); IRC § 1445 (a TIN is required on Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests).

⁴²See, e.g., Systemic Advocacy Management System (SAMS) submissions No. 25328, 25401, and 24891; TAS Teleconferences with the ABA Commission on Immigration and the Section of Taxation (Aug. 30, 2012); ABA Section of Litigation, Immigration Litigation Committee (Aug. 30, 2012); AICPA letter to the IRS Commissioner (Aug. 28, 2012).

⁴³ SAMS Issue No. 24891 (July 6, 2012) (Consent for Disclosure of Tax Information is on file with the National Taxpayer Advocate).

⁴⁴ AICPA letter to the IRS Commissioner (Aug. 28, 2012); National Community Tax Coalition (NCTC) letter to the IRS Commissioner (Aug. 20, 2012).

⁴⁵See Ariz. Rev. Stat. Ann. § 11-1051(B) (passed as a part of Arizona S.B. 1070 law); Arizona v. U.S., 132 S.Ct. 2492 (2012) (officer conducting stop, detention, or arrest can verify individual's immigration status with federal government if officer had suspicion that the person was unlawfully in the U.S.). Similar statutes were passed in Georgia, Alabama, Indiana, South Carolina, and Utah. The New York Times, Arizona Immigration Law (SB 1070) (June 25, 2012), available at http://topics.nytimes.com/top/reference/timestopics/subjects/i/immigration-and-emigration/arizona-immigration-law-sb-1070/index.html (last visited Dec. 20, 2012).

⁴⁶ SAMS Issue No. 25007 (July 9, 2012). See also AICPA letter to the IRS Commissioner (Aug. 28, 2012); National Community Tax Coalition (NCTC) letter to the IRS Commissioner (Aug. 20, 2012) (NCTC is a membership coalition of community-based organizations offering free tax and financial services to low- and moderate-income, working families through Volunteer Income Tax Assistance (VITA) programs).

⁴⁷ For example, all Belgians from the age of fifteen are required to carry electronic identity cards at all times. See Electronic Identity Documents, Belgian Official eID web site, available at http://eid.belgium.be/en/find_out_more_about_the_eid/the_electronic_identity_documents/ (last visited Oct. 20, 2012). In Turkey, locals have compulsory ID cards, which they must carry with them at all times. See Turkey's Official Travel Portal, available at http://www.goturkey.com/content.php?cid=51533&typ=c=en (last visited Oct. 20, 2012).

⁴⁸ AICPA letter to the National Taxpayer Advocate (Oct. 16, 2012).

⁴⁹ TAS teleconferences with LITCs (Aug. 27, 2012); TAS Teleconferences with the ABA Commission on Immigration and the Section of Taxation (Aug. 30, 2012); National Community Tax Coalition (Aug. 23, 2012); TAS attorney advisor and Systemic Advocacy analyst meeting with case advocates at Austin campus (Sept. 19, 2012); TAS call to the Embassy of Ukraine in Washington, D.C. (Sept. 27, 2012). For a detailed discussion of the apostille certification process, see Hague Apostille Convention available at http://www.hcch.net (last visited Dec. 20, 2012).

⁵⁰ TAS teleconferences with Low Income Taxpayer Clinics (Aug. 27, 2012); TAS teleconferences with the ABA Commission on Immigration and the Section of Taxation (Aug. 30, 2012); NCTC (Aug. 23, 2012); TAS attorney advisor and Systemic Advocacy analyst meeting with case advocates at Austin campus (Sept. 19, 2012).

⁵¹E.g., a TIN is required to claim a Child Tax Credit (CTC) or a dependency exemption. IRC §§ 24(e); 151(e). If a return is filed without a TIN, the IRS may disallow credits and exemptions and assess any resulting deficiency under procedures for mathematical or clerical errors. IRC § 6213(g)(2).

⁵² National Taxpayer Advocate and IRS teleconference with LITCs (Sept. 27, 2012).

⁵³ Teleconferences with TAS case advocates (Aug. 24, 2012); LITCs (Aug. 27, 2012).

⁵⁴ IRM 3.21.263.5.2.10 (Jan. 1, 2011).

⁵⁵ Over 19 million pieces of mail each year, or ten percent of all correspondence the IRS sends to taxpayers, are returned as "undeliverable as addressed." The documents may also be lost within the IRS. For a more detailed discussion, see Status Update: Underfunding IRS Initiatives to Modernize its Taxpayer Address Correspondence Systems Undermines Taxpayers' Statutory Rights and Impedes Efficient Resource Allocation, infra.

⁵⁶ SERP IRM 3.21.263.5.2.11 (5) (June 27, 2012) and IRM 3.21.263.5.10.4 (11) and (12) (Sept. 24, 2012).

⁵⁷ Randy Capps et al., A Profile of Low-Income Working Immigrant Families 2, The Urban Institute (June 2005), http://www.urban.org/UploadedPDF/311206_B-67.pdf (last visited Nov. 2, 2012). See also American College of Emergency Physicians, Illegal Immigrant Care in the Emergency Department, http://www.acep.org/content.aspx?id=25206 (last visited Nov. 2, 2012).

⁵⁸ About 92 percent of all adults in the United States have a cell phone. Forrester Research, Inc., North American Technographics Online Benchmark Survey (Part 2), Q3 2012. However, the lack of paid minutes for some low income taxpayers may limit reliability of cell phone access.

⁵⁹See National Taxpayer Advocate 2010 Annual Report to Congress 221-234 (Most Serious Problem: The IRS has not Studied or Addressed the Impact of the Large Volume of Undelivered Mail on Taxpayers).

⁶⁰See Form 1040, U.S. Individual Tax Return (2011) which contains a third party designee box on page 2 of the return. It allows a preparer, a friend, a family member, or any other person to discuss tax return with the IRS over the phone and answer any questions that may arise during processing. The designee may also provide the IRS any information missing from the return, call the IRS for information about the processing of the return or the status of any refund or payment, receive copies of IRS notices and provide responses to such notices. See Form 1040 Instructions (2011), at 72.

⁶¹ TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications (July 2012). The report identified erroneous Child Tax Credit refunds and thousands of returns filed from a few addresses.

⁶²See generally IRC §§ 24 and 151.

⁶³See generally IRC §§ 152(b)(3)(A); 873(b)(3). See also U.S.-Republic of Korea Tax Convention, Art. 4(7) and U.S.-India Tax Convention, Art. 21(2). These restrictions do not apply if the ITIN applicant is a nonresident alien married to a U. S. citizen or resident alien and has chosen to be treated as a resident of the United States. For a more detailed discussion of the contiguous country rule for dependency exemptions, see Legislative Recommendation: Simplify the National Status and Related Requirements for Qualifying Children, infra.

⁶⁴ In PY 2012 (through August 2012), the IRS received about 90 percent of all ITIN applications from the nationals of the following countries: Mexico -- 71.9 percent; Guatemala -- 7.1 percent; Honduras -- 4.7 percent; El Salvador -- 3.4 percent; and India -- 3.1 percent. IRS response to TAS information request (Sept. 17, 2012).

⁶⁵See, e.g., National Taxpayer Advocate 2010 Annual Report to Congress 319-34 (Status Update: Despite Program Improvements, the IRS Policy of Processing Most ITIN Applications with Paper Returns During Peak Filing Season Continues to Strain IRS Resources and Unduly Burden Taxpayers), National Taxpayer Advocate 2009 Annual Report to Congress 520-22; National Taxpayer Advocate 2008 Annual Report to Congress 126-40 (Most Serious Problem: IRS Handling of ITIN Applications Significantly Delays Taxpayer Returns and Refunds); Taxpayer Advocate Directive (TAD) 2009-1 (Processing of Forms W-7/Filing of ITIN Applications and Associated Tax Returns) (Feb. 25, 2009).

⁶⁶ National Taxpayer Advocate 2010 Annual Report to Congress 327-28. See also Government Accountability Office (GAO), Ref. No. GAO-04-529T, Individual Taxpayer Identification Numbers Can Be Improperly Obtained and Used (Mar. 10, 2004); TIGTA, Ref. No. 2004-30-023, The Internal Revenue Service's Individual Taxpayer Identification Number Creates Significant Challenges for Tax Administration (Jan. 2004).

⁶⁷See Figure 1.9.1, ITINs Used for Tax Administration Purposes Compared to Total ITINs Issued From 1996 Through August 31, 2012, supra.

⁶⁸ U.S. Immigration and Customs Enforcement, Factsheet, Applying for a Driver's License or State Identification Card (Jan. 17, 2012). In most states, however, the nonimmigrant alien needs to apply for an SSN and present a Form SSA-L676, Refusal to Process SSN Application, when applying at the Department of Motor Vehicles.

⁶⁹ Acting on TAS's recommendation, the IRS now accepts pay stubs, letters from the employer on the employer's letterhead, earnings statements, and other corroborating documents such as employee benefits forms as a proof of wage income and tax filing need. See IRM 4.19.15.38.4 (Sept. 6, 2012). See also National Taxpayer Advocate Fiscal Year 2013 Objectives Report to Congress 54.

⁷⁰ AMTAP uses the Electronic Fraud Detection System (EFDS) for these purposes. EFDS employs "data mining" computer scoring models for detecting fraud. Returns that are flagged are diverted into a workload for further inspection before any refund is issued. For a detailed discussion, see Most Serious Problem: Despite Some Improvements, the IRS Continues to Harm Taxpayers by Unreasonably Delaying the Processing of Valid Refund Claims that Happen to Trigger Systemic Filters, supra.

⁷¹ TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications (July 2012).

⁷² Treas. Reg. § 31.6109-2. IRS Notice 2011-6, 2011-3 I.R.B. 315, specifically excludes the Form W-7 from the list of forms requiring a PTIN.

⁷³See, e.g., Circular 230, Regulations Governing Practice before the Internal Revenue Service; IRC § 7402(a).

⁷⁴ For example, the United States Citizenship and Immigration Services (USCIS) E-Verify System verifies a foreign person's identity and status using its own, United States Department of State, and SSA data electronically. E-Verify now requires the foreign individual's passport number and the country of issuance. USCIS also administers a similar electronic Systematic Alien Verification for Entitlements (SAVE) program. SSA has a special arrangement for direct electronic access to state records (called SASPRO) such as those for human services (TANF/Medicaid/Food Stamps), wage, unemployment, vital statistics (birth/death records), and workers' compensation. The IRS should explore the availability of systems for electronic verification of documents submitted with ITIN applications.

⁷⁵ IRS, IRS Clarifies Temporary ITIN Application Requirements for Noncitizens with Tax Extensions and Many Foreign Students (Oct. 2, 2012).

⁷⁶See Instructions for Form W-7, Application for IRS Individual Taxpayer Identification Number (Jan. 2012).

⁷⁷ Hague Conference on Private International Law (HCCH), Outline, Hague Apostille Convention available at http://www.hcch.net/index_en.php?act=publications.details&pid=3121=2 (last visited on Sept. 24, 2012).

⁷⁸ The main examples of public documents for which apostilles are issued in practice include birth, marriage and death certificates; extracts from commercial registries and other registers; patents; court rulings; notarial acts and notarial attestations of signatures; and academic diplomas issued by public institutions. HCCH, Outline, Hague Apostille Convention.

⁷⁹Id.

⁸⁰ An e-Register under the e-APP allows for easy online verification that a presented Apostille has really been issued by the Competent Authority. HCCH, Operational E-Registers by State, available at http://www.hcch.net/index_en.php?act=text.display&tid=146 (last visited Sept. 24, 2012). HCCH and NNA successfully piloted the program since April 2006.

⁸¹ HCCH, Operational E-Registers by State, available at http://www.hcch.net/index_en.php?act=text.display&tid=146 (last visited Sept. 24, 2012).

⁸² About 72 percent of all ITIN applications came from nationals of Mexico in PY 2012. IRS response to TAS information request (Sept. 27, 2012).

⁸³ Treas. Reg. § 301.6109-1(d)(3)(iv)(B); Rev. Proc. 2006-10, 2006-1 C.B. 293, § 4.02(1).

⁸⁴ TIGTA, Ref. No. 2012-42-081, Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications (July 2012).

⁸⁵See, e.g., NCTC letter to the IRS Commissioner (Aug. 20, 2012); IRS and TAS teleconference with the members of the NCTC (Aug. 23, 2012).

⁸⁶See generally Bank Secrecy Act, 31 U.S.C. §§ 5311-5314, 5316-5322; 12 U.S.C. § 1829(b); USA PATRIOT ACT, § 326, Pub. L. No. 107-56, 115 Stat. 307 (2001); 31 C.F.R. §§ 1010.410, 1010.620, 1022.400. See also IRM 4.26.5.6 and IRM 4.26.5.6.1 (Oct. 3, 2012) (these requirements apply for a funds transmittal of $3,000 or more, and for any bank transaction over $100).

⁸⁷ IRC § 7526; IRM 21.3.4.21.1 (Oct. 1, 2008). LITCs receive federal funding to provide education and outreach on the rights and responsibilities of U.S. taxpayers to individuals who speak English as a second language (ESL) and provide free or nominal fee legal assistance to low income taxpayers in resolving controversies with the IRS.

⁸⁸ These tax professionals are also subject to Circular 230 rules and the jurisdiction of the IRS Office of Professional Responsibility. It is highly unlikely that they will actively pursue ITIN application fraud.

⁸⁹ An enrolled agent is a person who has earned the privilege of representing taxpayers before the IRS by either passing a three-part comprehensive IRS test covering individual and business tax returns, or through experience as a former IRS employee. See Treasury Department Circular No. 230, §§ 10.4-10.6, 31 C.F.R. §§ 10.4-10.6.

⁹⁰ Certification of documents by state school boards may be particularly useful for verification of eligibility for a dependency exemption and CTC.

⁹¹ The IRS does not provide periodic trainings to CAAs.

⁹² IPO News 7 (June 2009).

⁹³See IRC § 152 (d)(2)(H).

⁹⁴ Email from LITC Director to TAS (Oct. 3, 2012).

⁹⁵ IRC § 6695(g) imposes a $500 penalty for the failure to comply with the EITC due diligence requirements. While the IRS may require CAAs to provide a due diligence checklist, it cannot impose penalties absent legislative change.

⁹⁶ IRS, IRS Strengthens Integrity of ITIN System; Revised Application Procedures in Effect for Upcoming Filing Season, IR-2012-98 (Nov. 29, 2012).

⁹⁷See IRS, ITIN Policy Change Summary for 2013, available at http://www.irs.gov/Individuals/ITIN-Policy-Change-Summary-for-2013. (last visited Dec. 7, 2012).

⁹⁸See Most Serious Problem: The IRS Lacks a Servicewide Strategy That Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

⁹⁹ Representatives of Low Income Taxpayer Clinics raised concerns about the requirement of many TACs or federal buildings in which some TACs are located to produce a valid, U.S.-issued ID to enter the building. 2013 Annual Low Income Taxpayer Clinic Grantee Conference, Recent Developments in IRS Policies and Procedures Related to ITIN Applications, panel discussion (Dec. 6, 2012).

¹⁰⁰ IRS response to TAS information request (Sept. 28, 2012). As of mid-2012, of the 906,848 total ITINs assigned, 614,714 were issued to dependents.

¹⁰¹ IRS, Real-Time System (RTS) reports (Dec. 1, 2012).

¹⁰²See Hague Apostille Convention; see also HCCH, The ABCs of Apostilles, How to Ensure That Your Public Documents Will be Recognized Abroad, Q&A 10, available at http://www.hcch.net/upload/abc12e.pdf (last visited Dec. 7, 2012).

¹⁰³ HCCH, Outline, Hague Apostille Convention.

¹⁰⁴See e.g., National Taxpayer Advocate 2010 Annual Report to Congress 334, National Taxpayer Advocate 2008 Annual Report to Congress 140, National Taxpayer Advocate 2004 Annual Report to Congress 162, Taxpayer Advocate Directive (TAD) 2009-1 (Processing of Forms W-7/Filing of ITIN Applications and Associated Tax Returns) (Feb. 25, 2009).

¹⁰⁵See IRS Comments to the Most Serious Problem: Challenges Persist for International Taxpayers as the IRS Moves Slowly to Address Their Needs (stating "Forms 1040NR, U.S Nonresident Alien Income Tax Return, and W-7, Application for IRS Individual Taxpayer Identification Number, have been identified as candidate forms for electronic filing"), infra/supra.

Beth Tucker, Deputy Commissioner, Operations Support

Steven T. Miller, Deputy Commissioner, Services and Enforcement

Julie Rushin, Deputy Chief Information Officer for Operations

Peggy Bogadi, Commissioner, Wage and Investment Division

DEFINITION OF PROBLEM

In the 2011 and 2009 Annual Reports, the National Taxpayer Advocate wrote about the benefits of accelerated third-party information reporting to both taxpayers and tax administration.¹ In late 2011, the IRS held two public meetings to solicit suggestions and concerns from external stakeholders regarding a potential real-time tax system (RTTS).² Further, in the IRS's response to the 2011 Most Serious Problem, it committed to working with the National Taxpayer Advocate as it takes steps to realize its long-term vision of a real-time system.³ We commend the IRS for prioritizing this issue and look forward to contributing to any future project. However, as the IRS continues to evaluate the idea of a real-time system, the National Taxpayer Advocate has the following concerns:

• When the IRS identifies a mismatch between third-party data and tax return information, it is unclear what type of compliance contact the IRS would make during the filing season before making an assessment. In addition, the level of taxpayer burden hinges upon the accuracy of the data, as well as the level of staffing allocated to problem resolution.

• We caution against the expansion of math error authority to cover mismatched third-party data. The National Taxpayer Advocate has written extensively about her concerns with the expansion of this authority.⁴ This issue was also raised by the taxpayer and consumer advocate panel at the first RTTS public meeting.⁵

• The IRS should provide taxpayers with electronic access to the third-party data to help them prepare returns. To avoid inadvertent omissions of tax items on filed returns, taxpayers and their representatives should have electronic access to a real-time transcript of data received by the IRS. The IRS would drive compliance rates even higher by providing a way for taxpayers to download the third-party data directly into their return preparation software and by developing a pre-populated return option for taxpayers.

Background

Approximately 97 percent of taxpayers receive at least one information return. Traditionally, the IRS has not matched this data with the items reported on the taxpayers' tax returns until long after the filing season has ended. The IRS has held several meetings with external stakeholders to solicit comments and suggestions regarding a potential real-time tax system. In general, any future RTTS would enable the IRS to match the information during the filing season and before releasing the associated refunds.⁶

In 2010, the IRS closed 4.3 million cases in which it identified a discrepancy between the taxpayer's return and third-party information, leading to $7.2 billion in additional assessments.⁷ The real volume of mismatches is significantly larger, because this data only reflects mismatches large enough for the IRS to actually work them, and does not include others that did not reach the established threshold. For example, the IRS identified almost 23.8 million mismatches on tax year (TY) 2010 returns, but only worked about 5.3 million cases (22 percent).⁸ If the IRS identified mismatches before releasing the refunds claimed on the returns, taxpayers would avoid the downstream consequences of these assessments.⁹

There is a General Consensus that Accelerated Information Reporting is Necessary.

In the 2011 and 2009 Annual Reports, the National Taxpayer Advocate wrote about the benefits of accelerated third-party information reporting to both taxpayers and tax administration.¹⁰ The IRS solicited additional comments from a variety of stakeholders at two public meetings. During the meeting held on December 8, 2011, the IRS heard statements from the members of three panels: (1) tax practitioners, (2) federal and state government representatives, and (3) taxpayer and consumer advocates. The second meeting held on January 25, 2012 solicited comments from four panels comprised of (1) payroll/W-2 filers, (2) Form 1099 issuers, (3) software providers, and (4) state revenue agencies.¹¹ While the participants expressed concerns about how the IRS would achieve a real-time tax system, there was consensus that the goal of the initiative would serve both taxpayers and tax administration.¹²

Matching Third-Party Data to Filed Return Data Upfront Will Benefit Taxpayers and Save Resources for the Government.

If implemented properly, an RTTS could benefit taxpayers and the government. Matching third-party data upfront would substantially reduce taxpayer burden in several ways.

• First, taxpayers will be better equipped to answer questions about an underlying economic transaction if the IRS identifies the mismatch within months rather than a year or more after the fact.

• Second, matching data before the IRS releases refunds will prevent taxpayers from facing IRS collection actions long after they have spent the refunds.

• Third, taxpayers will save money by avoiding the long-term accrual of penalties and interest on unintentionally omitted or under-reported items.

• Fourth, upfront matching can potentially reduce taxpayers' vulnerability to identity theft-related refund fraud.¹³

• Finally, giving taxpayers access to third-party data before the return filing deadline will help them prepare returns and prevent inadvertent omissions and understatements.

The Preservation of Taxpayer Rights is Crucial as the IRS Identifies Mismatches Early in the Process.

As the IRS continues to solicit comments from stakeholders on a potential RTTS, the National Taxpayer Advocate raises the following concerns:

The IRS has not committed to any particular compliance contact once it identifies a mismatch between the data reported by the taxpayer on the return and the data reported by third parties on information returns. Under the IRS's traditional Automated Underreporter (AUR) system,¹⁵ an assessment of tax is already reported on the original return and the IRS applies deficiency procedures when it identifies a mismatch after the filing season. However, it is unclear exactly what would happen when the IRS identifies the mismatch before making an assessment.

While we agree that upfront matching will reduce taxpayer burden and save IRS resources in the long term, it will also prompt taxpayers to respond to the IRS no matter which compliance action the IRS takes. In customer satisfaction surveys conducted in fiscal year (FY) 2007 for the Wage and Investment (W&I) Division AUR program, at least 24 percent of taxpayers stated that their primary reason for calling the IRS was to have an employee explain the AUR notice.¹⁶ Thus, sufficient staffing to handle the anticipated increase in taxpayer contacts is imperative to a successful initiative.¹⁷ Any planned action by the IRS will occur during filing season when resources are already stretched. The IRS could cause significant upfront burden on taxpayers if it does not prepare for the increase in contacts during an already busy time.

The consequences of understaffing are illustrated by the IRS Wage Verification Program, in which the IRS holds the taxpayer's refund until it can verify the wages reported on the tax return, by either matching them to the Form W-2, Wage and Tax Statement, or contacting third parties directly. If the IRS verifies the wages and withholding as accurate, it releases the refund. When the IRS cannot initially verify wage and withholding documents systemically by comparing them to the Information Returns Master File (IRMF), it freezes the account. In the meantime, the IRS mails the taxpayer a letter requesting additional documentation and attempts to manually verify the wages by contacting the employer.¹⁸

For the most recent filing season, despite having access to third-party data earlier than in the past, the IRS froze approximately 142,000 accounts from April 28, 2012 through June 23, 2012.¹⁹ In a review of TAS wage verification cases in FY 2012, TAS was able to obtain full relief in 78 percent and partial relief in two percent of these cases.²⁰ According to the IRS's own reports, nine percent of the cases the Accounts Management Taxpayer Assurance Program (AMTAP) selected for review (more than 92,000 as of June 31, 2012) were legitimate refund claims.²¹ We suspect AMTAP is using hard freezes (refund holds that do not expire) as an inventory management tool due to overwhelming caseloads. Once it places a hard freeze on the account, the IRS can leave the returns to languish, as there is no pressure to work the case quickly.

Likewise, in the thick of the filing season when taxpayers are anticipating their refunds, any upfront matching associated with a real-time tax system could quickly overload IRS employees with inventory and jeopardize the taxpayers' due process rights, as follows:

• The IRS could inappropriately freeze many legitimate refunds.

• The IRS could issue unnecessary Statutory Notices of Deficiency, which would increase Tax Court litigation or audit reconsiderations. It is also unclear whether these taxpayers would receive pre-deficiency administrative appeal rights.

• Rather than freezing refunds, the IRS might use this increased workload to justify using math error authority to make any necessary adjustments.

For any future initiative to benefit both taxpayers and the IRS, the third-party data used to match to the taxpayers' returns must have a high degree of accuracy. In reality, the data received on information returns is not perfect. Although the IRS does not track corrected information documents, it guesses that less than one percent of information reports are subject to subsequent amendments or corrections. Even if we accept the IRS's estimate, the number is still significant considering that the IRS receives approximately 1.8 billion information reports per year, of which only approximately 49 million were received on paper. Further, IRS projections show the number of information reports steadily increasing through 2020.²² The taxpayers associated with these corrected reports might be entangled in the IRS enforcement procedures during the filing season through no fault of their own.²³ In addition, approximately 4.3 percent of AUR assessments in FY 2010 were abated. Specifically, 139,652 taxpayers received abatements on AUR assessments in FY 2010.²⁴ Therefore, the IRS already entangles compliant taxpayers in enforcement initiatives based on third-party data. This unnecessary burden is imposed on compliant taxpayers in the following scenarios:

Further, in cases before the Tax Court, the burden of proof for a deficiency of tax shifts to the IRS if the deficiency is based solely on information included on a third-party information report.²⁶ Therefore, the IRS has an additional incentive to adopt procedures to attempt to verify third-party data through other means, especially through information available internally, to screen out false positives or mismatches before taking enforcement actions.

The burden on these taxpayers will increase if they are dealing with these issues during the filing season when IRS resources are already scarce and the taxpayer must wait to receive a legitimate refund. These problems will worsen as the IRS increases the volume of third-party data it receives under new initiatives, including several new third-party information reporting requirements. Most notably, credit card issuers generally must report the aggregate amount of reportable payments they process for businesses,²⁷ and brokerage firms generally must report the cost bases (as well as gross proceeds) of stock, bond, and mutual fund sales.²⁸ Thus, not only will the IRS receive significantly more data in the future, but it will also be expected to process it earlier. Therefore, even a low error rate will translate into substantial costs to the IRS and increased burden on the taxpayers.

Any Acceleration of Third-Party Information Report Processing May Impact Third-Party Payers.

While the acceleration of the processing of third-party information reports will benefit both taxpayers and the IRS, the impact on third-party payers cannot be overlooked. Any acceleration of deadlines will potentially burden this population. Therefore, the IRS should work with these stakeholders to determine the best way to accomplish a real-time tax system.

The following table sets forth the deadlines for common information reports. With most of the forms listed below, the payer must submit the form to the payee by January 31, which is generally one or two months before the deadline to submit it to the IRS, depending whether the payer files the form on paper or electronically.

      TABLE 1.10.1, Current Deadlines for Filing information reports²⁹

In addition, if the IRS experiences a high amendment rate for certain information reports, it should evaluate different ways to reduce amendments, with a customized approach for each type of report. For example:

• Bifurcate Information Report Filing Deadlines. If certain data on an information report lends itself to delays in reporting due to complexity or record-keeping issues, the IRS could bifurcate the information report deadlines. For example, if employers need more time to report pension benefit calculations, the IRS could require earlier reporting of the basic Form W-2 data such as wages and withholdings and give employers time to file a supplemental earnings statement with the more complicated items later. Taxpayers and the IRS would receive the information they need for return filing early in the filing season and the IRS would receive the other, more complex information soon enough for compliance purposes.

• Build flexibility into the reporting period. The IRS should evaluate the feasibility of providing an option for payers to report certain complex transactions occurring during the last two months of the year on the return for the subsequent tax year.³¹

We caution against the expansion of math error authority in the context of real-time information reporting.³² In the 2011 Annual Report, the National Taxpayer Advocate discussed how the inappropriate expansion of math error authority places significant burden on taxpayers and erodes taxpayer protections.³³ Moreover, serious concerns about the application of math error authority to RTTS were raised by the consumer and taxpayer advocate panel of the December 8, 2011 public meeting for RTTS. Specifically, in his written statement, Keith Fogg, Director of the Villanova Law School Federal Tax Clinic, stated:

Direct Electronic Access for Taxpayers Would Improve Compliance.

Providing taxpayers and their representatives with direct electronic access to their third-party information would prevent mismatches from occurring in the first place. Consider taxpayers who have worked several different jobs during the tax year and moved after completing one job early in the year. If the W-2 or 1099 associated with the first job is not properly forwarded to the taxpayer's current address, he or she could inadvertently omit the item from the return and not realize it until the IRS sends the taxpayer a CP 2000 notice. To address this issue of inadvertent omissions, the IRS should provide access to real-time transcripts of third-party data to aid in return preparation. Taxpayers and preparers could refer to the transcript to make sure they do not inadvertently omit any income. In fact, this issue was raised on the practitioner panel during the December 8 public meeting.³⁵

One step above the transcript would be to provide a platform from which taxpayers and preparers could download third-party data submitted to the IRS or the Social Security Administration directly into tax preparation software. This second option would eliminate transcription errors and provide a one-stop-service to taxpayers who would not need to download the data separately from each third party. Finally, the IRS should follow the lead of other countries and provide taxpayers with an option to use a preliminary return pre-populated with information submitted to the IRS through third party reports.³⁶

CONCLUSON

The IRS is evaluating the feasibility of developing a real-time tax system. The National Taxpayer Advocate continues to believe that accelerating third-party data matching to occur during the filing season would reduce taxpayer burden and save government resources. However, it is imperative that any such system maintain taxpayer protections.

IRS COMMENTS

As discussed in the report, the IRS has been taking steps toward the early development of a real-time tax system. The goal of this initiative is to improve the tax filing process by both reducing burden for taxpayers and improving overall compliance upfront.

This is a long-term vision that will take years to fully realize. Over the last year, the IRS has been soliciting feedback and input from outside stakeholders on issues related to the concept. We have held public meetings and talked to a variety of groups representing varying perspectives and will continue these dialogues into the future.

The IRS recognizes that taxpayer rights must be preserved in any changes that may take place. While it is premature to speculate on the specifics of any future state, the IRS will continue to ensure that taxpayer rights are respected. We look forward to working with the National Taxpayer Advocate in this effort.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS recognizes the value of a real-time tax system in reducing taxpayer burden and increasing overall compliance. We believe the IRS is taking appropriate steps by soliciting comments and perspectives from a variety of internal and external stakeholders in the planning stages of the initiative. However, we are concerned that the IRS has not shared the findings of any discussions held since the public meetings and has not publicly committed to any goals with specific timeframes. We accept the IRS's offer to actively engage the participation of the Taxpayer Advocate Service as it continues to plan and subsequently develop specific procedures for the initiative to ensure that taxpayers' rights are protected.

In addition to upfront matching in a real-time tax system, we believe that the IRS could minimize taxpayer burden and drive compliance rates even higher by providing taxpayers with electronic access to the third-party data to assist in return preparation. Taxpayers and their representatives would avoid inadvertent omissions of tax items on filed returns if they had access to a real-time transcript of data received by the IRS. The IRS could further reduce burden and increase compliance by providing a way for taxpayers to download the third-party data directly into their return preparation software and by developing a pre-populated return option for taxpayers.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

² IRS, IR-2011-114, IRS to Host Public Meeting Dec. 8 on Real-Time Tax System (Nov. 30, 2012), available at http://www.irs.gov/uac/IRS-to-Host-Public-Meeting-Dec.-8-on-Real-Time-Tax-System (last visited Oct. 24, 2012).

³ National Taxpayer Advocate 2011 Annual Report to Congress 284-295 (Most Serious Problem: Accelerated Third-Party Information Reporting and Pre-Populated Returns Would Reduce Taxpayer Burden and Benefit Tax Administration But Taxpayer Protections Must Be Addressed).

⁴Id. 74-92 (Most Serious Problem: Expansion of Math Error Authority and Lack of Notice Clarity Create Unnecessary Burden and Jeopardize Taxpayer Rights).

⁵ IRS, Transcript of the Public Meeting on Real Time Tax System Initiative 92-94 (Dec. 8, 2011), available at http://www.irs.gov/Tax-Professionals/December-8,-2011-Meeting (last visited Oct. 24, 2012).

⁶ IRS, PowerPoint, Real Time Tax System Initiative, Public Meeting 2 (Dec. 8, 2011), available at http://www.irs.gov/pub/irs-utl/rtts_deck.pdf (last visited Oct. 24, 2012).

⁷Id.

⁸ IRS response to TAS information request (Oct. 17, 2012).

⁹ When the IRS's Automated Underreporter (AUR) system identifies a mismatch between items reported on the taxpayer's return and information reports, it generates a CP 2000 notice to be mailed to the taxpayer. In TY 2010, the IRS mailed 3,823,766 of these notices to taxpayers with an estimated 45 percent response rate. These numbers have actually decreased from 4,546,817 notices in TY 2009 (with an estimated response rate of 60 percent) and 4,788,360 notices in TY 2008 (with an estimated response rate of 57 percent). IRS response to TAS information request (Oct. 17, 2012) (data through Oct. 16, 2012).

¹⁰ National Taxpayer Advocate 2011 Annual Report to Congress 284-295 (Most Serious Problem: Accelerated Third-Party Information Reporting and Pre-Populated Returns Would Reduce Taxpayer Burden and Benefit Tax Administration But Taxpayer Protections Must Be Addressed); National Taxpayer Advocate 2009 Annual Report to Congress 338-345 (Legislative Recommendation: Direct the Treasury Department to Develop a Plan to Reverse the "Pay Refunds First, Verify Eligibility Later" Approach to Tax Return Processing).

¹¹ For written and oral statements of panelists at the two RTTS public meetings, see http://www.irs.gov/Tax-Professionals/Real-Time-Tax-Initiative (last visited Oct. 24, 2012).

¹²Id.

¹³ IRS, PowerPoint, Real Time Tax System Initiative, Public Meeting 1 (Dec. 8, 2011), available at http://www.irs.gov/file_source/pub/irs-utl/rtts_deck.pdf (last visited Oct. 24, 2012). For more information on identity-theft refund fraud, see Most Serious Problem: The IRS Has Failed to Provide Effective and Timely Assistance to Victims of Identity Theft, supra.

¹⁴ IRS, PowerPoint, Real Time Tax System Initiative 1, Public Meeting (Dec. 8, 2011), available at http://www.irs.gov/file_source/pub/irs-utl/rtts_deck.pdf (last visited Oct. 24, 2012).

¹⁵ The AUR program compares amounts shown on a taxpayer's return with third-party reports such as Forms W-2 and 1099 received and uploaded by the IRS. IRM 4.19.3.1.

¹⁶ This survey result indicates that the AUR notice and process was confusing to those taxpayers. Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2008-40-180, Most Automated Underreporter Program Notices are Correct; However, Additional Oversight is Needed (Sept. 25, 2008).

¹⁷ Similarly, the National Taxpayer Advocate has expressed concern regarding increasing volume of questionable refund claims that the Electronic Fraud Detection System (EFDS) stops without increasing AMTAP staffing to perform the required reviews. This leads to freezing taxpayer refunds for extended lengths of time while the IRS attempts to verify entitlements to claimed refunds. See National Taxpayer Advocate 2011 Annual Report to Congress 41. See also Most Serious Problem: Despite Some Improvements, the IRS Continues to Harm Taxpayers by Unreasonably Delaying Processing of Refunds That Trigger Systemic Filters, infra/supra.

¹⁸See also Most Serious Problem: Despite Some Improvements, the IRS Continues to Harm Taxpayers by Unreasonably Delaying Processing of Refunds That Trigger Systemic Filters, supra.

¹⁹ Email from AMTAP (May 10 2012). In general, the IRS receives over 200 million valid W-2s for each tax year. SB/SE response to TAS information request (Sept. 12, 2012). For example, in calendar year 2011, the IRS received 228,231,132 Forms W-2. IRS Publication 6961, 2012 Update: Calendar Year Projections of Information and Withholding Documents for the United States and IRS Campuses, 2012-2020, Table 2.

²⁰ TAS analysis of CDW data from the Individual Returns Transaction File of 474 closed TAS cases with PIC 045 (Pre-Refund Wage Verification) pulled on October 5, 2012 (hereinafter "TAS 2012 Study").

²¹ W&I response to TAS information request (Aug. 28, 2012).

²² IRS Publication 6961, 2012 Update: Calendar Year Projections of Information and Withholding Documents for the United States and IRS Campuses, 2012-2020, Tables 2, 3.

²³ IRS, PowerPoint, Real Time Tax System Initiative 2, Public Meeting (Dec. 8, 2011), available at http://www.irs.gov/pub/irs-utl/rtts_deck.pdf (last visited Oct. 24, 2012).

²⁴ In FY 2010, approximately $1.05 billion of the approximately $6.9 billion tax assessed through AUR was abated (15.2 percent). In FY 2011, 68,984 taxpayers (or 2.1 percent) received approximately $307 million in abatements (5.2 percent of the tax assessed through AUR was abated). IRS Enforcement Revenue Information System's FY 2011 database.

²⁵ See National Taxpayer Advocate 2011 Annual Report to Congress, vol. 2, 119-120.

²⁶ IRC § 6201(d). In order for the burden to shift to the IRS in a Tax Court case, the taxpayer must assert a reasonable dispute to the IRS within a reasonable time and must have fully cooperated with the IRS.

²⁷ IRC § 6050W. The projected filings of Form 1099-K, Merchant Card and Third Party Payments, will see an increase from approximately nine million projected filings in calendar year 2012 to almost 22 million projected filings in CY 2020. IRS Publication 6961, 2012 Update: Calendar Year Projections of Information and Withholding Documents for the United States and IRS Campuses, 2012-2020, Table 2.

²⁸ IRC § 6045(g).

²⁹ IRS, General Instructions for Certain Information Returns -- Main Contents, available at http://www.irs.gov/instructions/i1099gi/ar02.html#d0e400 (last visited Oct. 12, 2012); Instructions to IRS Form 1098-T, Tuition Statement; Instructions to 1099-DIV, Instructions to IRS Form 1099-INT, Interest Income; Instructions to IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc, Social Security Administration, Deadline Dates to Submit W-2s, available at http://www.ssa.gov/employer/filingDeadlines.htm (last visited Oct. 12, 2012).

³⁰ IRS Public Hearing, Proposed Real-Time Tax System, Comments from the National Payroll Reporting Consortium (Jan. 25, 2012).

³¹ IRS Public Hearing, Proposed Real-Time Tax System, Comments from the National Payroll Reporting Consortium (Jan. 25, 2012). The IRS already allows this for certain fringe benefits. See Announcement 85-113, 1985-31 I.R.B. 31 (Aug. 5, 1985).

³² IRC § 6213.

³³ See National Taxpayer Advocate 2011 Annual Report to Congress 74-92 (Most Serious Problem: Expansion of Math Error Authority and Lack of Notice Clarity Create Unnecessary Burden and Jeopardize Taxpayer Rights).

³⁴ Comments of T. Keith Fogg, Director, Villanova Law School Federal Tax Clinic, Real Time Tax System Initiative (Dec. 8, 2011), available at http://www.irs.gov/pub/irs-utl/t._keith_fogg_aba_tax_section_and_low_income_tax_clinic.pdf (last visited Aug. 2, 2012).

³⁵ IRS, Transcript of the Public Meeting on Real Time Tax System Initiative 42 (Dec. 8, 2011), available at http://www.irs.gov/Tax-Professionals/December-8,-2011-Meeting (last visited Oct. 24, 2012).

³⁶ For a detailed discussion of the pre-filled return options available in other countries in 2009 and expected in 2012, see Organisation for Economic Co-Operation and Development, Centre for Tax Policy and Administration, Forum On Tax Administration: Taxpayer Services Sub-Group, Survey of Trends and Developments in the Use of Electronic Services for Taxpayer Service Delivery 34-38 (March 2010).

Joseph H. Grant, Acting Commissioner, Tax Exempt and Government Entities Division

DEFINITION OF PROBLEM

Over the past 18 months, as mandated by the Pension Protection Act of 2006, the IRS notified more than 440,000 organizations that their tax-exempt status had been automatically revoked because they failed to file required returns or notices for three consecutive years.¹ The IRS included these organizations on a list of those whose exempt status had been revoked, and, if they appeared on it, removed their names from another list of permissible recipients of tax-deductible contributions.

The National Taxpayer Advocate had several concerns about the manner in which the IRS would administer the automatic revocation process, and her concerns have been borne out.² For example:

• The IRS requires organizations seeking reinstatement to submit IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, the same form about 60,000 other organizations file each year to request initial recognition of exempt status;³

• The increased volume in applications for exempt status coincides with staff reductions, so that fiscal year (FY) 2012 inventory is expected to be more than double the FY 2010 level, and applications that require assignment to a reviewer now take nine months to be assigned;⁴

• Taxpayers who call the IRS for assistance will wait on average almost 20 minutes for assistance (up from ten minutes last year and seven minutes in 2010), and almost 40 percent of calls will go unanswered (up from 24 percent last year and 19 percent in 2010);⁵

• The IRS erroneously treated thousands of organizations as no longer exempt, yet does not provide administrative review that might have averted the errors or lessened their impact;⁶ and

• TAS case receipts with exempt organization issues have increased more than fourfold from 2010 to 2012, a clear indication that the IRS's processes are causing significant hardship for these organizations.

ANALYSIS OF PROBLEM

Background

The Pension Protection Act of 2006:

• Imposed a new annual reporting requirement, Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt EOs Not Required to File Form 990 or 990-EZ, on small exempt organizations (EOs);⁷

• Provided for automatic revocation of tax-exempt status for failing to file a required return or e-Postcard for three consecutive years;⁸ and

• Required an application for reinstatement of exempt status.⁹

• Had annual gross receipts of not more than $50,000 in the most recently completed tax year;

• Not been required to file a Form 990 or 990-EZ prior to 2007; and

• Been eligible to file an e-Postcard in 2007, 2008, and 2009.¹¹

The IRS implemented the Pension Protection Act by informing EOs of the new filing requirements, notifying them when their exempt status had been automatically revoked, and listing them on its Select Check database as having had their status automatically revoked. As of August 9, 2012, 443,441 EOs were listed as no longer exempt.¹³ As of June 7, 2012, more than 18,000 organizations had applied for reinstatement.¹⁴ Using the transitional relief provisions, as of June 7, 2012, the IRS had reinstated the exempt status of almost 8,000 organizations retroactively.¹⁵ However, despite the National Taxpayer Advocate's urging, the IRS does not provide administrative review of its decision to treat an organization as having had its exempt status automatically revoked.¹⁶

Automatic Revocations and Reduced Staff Cause Delays.

The IRS's Exempt Organization (EO) Rulings and Agreement staff in its Cincinnati Determinations office evaluate requests for reinstatement along with the approximately 60,000 routine applications for exempt status (i.e., not resulting from automatic revocations) the IRS receives each year.¹⁷ From 2009 to 2011, when the IRS issued the first notifications of automatic revocation, the number of full-time employees in the Determinations office decreased by about seven percent.¹⁸ The volume of applications for reinstatement of exempt status and the number of employees who handle them are shown in Figure 1.11.1.

 

FIGURE 1.11.1, Full-Time Cincinnati Determinations Staff vs.

 

Applications for Reinstatement of Exempt Status¹⁹

 

 

 

 

FIGURE 1.11.2, EO Determinations Inventory²⁰

 

 

 

 

FIGURE 1.11.3, Average Wait Time for TE/GE Toll Free Calls vs.

 

Percent of Calls Answered²²

 

 

 

In the two years preceding the automatic revocations, TE/GE devised a contingency plan "to meet whatever application processing needs [are] presented."²⁵ The plan was to transfer backlogged applications from the Cincinnati Determinations office to EO Rulings and Agreement employees in Washington D.C.²⁶ TE/GE has not put this contingency plan into effect "[b]ecause we have not experienced timeliness issues processing the reinstatement cases."²⁷ TAS cases and the data cited above show otherwise -- that by every meaningful measure of taxpayer service, the burden on new and revoked EOs applying for exemption has increased significantly.

TE/GE is not devising any new notices that might avert automatic revocations in the future, preferring to monitor whether the current notices are effective now that it has organizations' updated address information.²⁸ However, because more than 72,000 organizations that lost exempt status were covered by group exemption letters, TE/GE has concerns about the extent to which these organizations understand their filing obligations.²⁹ TE/GE is developing a questionnaire to send to a random sample of group ruling holders to learn more about how parent and subordinate organizations satisfy their reporting obligations.³⁰

Applying for Exempt Status is Unnecessarily Burdensome

As the National Taxpayer Advocate has pointed out, Form 1023, a 12-page form requiring as many as eight schedules, is unnecessarily detailed for many small organizations.³¹ The National Taxpayer Advocate has recommended that TE/GE develop a Form 1023-EZ for small organizations as an alternative to Form 1023, and make Form 1023 available as a web-based interactive product. The Advisory Committee on Tax Exempt and Government Entities recommended against creating a Form 1023-EZ, but proposed that the IRS redesign Form 1023 as a short core form with supplemental supporting schedules and offer more educational tools about the form.³² The Advisory Committee noted that reformatting Form 1023 in this way would reduce the need for smaller organizations to respond to certain questions that currently appear, lessening the burden on them.³³ While the Advisory Committee's recommendations address the National Taxpayer Advocate's concerns about unnecessary burden and information-collection, we note that the success of any revised form will depend on the details of the new design. A redesigned form with interactive directions that asks plain-language questions and specifies the documents and schedules the applicant must attach would minimize errors and omissions and reduce taxpayer burden. TE/GE is responding to the Advisory Committee's recommendation by creating an interactive version of Form 1023, but it does not plan to revise or reformat it because "such revisions would require resources beyond Exempt Organizations."³⁴ The National Taxpayer Advocate finds this response inadequate in light of demonstrated need, and recommends that TE/GE work with the National Taxpayer Advocate, the Advisory Committee, and the appropriate state agencies and IRS functions to revise and reformat Form 1023.³⁵

TE/GE Erroneously Placed Organizations on the List of Revoked Organizations, with Severe Consequences for Some.

The decline in service to organizations requesting reinstatement of exempt status, coupled with the lack of administrative review, is particularly unfair to taxpayers that the IRS erroneously treated as no longer exempt. After the Treasury Inspector General for Tax Administration found that a programming problem existed, TE/GE identified more than 2,270 cases in which an organization was erroneously listed as having had its exempt status revoked, and 300 to 400 additional entities identified themselves as erroneously so listed.³⁶ The most common reason for the erroneous revocations was that IRS systems did not recognize subordinate organizations as part of a group return when the subordinates and the parent organizations had different accounting periods.³⁷ Upon discovering an erroneous revocation that appeared to be due to a systemic error, TE/GE researched whether other organizations were also erroneously treated as no longer exempt based on the same systemic condition. If so, TE/GE corrected their accounts as necessary, removed them from the revocation list, and notified them of the error. TE/GE worked with IRS Modernization & Information Technology Services to address programming errors.³⁸

The IRS updates its records monthly, but if the IRS recognizes, even as soon as the day after a scheduled update, that it erroneously listed an organization as no longer exempt, the organization may not appear as exempt on IRS records for two months.³⁹ This can create serious problems for the organization, as some donors base contribution decisions exclusively on an organization's classification in IRS electronic records.⁴⁰ As the Chief Financial Officer of one organization erroneously placed on the list of revoked organizations noted,

These consequences pose extreme hardship for organizations whose existence depends on their IRS list status. A process of administrative review might allow an organization to quickly resolve any errors and prevent it from being listed as no longer exempt, or at least minimize the period during which it is treated as having had its exempt status revoked.

CONCLUSION

In conclusion, the National Taxpayer Advocate preliminarily recommends that:

Congress passed the Pension Protection Act in 2006, amending IRC § 6033. The law now requires most tax-exempt organizations to file an annual information return or notice with the IRS. For small organizations, the law imposed a reporting requirement (e-Postcard, or Form 990-N) for tax years beginning after December 31, 2006. The new law also provides for the automatic revocation of the tax-exempt status of any organization that does not file a required return or notice for three consecutive years. In addition, the law states that all organizations automatically revoked by operation of law "must apply in order to obtain reinstatement of such status regardless of whether such organization was originally required to make such an application."⁴⁴ Therefore, as required by the statute, automatically revoked organizations must file an application for exemption to have their tax-exempt status reinstated, just as any other organization seeking IRS recognition of tax-exempt status.

The IRS is proud of its implementation of Congress' mandate. Over several years, the IRS took unprecedented steps in bringing awareness of the provision to the exempt organizations community through targeted as well as general outreach. The IRS also provided small organizations additional time for filing after releasing a preliminary list of organizations for which we had not received a filing. Slightly larger organizations were also given an opportunity to come into compliance without losing their tax-exempt status. In addition, after the revocation list was released, the IRS provided a special transition process for smaller organizations to have their tax-exempt status reinstated. In the years building up to the imposition of the automatic revocation, and in this period following revocation, the IRS has continually taken steps to assist EOs, especially those that are smaller.

The IRS agrees with the National Taxpayer Advocate that it could be beneficial to taxpayers to redesign the Form 1023 as an electronic short core form with supplemental supporting schedules, as recommended by the Advisory Committee on Tax Exempt and Government Entities (ACT) in its report released in June 2012.⁴⁵ This type of total redesign would, however, require resources from many parts of the IRS, including information technology. Because the IRS must balance a number of competing needs, we cannot presently predict when we can undertake the full redesign. However, to more immediately address the issue, the IRS asked the ACT to suggest steps to assist taxpayers with the application process in the interim. In response, the ACT suggested that the IRS post previously developed educational information on the IRS website to assist applicants. The IRS is going one step further, and is in the process of incorporating that previously developed information into an interactive web-based version of the existing Form 1023 that applicants can prepare online and then print and send into the IRS for review. We expect to make the interactive form available during the next calendar year.

The IRS understands that delayed notification of reinstatement can be a hardship for organizations that have been erroneously revoked. When the IRS determines that an organization has been erroneously revoked, it issues a letter advising the organization of the error, and this letter may be used by the organization to establish its tax-exempt status with donors, the public, or other government agencies.

The IRS also understands that organizations and their contributors often wish to use IRS's online resources, rather than a letter, to confirm tax-exempt status. For that reason, the IRS has been taking steps to increase the speed at which information about the tax-exempt status of organizations is updated on its publicly available resources. To provide the public with more timely information about the tax-exempt status of organizations, in January, 2011, the IRS began updating its publicly available online resources on a monthly rather than quarterly basis. Adding more frequent updates or creating a smaller electronic file or "addendum" would require additional programming and resources, which will have to be balanced with other competing IRS needs and systems limitations.

Under the PPA, automatic revocation of exemption occurs by operation of law. Because the IRS makes no determination regarding the automatic revocation, there is no IRS conclusion or determination to review. Automatic revocations are generated from data within the IRS BMF, which indicates the organizations that have failed to meet their filing requirements for three consecutive years. When passing the PPA, Congress recognized that the taxpayer information in the IRS systems may no longer be correct and that the new filing requirements could assist the IRS in updating this information and ensuring the accuracy of IRS systems going forward. Because the IRS also recognizes that automated systems can produce mistaken results, either because of programming issues or because of faulty data, the IRS has told organizations to notify the IRS if they believe they have been erroneously included on the Automatic Revocation List. The IRS will correct any mistakes.⁴⁶

Preliminarily, approximately 450,000 organizations have been automatically revoked for failing to file an annual notice or return for three consecutive years. As of November 5, 2012, the IRS had received approximately 27,000 applications for reinstatement of tax-exempt status from automatically revoked organizations (approximately six percent of revoked organizations), and had closed approximately 17,000 of those applications (approximately 63 percent of requested reinstatements).

The IRS appreciates the importance of processing applications for exemption in a timely manner and providing quality customer service at our call sites. We have initiated a number of efficiencies to improve the timeliness of our review of applications for tax-exempt status. Rather than assigning all cases to an agent for development, we put in place a screening system to fast-track those applications that are complete and require little or no further development.

This process has dramatically decreased the number of cases that need to be assigned for full development. For example, in FY 2012, 70 percent of all application cases were reviewed and closed within approximately 120 days during this initial technical screening process. Organizations whose applications cannot be completed through technical screening are sent letters informing them that more development of their application is needed.

To give applicants a sense of how long the wait could be before their application is assigned to a reviewer, we post on the IRS website ("Where's My Application") the date of applications currently being assigned. In an abundance of caution, however, the date given on the website is the oldest date of applications awaiting assignment. Most applications requiring full development are assigned well before that date, and the average wait time for full development applications at this time is roughly five months from the date we receive the application. We know the web page has created some confusion and we are in the process of revising the "Where's My Application" web page and letters to applicants to provide better information on wait times.

In addition, we continue to improve our process for reviewing applications and provide more education to applicants so more applications may be reviewed and closed during the screening process. We are confident that the new interactive Form 1023 will help in this respect.

To provide a high level of assistance to the ever-increasing number and complexities of tax-exempt organizations, while using our resources most effectively, the IRS takes a balanced approach towards customer service. First, the IRS website provides numerous resources to exempt organizations to assist them with all compliance issues. For automatic revocation specifically, we have developed "Frequently Asked Questions" targeted topic pages and tax tips directed towards both organizations and their contributors, to answer most auto-revocation scenarios. We encourage organizations to look to the website first to find information regarding their situations. Because website availability is not limited by work hours or staffing, it is a good way for organizations to instantly get the information they need at their convenience.

Second, the IRS recognizes that there may be some questions/concerns that cannot be answered by the website. For those less usual circumstances, call site staff, who are trained and dedicated solely to exempt organization issues, are available to provide assistance. In some cases, Rulings and Agreements staff also provide technical support to individuals on revocation/reinstatement issues. Unfortunately, people do not always go to the website first to find the answers to their questions, but instead go directly to the call site, which can lead to longer wait times for all callers. We will continue to improve our educational efforts to encourage customers to review the website for their questions before contacting the call site.

The IRS remains committed to ensuring a fair and effective implementation of section 1223 of the PPA with the automatic revocation and reinstatement process created by section 1223 of the PPA. Despite the increase in applications due to requests for reinstatement, the IRS has maintained a high level of service to organizations and the public, and will continue look for additional ways to provide quality assistance.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends TE/GE for developing an interactive version of the present Form 1023, which would be an improvement, but we retain our recommendation that TE/GE heed the recommendation of its Advisory Committee to redesign the form in ways that will significantly lessen the burden on taxpayers.⁴⁷ Without a more definitive commitment, it is not clear that TE/GE would actually undertake the redesign even if resources were readily available. Similarly, TE/GE does not articulate any objection, beyond resource considerations, to updating its electronic database more frequently than once a month, but doing so does not appear to be a priority. We therefore retain our recommendation that TE/GE provide these updates. We note that the tax exempt sector fulfills an essential role in the charitable, civic, scientific, and educational sectors of our economy, among others, and the IRS's failure to immediately update its records with respect to eligible charities unnecessarily harms these entities and undermines public policy.⁴⁸

Finally, we retain our recommendation that TE/GE make administrative review available, a proposal that TE/GE rejects on the grounds that revocations under PPA occur automatically and thus there is no "determination" to review. At the same time, TE/GE acknowledges that inaccurate automatic revocations can result from programming errors or faulty data. Nothing in PPA prevents or prohibits TE/GE from establishing a regularized procedure for taxpayers to alert the IRS about an erroneous revocation. TE/GE's ad hoc approach of correcting mistakes that single taxpayers bring to its attention is not a substitute for publicly available, established procedures for requesting review, which standards of tax administration and administrative procedure require.

The National Taxpayer Advocate is encouraged by TE/GE's initiatives to improve the efficiency with which it processes applications for exempt status. However, TE/GE reports that its new screening procedures reduce the number of days it takes to review and close some cases. It is not clear whether this reduced time includes the number of days the IRS has the application but has not begun to review it. Moreover, the reduced processing time for cases that need little or no development is 120 days -- four months. At any rate, in spite of its new procedures, TE/GE's June, 2012, volume of open inventory was 36,034 cases, compared to the June, 2011, volume of 17,451 cases, so while taxpayers might have been even worse off without the new procedures, the sheer volume of applications may be outpacing the gains in efficiency.⁴⁹

Recommendations

To improve the automatic revocation and reinstatement process, and to lessen the burden on taxpayers seeking recognition of exempt status, the National Taxpayer Advocate recommends that:

² National Taxpayer Advocate 2011 Annual Report to Congress 437 (Status Update: The IRS Makes Reinstatement of an Organization's Exempt Status Following Revocation Unnecessarily Burdensome).

³Hearing on Public Charity Organizational Issues, Unrelated Business Income Tax, and the Revised Form 990, Hearing before the H. Comm. On Ways and Means, Subcomm. on Oversight, 112th Cong. 2nd Sess., (July 25, 2012) 2 (testimony of Steven T. Miller, Deputy Commissioner of Services and Enforcement, Internal Revenue Service), available at http://waysandmeans.house.gov/UploadedFiles/Miller_Testimony_7.25.pdf (noting that "We consistently receive about 60,000 applications for tax-exempt status each year. Most are requesting status under section 501(c)(3).").

⁴ Tax Exempt and Government Entities (TE/GE) Division Business Performance Review (BPR) FY 2012: Second Quarter 15 (May 23, 2012) available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_2nd_Quarter_FY2012.pdf (reporting that there were 15,570 open determination cases in fiscal year (FY) 2010 and that TE/GE expects to have 40,304 open determination cases in FY 2012). See Where Is My Exemption Application?, available at http://www.irs.gov/charities/article/0,,id=156733,00.html, showing that in August 2012 TE/GE was assigning applications that were submitted in November 2011. Not all applications for exempt status must be assigned to a reviewer. For "plain vanilla" applications that do not require further development, the IRS either issues a determination letter or requests additional information within approximately 90 days. The IRS does not maintain information about processing times broken down by requests that can be disposed of at a screening stage and those that require further development. IRS response to TAS information request (Aug. 26, 2011).

⁵ TE/GE BPR FY 2012: Second Quarter 27 (May 23, 2012) available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_2nd_Quarter_FY2012.pdf.

⁶ Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2012-10-027, Appropriate Actions Were Taken to Identify Thousands of Organizations Whose Tax-Exempt Status Had Been Automatically Revoked, but Improvements Are Needed 9 (Mar. 30, 2012).

⁷ IRC § 6033(i). Under IRC § 501(a) and (c)(3), some organizations (exempt organizations or EOs) devoted to charitable, religious, educational, or certain other purposes may be exempt from federal tax. Formerly, under IRC § 6033(a)(3)(A)(ii), these EOs with annual gross receipts of normally not more than $5,000 were not required to file annual reports such as Form 990, Return of Organization Exempt from Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax. With Rev. Proc. 83-23, 1983-1 C.B. 687, the IRS increased the gross receipts amount to $25,000. For tax years beginning on or after January 1, 2012, the gross receipts amount is $50,000. Rev. Proc. 2011-15, 2011-3 I.R.B. 332. Exceptions to the new reporting requirement include churches, their integrated auxiliaries, and conventions or associations of churches.

⁸ IRC § 6033(j).

⁹ IRC § 6033(j)(2) provides that an organization must reapply for reinstatement following automatic revocation even if it was not required to apply for initial recognition of its tax exempt status.

¹⁰ IRC § 6033(j)(3).

¹¹ Notice 2011-43, 2011-25 I.R.B. 882. For tax years beginning on or after January 1, 2010, organizations with gross receipts normally of $50,000 or less may submit Form 990-N (e-Postcard). Rev. Proc. 2011-15, 2011-3 I.R.B. 322 (an increase from the earlier threshold of $25,000 or less).

¹² Rev. Proc. 2011-36, 2011-25 I.R.B. 915. The user fee for filing Form 1023 is usually $400 for EOs with gross receipts of $10,000 or less and $850 for those with gross receipts in excess of $10,000. Rev. Proc. 2012-8, 2012-1 I.R.B. 235.

¹³ Select Check, available at http://apps.irs.gov/app/eos/. In addition to containing a searchable list of organizations whose tax exempt status was automatically revoked, the tool provides searchable lists of organizations eligible to receive tax-deductible charitable contributions and organizations that have filed an e-Postcard.

¹⁴ IRS response to TAS information request (Aug. 2, 2012). TE/GE received 11 applications for reinstatement in 2010, 6,199 in 2011, and 12,269 as of June 7, 2012. TE/GE closed 9,504 of these applications. Id.

¹⁵Id. TE/GE closed 7,908 applications for reinstatement pursuant to Notice 2011-43, with almost all applicants receiving retroactive reinstatement. The IRS also reinstated 1,596 organizations other than under the transitional relief provisions. The vast majority (1,390, or 87 percent) of these organizations had annual gross receipts of less than $200,000 and only 26 obtained retroactive reinstatement. Id.

¹⁶ National Taxpayer Advocate 2011 Annual Report to Congress 562 (Legislative Recommendation: Provide Administrative Review of Automatic Revocations of Exempt Status, Develop a Form 1023-EZ, and Reduce Costs to Taxpayers and the IRS by Implementing Cyber Assistant).

¹⁷ IRS response to TAS information request (Aug. 2, 2012). In its BPR, EO reports on its "determination case receipts." Determination cases include applications submitted on Form 1023 as well as those submitted on Form 1024, Application for Recognition of Exemption Under Section 501(a), and also other determinations such as public charity and private foundation status determinations, advance approval of scholarship grant procedures, and group determinations of tax-exempt status. IRS response to TAS information request (Aug. 26, 2011). For FY 2009, before there were any requests for reinstatement, determination case receipts were 71,836. TE/GE BPR FY 2011: Fourth Quarter 16 (Nov. 15, 2011), available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_4th_Quarter_FY2011.pdf. For FY 2010, determination case receipts were 65,545, of which 11 were requests for reinstatement. For FY 2011, determination case receipts were 66,038, of which 6,199 were requests for reinstatement, leaving 59,839 routine requests. TE/GE BPR FY 2012: Second Quarter 15 (May 23, 2012) available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_2nd_Quarter_FY2012.pdf.

¹⁸ AWSS Employee Support Services, Payroll/Personnel Systems, HR Reporting Section, https://persinfo.web.irs.gov/track/workorg.asp (showing all fulltime Cincinnati Determinations employees as 221, 208, and 206 as of the end of September in 2009, 2010, and 2011 respectively, a decrease of 6.8 percent).

¹⁹ AWSS Employee Support Services, Payroll/Personnel Systems, HR Reporting Section, https://persinfo.web.irs.gov/track/workorg.asp.

²⁰ The FY 2010 open inventory consisted of 15,570 determinations cases. For FY 2011, the level was 17,677 cases, and for FY 2012, the level is expected to arrive at 33,505 cases. TE/GE BPR FY 2012: Second Quarter 15 (May 23, 2012) available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_2nd_Quarter_FY2012.pdf.

²¹See National Taxpayer Advocate 2011 Annual Report to Congress 449; Where Is My Exemption Application?, available at http://www.irs.gov/Charities-&-Non-Profits/Where-Is-My-Exemption-Application%3F.

²² TE/GE BPR FY 2012: Second Quarter 27 (May 23, 2012) available at http://tege.web.irs.gov/lib/my-resources/TEGE_BPR_2nd_Quarter_FY2012.pdf.

²³ TAS Inventory Report, Year to Date Receipts by Primary Issue Code/Description Codes 160 and 460 for FY 2010 and FY 2012.

²⁴ IRC § 7811(a) authorizes the National Taxpayer Advocate to issue a Taxpayer Assistance Order if the National Taxpayer Advocate determines the taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the internal revenue laws are being administered by the Secretary. Treas. Reg. § 301.7811(a)(4)(ii) provides that "Significant hardship includes situations in which a system or procedure fails to operate as intended or fails to resolve the taxpayer's problem or dispute with the IRS. A significant hardship also includes, but is not limited to: (A) An immediate threat of adverse action; (B) A delay of more than 30 days in resolving taxpayer account problems; (C) The incurring by the taxpayer of significant costs (including fees for professional representation) if relief is not granted; or (D) Irreparable injury to, or a long-term adverse impact on, the taxpayer if relief is not granted."

²⁵ National Taxpayer Advocate 2011 Annual Report to Congress 437, 447 (Status Update: The IRS Makes Reinstatement of an Organization's Exempt Status Following Revocation Unnecessarily Burdensome, IRS Comments).

²⁶ IRS response to TAS information request (Aug. 2, 2012).

²⁷Id.

²⁸ IRS response to TAS information request (Aug. 2, 2012).

²⁹Id. A group of organizations affiliated with a central organization may apply for recognition of exempt status as a group, rather than each organization applying individually. The IRS may recognize a group of organizations as exempt and issue one determination letter that applies to more than one organization. The filing requirements for the subordinates in the group remain the same, but the central organization may file annual group returns for those subordinate members of the group that, among other things, have the same accounting period as the central organization. See Treas. Reg. § 6033-2(d) and IRS Publication 4573, Group Exemptions.

³⁰Id.

³¹ National Taxpayer Advocate 2011 Annual Report to Congress 562 (Legislative Recommendation: Provide Administrative Review of Automatic Revocations of Exempt Status, Develop a Form 1023-EZ, and Reduce Costs to Taxpayers and the IRS by Implementing Cyber Assistant).

³² IRS response to TAS information request (Aug. 2, 2012); Advisory Committee on Tax Exempt and Government Entities (ACT) Report of Recommendations Exempt Organizations: Form 1023 -- Updating It for the Future 2, 30-34 (June 6, 2012), available at http://www.irs.gov/pub/irs-tege/tege_act_rpt11.pdf.

³³Id.

³⁴ IRS responses to TAS information request (Aug. 2, Aug. 17, 2012). The projected release date for an interactive Form 1023 is not yet known, nor has a user fee been determined. The interactive form will not be filed electronically.

³⁵ IRM 1.1.23.5(4)(h) (Feb. 1, 2007) provides that to accomplish its mission, EO "Coordinates with state agencies and Director TE/GE Customer Account Services on the design of EO forms and instructions and on the processing of EO forms."

³⁶ TIGTA, Ref. No. 2012-10-027, Appropriate Actions Were Taken to Identify Thousands of Organizations Whose Tax-Exempt Status Had Been Automatically Revoked, but Improvements Are Needed 9 (Mar. 30, 2012). See ABA Meeting: Official Encourages Contact from EOs with Wrongly Revoked Exemptions, Tax Notes Today (May 11, 2012), available at 2012 TNT 93-33 , in which an IRS official noted "the IRS has made corrections for 300 to 400 organizations that came to the IRS and explained why the revocations were erroneous."

³⁷ IRS response to TAS information request (Aug. 2, 2012). Other erroneous revocations occurred when IRS systems did not recognize EOs with more than one Employer Identification Number (EIN) that filed a return showing only one EIN; when IRS systems did not recognize, and therefore did not accept, an e-Postcard from organizations that had never previously filed a return or application for exempt status; when the IRS was unaware that state credit unions no longer had a filing obligation because they had become federally chartered; and when IRS systems had not been updated to reflect an IRS determination that the EO did not have a filing obligation, or the IRS erred in advising the organization that it did not have a filing obligation.

³⁸ IRS response to TAS information request (Aug. 2, 2012).

³⁹ See Correction: Some EOs Seeking Reinstatement May Not Appear on IRS Website For Up to 2 Months, Tax Notes Today (May 15, 2012), available at 2012 TNT 95-9 .

⁴⁰ TAS, Taxpayer Advocate Management Information System (TAMIS) Case File 272001. Despite the IRS's assertion that a letter from the IRS affirming the organization's exempt status is "good as gold" (see ABA Meeting: Official Encourages Contact from EOs with Wrongly Revoked Exemptions, Tax Notes Today (May 11, 2012), available at 2012 TNT 93-33 ), donors may not be able to integrate such a letter into their electronic grant making systems, which automatically consult IRS electronic records only.

⁴¹ TAS, TAMIS Case File 5272001, email from taxpayer's Chief Executive Officer to Deputy Director of Communications, Office of Rep. Israel (Mar. 12, 2012), on file with TAS. When TAS asked the IRS what caused this organization to be erroneously treated as no longer exempt, the IRS responded, "The IRS system does not reflect that this organization was ever automatically revoked. However, the IRS system does show that the organization's account was updated to a status that indicates that the organization was no longer in business. Once notified by the organization, the status was corrected." IRS response to TAS information request (Aug. 2, 2012). We find it disturbing that the IRS could be unaware of what actually happened in this case.

⁴² TAS TAMIS Case File 5213829.

⁴³ TAS TAMIS Case File 5240782.

⁴⁴ Pension Protection Act of 2006, Pub. L. No. 109-280 § 1223, 120 Stat. 780, 1090 (2006).

⁴⁵ Advisory Committee on Tax Exempt and Government Entities (ACT), Report of Recommendations Exempt Organizations: Form 1023 -- Updating It for the Future 32 (June 6, 2012), available at http://www.irs.gov/pub/irs-tege/tege_act_rpt11.pdf.

⁴⁶See Automatic Exemption Revocation for Non-Filing: Frequently Asked Questions, at http://www.irs.gov/Charities-&-Non-Profits/Automatic-Exemption-Revocation-for-Non-Filing:-Frequently-Asked-Questions-2. The answer to Frequently Asked Question 10, ("If an organization on the Auto-Revocation List has documentation that it met its filing requirement for one or more years during the three-year period, what should it do?") is: "An organization possessing documentation (an IRS receipt for a filed return, for example) that shows it has not failed to file for three consecutive years should contact Customer Account Services, or send the documentation directly to the Exempt Organizations Account Unit." The answer to Frequently Asked Question 11, ("If an organization on the Auto-Revocation List has a letter from the IRS stating that it does not have an annual filing requirement, what should it do?") is: "An organization with a letter from the IRS stating that it does not have an annual filing requirement should contact Customer Account Services."

⁴⁷ The "interactive web-based version of the existing Form 1023 that applicants can prepare online and then print and send into the IRS for review," referred to in the IRS's response, sounds very similar to Cyber Assistant, a web-based software program the IRS announced would be available in 2010, and an initiative the National Taxpayer Advocate supported. See National Taxpayer Advocate 2011 Annual Report to Congress 562 (Legislative Recommendation: Provide Administrative Review of Automatic Revocations of Exempt Status, Develop a Form 1023-EZ, and Reduce Costs to Taxpayers and the IRS by Implementing Cyber Assistant). The release of Cyber Assistant was delayed until further notice. IRM 3.45.1.11.6.2 (Jan. 1, 2012).

⁴⁸ The Independent Sector, a nonpartisan coalition of approximately 600 organizations founded in 1980, reports that the nonprofit sector provides 5.5 percent of the nation's entire gross domestic product or $751 billion worth of output. Moreover, "[i]n 2009, nonprofits employed 13.5 million individuals, or approximately 10% of the country's workforce. To provide a comparison, more people work in the sector than in the finance industry, including insurance and real estate, combined." Additionally, "[e]mployees of nonprofit organizations account for 9% of wages paid in the U.S. in 2009, and the nonprofit sector paid $668 billion in wages and benefits to its employees." (Fn refs. omitted). The Economic Sector, The Sector's Economic Impact, available at http://www.independentsector.org/economic_role.

⁴⁹ TE/GE BPR FY 2012: Third Quarter 27 (Aug. 16, 2012) available at http://tege.web.irs.gov/article.asp?category=resources&title=reports-budget-it=/my-resources/reports-budget-it.

The IRS has entered the twenty-first century after evolving from an organization of local collection districts into a centralized nationwide processing operation.² Yet concerns articulated by congressional experts shortly after enactment of the mass income tax, as quoted above, persist today. Information technology has facilitated mass production under tight budgetary constraints at a cost of individualized service. This section surveys taxpayer service through eight Most Serious Problems (MSPs), four of which concern means of communication or serving taxpayers, including telephone, correspondence, electronic technology, face-to-face and video-conferencing. Another four MSPs address various sectors, including tax professionals as well as low income, small business, and international taxpayers. Thus, a matrix of technological channels and taxpayer preferences confronts the IRS, which must use limited resources to deliver personal service where necessary. Internally, the IRS needs to consider potential repercussions to taxpayers from telework practices. Some channels that appear expensive at first may turn out to be the most effective for certain taxpayer populations or issues, potentially proving to be efficient in the end.

BACKGROUND

The IRS has to meet taxpayers where they are. All taxpayers live in geographic locations where homogeneity at different levels, including tax compliance behavior, delineates cultural regions.³ Geography is everywhere, and IRS efforts to encompass all taxpayers with a single apparatus cannot avoid regional differences. It would be better to confront regional and other differences directly.

Against inherent taxpayer diversity, mass production has been an inevitable alternative to processing a growing return population. Historically, mass production flourished under a model of scientific management famously articulated by the engineer Frederick Winslow Taylor, whereby an office "divided skills into a sequence of simple procedures to be taught to workers and monitored by management."⁴ In 1911, Taylor's regime focused on individual output: "when accurate records are kept of the amount of work done by each man and of his efficiency, and then each man's wages are raised as he improves, and those who fail to rise to a certain standard are discharged . . ."⁵ In 1925, the IRS established an "Efficiency-Record Section" for personnel functions as well as training of income tax auditors and technicians.⁶ Even today, any particular IRS employee may develop efficiency in one skill or program, but few employees (mostly higher-level managers) know the tax system as a whole. As a result, an IRS employee may not realize how a program affects a taxpayer overall. In the words of a critic, Taylorism requires a clerk to "'forget' or not think about the intellectual content of the text he is reproducing."⁷ While Taylor's management science was an advance when he introduced it, in the twenty-first century it may be time for something more holistic.⁸

Nevertheless, the pressure to operate efficiently cannot be overlooked, especially when the IRS operates under resource constraints that may be disproportionate in the developed world. Of 34 countries listed by the Organisation for Economic Co-operation & Development, only four have higher ratios than the U.S. of citizens to tax staff. Taxpayer workload in the face of limited resources puts pressure on IRS efficiency.

 

FIGURE 1.1, Ratio of Citizens to Tax Staff by Country⁹

 

 

 

The IRS Has an Information-Gathering Apparatus.

The IRS has ways to gather information about taxpayers' needs and communicate with them about the services it offers. In particular, the IRS has research and communication functions embedded in the National Office as well as the Operating Divisions, highlights of which are summarized below. The Taxpayer Advocate Service (TAS) has parallel functions.

In the National Office, the Research, Analysis & Statistics division contains an Office of Program Evaluation and Risk Analysis (OPERA). Founded by Commissioner Charles Rossotti in the aftermath of the IRS Restructuring & Reform Act of 1998 OPERA includes, approximately 40 analysts, economists, statisticians, and researchers who help the IRS determine resource allocations, mitigate potential risks, and develop plans and other program management capabilities.¹⁰ Also in Washington, DC, the National Public Liaison (NPL) within the headquarters Communication & Liaison (C&L) function, among other activities, coordinates professional seminars called Nationwide Tax Forums, as well as two Federal Advisory Committees.¹¹

The Wage & Investment (W&I) operating division, with individual taxpayers in its customer base, has a Research & Analysis (R&A) function comprising seven groups focusing on:

• Taxpayer Needs, Preferences & Burden;

• Electronic Tax Administration Support & Self-Preparer Taxpayer Studies;

• Relationship of Service & Compliance;

• IRS Partner Needs & Preferences;

• Refundable Credits;

• Knowledge Infrastructure; and

• Survey Administration & Analysis.¹²

In the Small Business/Self-Employed (SB/SE) operating division, a half-dozen Research groups identify economic and demographic trends.¹⁴ Techniques include:

• Trend analysis of filing, payment, and reporting patterns;

• Market research;

• Impact measurement; and

• Development and prioritization of alternative methods of enhancing voluntary compliance.

In the Large Business & International (LB&I) operating division, a Planning, Analysis, Inventory & Research (PAIR) function includes, among others, a Workload Identification office, which has a few branches of almost ten employees each to:

• Conduct cross-industry research on compliance risk; link with the Pre-Filing Technical Group;

• Leverage academic and other external research to identify emerging issues and trends in tax administration and compliance; and

• Develop return scoring models and filters for compliance risk.¹⁷

Finally, TAS has some half-dozen R&A staff who produce studies that:

• Review IRS interactions with taxpayers and suggest ways to improve IRS communications;

• Evaluate audit, collection, and other IRS enforcement programs to protect taxpayer rights and minimize taxpayer burden;

• Summarize taxpayer statistics annually for each congressional district;

• Explore taxpayers' service needs;

• Focus on Earned Income Tax Credit (EITC) taxpayers;

• Identify characteristics of TAS customers and factors that affect TAS's workload; and

• Address factors that influence taxpayers and preparers to comply with the tax laws.¹⁹

In sum, national and divisional components of the IRS have research and communication functions in part to understand and respond to taxpayer needs. These parallel functions are targeted to each component's customer base. While there is coordination through a Servicewide Research Council (SRC) that "serves as a forum for sharing information, coordinating crosscutting actions and resolving procedural issues that affect the execution of research and analysis across operating divisions," SRC "will not supplant the authority and accountability, which resides in the research organizations, embedded in the operating divisions and the functions."²¹ In any case, the multi-level research and communication apparatus should leave no doubt about the importance of information gathering and exchange between the IRS and taxpayers. The question may be how to interpret and apply information.²²

Taxpayer Needs Vary by Sector.

Taxpayer needs vary by sector as well as by inherent geographic variations. The MSPs that follow discuss needs of some salient sectors. In the case of tax professionals, return preparers, or other advisors, IRS errors and omissions in recognizing their powers of attorney or similar authorizations harm not only the professional but also the client.²³ For low income and small business populations, IRS representatives such as Stakeholder Liaison discussed in an MSP below face a historic low in staffing that paradoxically coincides with increases in demand for assistance.²⁴

Other taxpayer needs relate to consumer preferences susceptible to market research by the research functions described above. For example, using "conjoint" techniques that allow researchers to deduce preferences from respondents' choices among an array of options, the IRS has surveyed preferences of randomly recruited taxpayers among seven telephonic, online, or postal media -- not including in-person channels such as Taxpayer Assistance Centers (TACs) -- relating to seven generic service tasks (rather than specific account resolutions).²⁵ From 2006 to 2011, preferences shifted slightly away from a toll-free telephone Customer Service Representative toward online service. In 2011, the online interactive tool was the most preferred channel for all needs (except getting a form or publication, for which printing, rather than ordering hard copy, from the website was the preferred channel). For newer media, the results showed that taxpayers prefer social media, which offer general information but not resolution of specific problems, at lower rates than more established channels. Similarly, smartphone owners prefer these devices, especially for "getting the status of a transaction," at higher rates than the general population. Consequently, the researchers recommended that the IRS investigate the possibility of developing smartphone apps for checking the status of a tax transaction and using social media accounts to disseminate information about how to obtain a prior year return, and about which credits and deductions may be available. This "conjoint" study is exemplary of research on taxpayer preferences, given that the study's scope was the general population, rather than any particular sector.²⁶

Research Can Prioritize Service Initiatives.

Other research focuses on preferences of certain taxpayer sectors. For example, some sectors are less likely than others to use the Internet.²⁷ Thus, the effect of constraints on face-to-face or similar services is not neutral with respect to taxpayer populations who prefer those channels.

As discussed in an MSP below, W&I and TAS have partnered on the Service Priorities Project to develop a ranking methodology that will take taxpayer preference into account.²⁸ The goal of the Project, which will use existing data while identifying data gaps, is to value each type of service from both the taxpayer and IRS perspectives. The Project will facilitate resource allocation decisions based on highest-valued services in the face of budget or staffing constraints.

Current Service Approaches May Not Meet Taxpayer Needs.

Merely identifying taxpayer needs and preferences may not mean that the IRS meets them. Given the expense of walk-in sites, the IRS often channels taxpayers into telephone or Internet service, where they may be underserved. Unfortunately, "walk-in" site is not only a name but is now a limitation, since TACs no longer schedule certain appointments, instead offering service on a first-come, first-served basis.²⁹ Even if taxpayers use the phone instead, the IRS simply fails to answer more than three out of ten calls, potentially leading to unnecessary audits or submission of incomplete documentation, drawing out the duration of a case.³⁰ Resource constraints demand creative solutions.

Where the IRS leverages technology for efficiency gains, it may neglect taxpayer needs. In the case of telecommuting, the IRS may save the cost of office space by allowing employees to work at home despite information security risks. While telecommuting affords flexibility, promoted by both private employers and the government, customer impact remains a question. In the case of the IRS, telecommuting may affect taxpayer rights, especially privacy rights. Different statutes, with underlying guidance, set forth telework goals and taxpayer privacy rights.³¹ Even if computer connections are secure, it may be impracticable to conceal tax return information from household members or neighbors visiting when the information is laid out in the flexible workplace at home. An option could be to allow taxpayers to consent to access of their return information by teleworking IRS employees, with the exception of Revenue Officers, Revenue Agents, or others whose job descriptions require working outside of the office. As of now, the rhetoric of telework omits customer impact, lacking a mechanism to assess and accommodate taxpayer preferences.

In short, current approaches effectively may ignore taxpayer needs. In some cases, cost may appear prohibitive. In other cases, taxpayers may not even be aware of potential risks surrounding IRS practices. In either case, the IRS should accommodate taxpayer needs and preferences both as a matter of principle and as a matter of encouraging compliance.

Taxpayer Diversity in the Face of Resource Constraints Calls for Innovation.

While resource constraints may be the primary concern, cost-effective innovations could yield improvements in taxpayer service. For example, at least for the Internet-savvy, a potential solution would be more self-service Web tools such as the popular "Where's My Refund?" application, as recognized by the IRS research described above. For small businesses, TAS has developed a Small Business Health Care Tax Credit Estimator to help plan for benefits available under the Affordable Care Act. For low income taxpayers, various needs could be met by a return-free or at least pre-populated filing system and a tax refund debit card.³² All taxpayers would benefit from a free e-filing portal.³³ For international taxpayers, lack of service could be mitigated by guidance on murky tax law questions.³⁴ Technological or other services could help these sectors help themselves.

The historic trend in tax administration has been away from personal service toward automation, which may be most effective for uniform provisions. Yet the tax Code has become more complex rather than more uniform. Given these inconsistent trends, an emerging option may be to use social and electronic technology to help taxpayers help themselves to unique options. As mentioned, automatic generation of taxpayer information as in the case of returns pre-populated by third-party information reports can give each taxpayer an individualized starting point. Web tools and smartphone applications such as those suggested by IRS research would further enable computer-savvy taxpayers to make transactions of their choosing.

A comparable mechanism could be self-service kiosks as now offered by retail establishments, automatic teller machines (ATMs), and even the Post Office. For relatively simple transactions, self-service can be more efficient. For more complex transactions, customer assistance may be necessary. Experts have cautioned that "coordinated human interactions are essential for the successful operation of retail kiosks."³⁵ This may be because kiosks are a form of "performance support technology [that] is quite distinct from automation. By definition, performance support technology is designed to support a human in accomplishing a task, not replace a human."³⁶ Kiosks or similar technology could allow the IRS to leverage staff as long as they can meet taxpayer needs, but if a complex transaction takes too long, a kiosk such as an ATM may "time out," leaving the customer to go to the teller anyway.³⁷ Successful use of self-service kiosks requires dedicated staff.³⁸

The IRS has "kiosks in 37 Taxpayer Assistance Centers (TACs) where individuals can perform a wide variety of tasks, including filing a return, printing forms, and obtaining transcripts."³⁹ Experience has shown that taxpayers may walk into a TAC "expecting someone to complete their return, only to be told that they must take the keyboard and input their information" which can "lead to a perception of "'bait-and-switch'."⁴⁰ Consequently, "education about the options" may be as essential as staff assistance.⁴¹

Likewise, video-conferencing technology, if strategically deployed, may facilitate effective virtual service delivery (VSD) for taxpayers and enforcement functions.⁴² For example, VSD may enable taxpayers and examiners to see one another as people when before they would have merely corresponded by mail. While technology in itself may not be the solution, a thoughtful combination of human effort with technological support can help.

FOR BETTER SERVICE, EVERY EMPLOYEE NEEDS TO KNOW HOW HIS OR HER WORK FITS INTO THE IRS MISSION.

Resource constraints are squeezing taxpayer service to a disproportionate extent, although enforcement efforts proceed. As discussed in an MSP below, international taxpayers feel pursued by enforcement initiatives even where certain rules remain unclear. Underserved groups continue to have needs, although certain innovations, like an e-filing portal, could address at least some of them. While creative solutions could come from creative thinking, the following parameters may help.

Like all populations, taxpayers are innately diverse on multiple dimensions, one of which is geographic diversity, particularly in a large country like the U.S.⁴³ Conversely, various regions contain cultures with an observable degree of internal consistency. Even in the high-technology industry, which is most likely to be adept at telecommunication, professionals gravitate toward local centers like Silicon Valley.⁴⁴ Like-minded people naturally form geographic communities.⁴⁵ By confronting cultural geography, along with other taxpayer sectors, through market segmentation or similar research techniques, the IRS could achieve an appreciable degree of targeting within cost-conscious service initiatives.⁴⁶ For instance, an MSP addressing stakeholder needs recommends the allocation of reduced liaison staffing to geographic areas or population strata that demonstrate the most critical needs.

The model of a locally centered occupational community may be helpful in rethinking management science. A hierarchical and specialized division of labor, in which clerical positions remain "permanently subordinated," may be characteristic of work and business in industrial and post-industrial societies.⁴⁷ At the same time, work would be less alienating where employees are better integrated into the office community both geographically or architecturally and substantively. In the past couple of decades, a trend toward "open" floor plans with cubicle dividers rather than office walls may have reflected, at least in part, an ideal of integration.⁴⁸ By contrast, telecommuting from home or other remote locations could isolate employees.

To train managers, the IRS has analyzed its organizational characteristics in terms of a well-known typology. According to the IRS: "In the type world of the Myers-Briggs Type Indicator (MBTI), the IRS is an ISTJ organization."⁴⁹ ISTJ refers to Introverted, Sensing, Thinking, and Judging, as opposed to Extroverted, Intuitive, Feeling, or Perceiving. The strength of ISTJ employees is "providing their own services or products . . . They are very reliable when it comes to getting details right." On the other hand, "[t]hey can lose contact with their constituency." By the same token, an ISTJ "organization is likely to be closed to outsiders . . . it is often difficult for anyone but an insider to spot internal problems at an early stage." Efficient yet detailed production is consistent with old-fashioned scientific management. Nevertheless, tax administration now demands contact with a constituency that has diversified over time. Telework or other technological approaches that increase isolation of employees who tend to be introverted and judgmental rather than extroverted and perceptive does not bode well for taxpayers who need help.

Connections between stovepiped functions and functionaries potentially could be forged through the multiple channels potentially available, such as Office Communicator and social media. In the case of TAS, all-employee conferences and other training sessions have fostered an understanding of the working of the whole organization among all employees, including clerical staff. Whatever the mechanism, the goal would be to inform each employee, no matter how small a cog in the bureaucratic apparatus, how his or her work integrates with that of others, with an ultimate impact on the taxpaying customer.

Finally, it would be hard to avoid the conclusion that unless IRS resources rise to a level comparable to that of counterpart agencies in other developed economies, American tax administration will not remain on par.⁵⁰ Some taxpayers will receive service while the IRS will collect from some transgressors. Other taxpayers, especially those in underserved sectors identified in the following MSPs, may face so many obstacles that they abandon voluntary compliance, especially if enforcement becomes so uneven as to create a perception that scofflaws go undetected. With ingenuity, social and technological innovations can address taxpayer needs and preferences while integrating employees into the mission of the IRS as a whole. This effort harks back to principles raised within the IRS when introducing sociotechnical design two decades ago:

²See National Taxpayer Advocate 2011 Annual Report to Congress, Vol. 2, § 1 at 1 (Research Study: From Tax Collector to Fiscal Automaton: Demographic History of Federal Income Tax Administration, 1913-2011).

³See generally Mona Domosh et al. THE HUMAN MOSAIC: A THEMATIC INTRODUCTION TO CULTURAL GEOGRAPHY 12th ed. (NY: W.H. Freeman & Co., 2012).

⁴A Short History of the Birth & Growth of the American Office, CARBONS TO COMPUTERS, Smithsonian Inst. (Washington, DC: 1998); see Frederick W. Taylor, THE PRINCIPLES OF SCIENTIFIC MANAGEMENT (NY: Harper Bros., 1911), ch. 2, stating: "Under the old type of management success depends almost entirely upon getting the 'initiative' of the workmen, and it is indeed a rare case in which this initiative is really attained. Under scientific management the 'initiative' of the workmen (that is, their hard work, their good-will, and their ingenuity) is obtained with absolute uniformity and to a greater extent than is possible under the old system . . . The managers assume . . . the burden of gathering together all of the traditional knowledge which in the past has been possessed by the workmen and then of classifying, tabulating, and reducing this knowledge to rules, laws, and formulae."

⁵ Taylor, PRINCIPLES OF SCIENTIFIC MANAGEMENT, ch.1 (quoting from presentation to Amer. Soc'y of Mechanical Engineers, June 1903). Taylor was a colleague of time & motion efficiency experts Frank B. & Lillian M. Gilbreth, whose family was portrayed in a book and movie, Cheaper by the Dozen (1950).

⁶ Subsequently, the Efficiency-Record Sec. was merged into a Personnel Div'n. See IRS Pub. 1694, Historical Fact Book: A Chronology, 1646-1992 at 99, 109, 114; Comm'r of Int. Rev., ANN'L REP'T (1920) at 13, (1922) at 11, (1924) at 7.

⁷Taylorism and the Mechanization of the Worker, ANTONIO GRAMSCI READER: SELECTED WRITINGS, 1916-1935, ed. David Forgacs (NY: Schocken Books, 1988).

⁸See Robert Kanigel, Taylor-made, 37 THE SCIENCES 18 (NY Acad. of Sci. 1997); Michael Maccoby, THE LEADERS WE NEED (Boston: Harv. Business School Press, 2007) 22-23.

⁹ The ratio is number of citizens per full-time tax employee. In Greece, Iceland, and Chile, data are unavailable or incomplete. In Switzerland, federal tax staff administer only the value-added tax (VAT) while local personnel (not in table) administer personal and corporate income tax. In Mexico, the tax system is smaller than in most other OECD countries. In the USA, there is no federal VAT. See OECD Forum on TAX ADMIN. TAX ADMINISTRATION IN OECD AND SELECTED NON-OECD COUNTRIES: COMP. INFO. Ss. (2010) Table 21, ¶¶ 13-22 at 134-37.

¹⁰http://opera.web.irs.gov/about.html (last visited Aug. 30, 2012).

¹¹http://irweb.irs.gov/AboutIRS/bu/cl/npl/default.aspx (last visited Aug. 30, 2012).

¹²http://win.web.irs.gov/Research/WIRA_webpage.htm (last visited Dec. 13, 2012).

¹³http://win.web.irs.gov/spec/docs/SPEC_Chart_FO.pdf (last visited Aug. 30, 2012).

¹⁴http://mysbse.web.irs.gov/AboutSBSE/Research/default.aspx (last visited Aug. 30, 2012).

¹⁵Id.

¹⁶http://mysbse.web.irs.gov/AboutSBSE/CLD/aboutsl/default.aspx (last visited Aug. 30, 2012).

¹⁷http://lmsb.irs.gov/hq/srp/RWI_Contacts/Research_Teams/Team_1.asp (last visited Aug. 30, 2012).

¹⁸http://lmsb.irs.gov/hq/cl/new_communications/communications_guidance.asp (last visited Aug. 30, 2012).

¹⁹http://tas.web.irs.gov/res/default.aspx (last visited Aug. 30, 2012).

²⁰http://tas.web.irs.gov/Comm/outreach/default.aspx (last visited Aug. 30, 2012).

²¹ SRC Charter (Mar. 14, 2001).

²² For previous commentary on aspects of IRS research, see National Taxpayer Advocate 2007 Annual Report to Congress 156 (Most Serious Problem: Taxpayer Service and Behavioral Research).

²³See Most Serious Problem: IRS Processing Flaws and Service Delays Continue to Undermine Fundamental Taxpayer Rights to Representation, infra.

²⁴See Most Serious Problem: The IRS Is Substantially Reducing both the Amount and Scope of its Direct Education and Outreach to Taxpayers and Does Not Measure the Effectiveness of its Remaining Outreach Activities, Thereby Risking Increased Noncompliance, infra.

²⁵ This paragraph summarizes IRS W&I R&A Group 2, T[axpayer] A[ssistance] B[lueprint] Conjoint Update, Project No. 2-10-09-S-058 (Feb. 2012) 2, 3-4 & 7. The tasks were: (1) getting a form or publication; (2) getting information about a notice you received from the IRS; (3) getting assistance determining tax credits and/or deductions you may be able to take on your tax return; (4) getting prior year return information; (5) making a payment or setting up a payment plan; (6) checking the status of a transaction; and (7) getting help making tax-related calculations.

²⁶ Another limitation was that the methodology assumed complete awareness, availability, and information relating to service channels. See TAB Conjoint Update, Appdx. A at 14.

²⁷See National Taxpayer Advocate 2011 Annual Report to Congress 273, 279 (Introduction to Diversity Issues: The IRS Should Do More to Accommodate Changing Taxpayer Demographics) (citing data indicating that low income, less educated, minority, elderly, disabled, or rural populations were less likely than others to use the Internet).

²⁸See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

²⁹See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

³⁰ For FY 2012, IRS toll-free assistors answered 30.8 million of 107.8 million calls, a 67.6-percent Level of Service, with a 16.7-minute Average Speed of Answer. See IRS Enterprise Snapshot Rep't (Sept. 29, 2012); see also Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2012-40-036, Interim Results of the 2012 Filing Season (Mar. 30, 2012); Most Serious Problem: The IRS Telephone and Correspondence Services Have Deteriorated over the Last Decade and Must Improve to Meet Taxpayer Needs, infra.

³¹See Dep't of Transp. & Related Agencies Appropriations, 2001, Pub. L. No. 106-346, 114 Stat. 1356A-36, § 359 (Oct. 23, 2000); Telework Enhancement Act of 2010, 5 USC § 6502(b)(4)(B); OMB Memo. M-11-27 (Jul. 15, 2011); IRM 6.800.2 (June 2, 2010); IRC § 6103.

³²See Most Serious Problem: A Proactive Approach to Developing a Government-Issued Debit Card to Receive Tax Refunds Will Benefit Unbanked Taxpayers, infra.

³³See Most Serious Problem: The IRS Has Failed to Make Free Return Preparation and Free Electronic Filing Available to all Individual Taxpayers, infra.

³⁴See Most Serious Problem: Challenges Persist for International Taxpayers as the IRS Moves Slowly to Address Their Needs, infra.

³⁵ Hira Cho & Susan Fiorito, Self-Service Technology in Retailing: The Case of Retail Kiosks, 1 Symphonya: Emerging Issues in Mgmt. 43, 45 (Univ. of Milan, 2010).

³⁶ Thomas Cavanagh, The Kiosk Culture: Reconciling the Performance Support Paradox in the Postmodern Age of Machines (Ph.D. diss., Univ. of Central Fla., 2006) 10.

³⁷ Cavanagh, Kiosk Culture at 84, citing Regina Colonia-Willner, Self-Service Systems: New Methodology Reveals Customer Real-Time Actions During Merger, 20 Computers in Human Behavior 243 (2004).

³⁸ In November, 2010, a TAS delegation observed successful staffed kiosk use in facilities of the internal revenue service of Chile in Santiago.

³⁹ IRS SPEC, Facilitated Self Assistance [FSA] Reference Manual for 2013 Filing Season 5 (Oct. 15, 2012).

⁴⁰ IRS SPEC, Facilitated Self Assistance [FSA] Reference Manual for 2013 Filing Season 8 (Oct. 15, 2012).

⁴¹Id.

⁴²See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra; see also Virtual Face-to-Face Audits: A prescription for curing the IRS's ailing correspondence examination process, http://www.taxpayeradvocate.irs.gov/Blog/virtual-face-to-face-audits (last visited Oct. 19, 2012).

⁴³See generally Wilbur Zelinsky, Cultural Geography of the U.S. (Prentice Hall, 1973).

⁴⁴See Edw. Glaeser, Triumph of the City (NY: Penguin Press, 2011).

⁴⁵ On local culture, see Clifford Geertz, Fact & Law in Comparative Perspective, Local Knowledge: Further Essays in Interpretive Anthropology (N.Y.: Basic Books, 1983) (originally delivered as Storrs Lectures, Yale Law School, 1981).

⁴⁶ On market segmentation, see, e.g., Dennis Adcock et al., Marketing: Principles & Practice 4th ed. (Prentice Hall, 2001).

⁴⁷Office Organization, Carbons to Computers, op. cit.

⁴⁸See John Tierney, From Cubicles, Cry for Quiet Pierces Office Buzz, NY Times (May 19, 2012) (discussing trade-off between communication and privacy).

⁴⁹ This paragraph quotes from IRS Training Pub. 28667-002, Front Line Manager Course: Participant Guide (Aug. 2011) 6-3.

⁵⁰See National Taxpayer Advocate 2011 Annual Report to Congress 3 (Most Serious Problem: The IRS Is Not Adequately Funded to Serve Taxpayers and Collect Taxes).

⁵¹ IRS, Draft Work System Design Handbook: A Guide to Integrating Technology with Human and Organizational Factors, Doc. 7733, Cat. No. 13057F (Mar. 1991), Intro. at 3.

Peggy Bogadi, Commissioner, Wage and Investment Division Faris Fink, Commissioner, Small Business/Self-Employed Division

DEFINITION OF PROBLEM

The IRS mission statement -- "[p]rovide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all" -- reflects the obligation of the agency to provide the means for all taxpayers to meet their tax obligations.¹ When the IRS cannot adequately answer taxpayers' telephone calls or correspondence, and sets declining expectations for performance, it cannot execute its mission.²

As the IRS faces budget cuts and places an increased emphasis on enforcement, key performance measures of taxpayer service have declined, including:

• The IRS received over 100 million calls in fiscal year (FY) 2012 and more than 30 percent went unanswered.³

• The IRS received about 10.5 million pieces of correspondence, and at the end of the last week of FY 2012, nearly 48 percent was "overage."⁴

• In FY 2012, the IRS answered almost 68 percent of taxpayer calls and in FY 2013 set a goal of answering only 63 percent, a seven percent decrease.⁵

• Wait time to speak to an IRS representative was nearly 17 minutes in FY 2012, compared with under three minutes in FY 2004, an increase of over 500 percent.⁶

• In FY 2012, the IRS received calls to the CAS and AM lines from over 75,000,000 unique telephone numbers with an average of two calls per phone number.⁷

Phones and correspondence represent taxpayers' main methods of communication with the IRS. As call volumes continue to rise, answering the phones to provide timely and comprehensive service to taxpayers must remain a priority. To serve taxpayers effectively, conducting rigorous research and analysis to understand what services are best provided through each channel, and using this information to guide the overall service strategy, is crucial. Applying the results of research and analysis to strategic service decisions will help the IRS allocate resources appropriately to meet taxpayer needs.

ANALYSIS OF PROBLEM

Background

Taxpayers call the customer service toll-free lines for many reasons. Prior to filing a tax return, a taxpayer may have an inquiry about the tax law or a question on how to prepare a form. After filing, taxpayers may want to check the status of a refund or respond to an IRS notice such as a math error notice.¹¹ Or a taxpayer might call because he or she has not received a timely reply to correspondence.

Taxpayers correspond with the IRS for the same reasons they call, or because they cannot reach a live assistor by phone, or may disconnect the call after being on hold for extended periods. Taxpayers may also write rather than call or visit a Taxpayer Assistance Center (TAC) or attempt to find an answer on the Internet when they cannot spend time away from work or other obligations to wait on hold or wait in line at a TAC.¹² In a survey of TAC customers in April 2012, members of the Taxpayer Advocacy Panel (TAP) asked taxpayers if they had attempted to contact the IRS by another means before visiting the TAC. About two of every three of these taxpayers stated they had contacted or attempted to contact the IRS by some other method before coming into the office (approximately 34 percent said they visited the IRS website prior to visiting the TAC and 25 percent said they phoned first).¹³

In FY 2012, the IRS taxpayer service functions received almost 110 million incoming phone calls and over ten million pieces of correspondence.¹⁴ While the IRS's workload has increased significantly, its budget has not grown to meet the demand despite repeated warnings from top IRS officials, including the National Taxpayer Advocate.¹⁵ In FY 2012, taxpayers made almost 110 million attempts to call the CAS toll-free lines, up from nearly 100 million in FY 2011.¹⁶ The IRS's budget was reduced slightly from FY 2010 to FY 2011,¹⁷ and was lowered by an additional 2.5 percent for FY 2012.¹⁸ These reductions affect the IRS's operations overall, and are particularly likely to impact taxpayer service. W&I Division Taxpayer Services began FY 2012 with almost 19,000 permanent employees, down nearly six percent from the FY 2011 level of just over 20,000.¹⁹ With an unknown budget for the current (2013) fiscal year and the possibility of mandatory across-the-board cuts, the decline in IRS resources appears to be a continuing trend for the near future.²⁰

Service Levels in Customer Account Services Have Steadily Decreased.

The CAS toll-free lines serve as a primary channel for taxpayers with filing questions or account issues. In FY 2004, the IRS answered over 87 percent of these calls but in FY 2012 it answered only about 68 percent -- a decline of nearly 23 percent.²¹

 

FIGURE 1.12.1, Level of Service for CAS/AM Toll-Free, FY 2004-FY

 

2012²²

 

 

 

 

FIGURE 1.12.2, CAS/AM Toll-Free Average Speed of Answer, FY

 

2004-2012²⁴

 

 

 

Phone Service Issues Are Not Limited to the IRS Main Toll-free Lines.

Customer service across IRS phone lines has generally declined since FY 2004.²⁵ LOS has decreased and ASA is longer across the Practitioner Priority Service (PPS), National Taxpayer Advocate, and Tax Exempt and Government Entities (TE/GE) organizations lines.²⁶ The PPS line is a professional support line staffed by IRS employees specifically trained to address practitioner questions.²⁷ From FY 2004 through FY 2012, ASA on the PPS line has increased by almost 1,100 percent, with practitioners having to wait an average of over 22 minutes to speak to a customer service representative.²⁸ Such delays frustrate practitioners and cost taxpayers money, as their representatives spend time waiting for the IRS to answer the phone. During the same period on the PPS line, LOS has decreased by more than 20 percent.²⁹

 

FIGURE 1.12.3, PPS Line LOS and ASA FY 2004-2012³⁰

 

 

 

At the Same Time Telephone Service Is Declining, the Volume of Aged, Unprocessed Correspondence is Growing.

Even as it becomes more challenging to communicate with the IRS by phone, it has also become more difficult for taxpayers to obtain a response to their correspondence. Comparing the final weeks of fiscal years 2004 and 2012, the backlog of correspondence in the tax adjustments inventory has jumped by nearly 190 percent.³³ During the same period, the percentage of correspondence classified as "overage" has increased by over 315 percent.³⁴

 

FIGURE 1.12.4, Adjustments Ending Correspondence Inventory

 

Volumes, FY 2004-FY 2012³⁵

 

 

 

 

FIGURE 1.12.5, Adjustments Ending Correspondence Overage

 

Percentage FY 2004-FY 2012³⁶

 

 

 

The National Taxpayer Advocate understands that the IRS must allocate a finite amount of resources among increasing work demands. For this reason, TAS invited W&I to join in developing a methodology that will help the IRS decide how to allocate taxpayer service resources by taking into account both government and taxpayer needs and expectations. Using Government Value and Taxpayer Value as its ranking criteria, the Service Priority Project team is developing a measured set of taxpayer services that can be used to identify priorities when budget or staffing issues dictate a change in services.³⁷ TAS has proposed three additional taxpayer value measures for the tool; however, W&I has not accepted those measures at this time. Research conducted to populate the values in the ranking tool will assist the IRS in understanding the best channel for each taxpayer service and optimizing its overall taxpayer service strategy.

The IRS Unnecessarily Increases Demand for Services Through Its Own Work Processes.

Notwithstanding recent IRS efforts to improve the clarity of its correspondence, IRS notices often confuse taxpayers and lead them to contact the IRS for an explanation or to find out the next steps. On the other hand, the IRS increases its own workload and creates taxpayer burden by sending notices that require responses even when the IRS already has the information it needs to correct an error.³⁸ For example, Taxpayer A has been claiming Dependent B on his tax return for the last ten years. This filing season, Taxpayer A inadvertently transposes two digits of Dependent B's Social Security number (SSN) on the return. Although the IRS could easily correct this error, as the correct SSN is shown on the taxpayer's previous filings, the IRS instead issues a math error notice that requires the taxpayer to contact the IRS to correct the return and takes on average about 12 weeks to resolve³⁹.

The IRS allows taxpayers to conduct simple actions through IRS.gov, but taxpayers cannot use the site for routine tasks such as:

• Correcting computational errors;

• Checking account status;

• Obtaining prior year return information immediately; or

• Making an individual tax payment.

Moving tasks to the Internet would permit willing taxpayers to use this channel for routine actions and could reduce stress on IRS telephone and correspondence resources, allowing IRS assistors to focus on taxpayers who need and prefer the phone or correspondence. The IRS has made progress improving taxpayer services provided via the Internet, including the release of the "Where's My Refund" web tool and smartphone application. However, this in itself has created additional demand on the toll-free lines at times when systems were unavailable or provided an unclear response.⁴⁰

CONCLUSION

Failing to provide service to taxpayers who require IRS assistance creates a burden for taxpayers who cannot resolve their tax issues timely. Downstream consequences of being unable to reach the IRS may include not filing a return, filing inaccurate returns, spending money on paid practitioners, or accumulating greater penalties or interest. By understanding through rigorous research and analysis what tasks taxpayers need to accomplish over the phones and correspondence, the IRS can appropriately allocate all taxpayer service resources to meet demand. With declining LOS and increasing ASA across many IRS phone lines, combined with increasing levels of overage correspondence, taxpayers are not receiving top quality service and may not be able to meet their tax obligations.

The National Taxpayer Advocate preliminarily recommends that the IRS:

The IRS places high importance on customer service, and we constantly strive to improve the customer experience. The IRS monitors telephone service in real time and constantly takes steps to move staff from programs that are less busy to telephone services with longer wait times. We routinely look at ways to decrease customer wait times and improve efficiency. We are exploring new technology such as virtual queuing, which provides customers the ability to request a call back during especially busy times in lieu of waiting on line, and electronic fax, which enables our assistors the ability to send and receive documents directly from employee workstations. These efforts are aimed at reducing telephone handle times and improving the customer experience. In addition, we are continually studying the reasons taxpayers need to contact us, which enables us to better serve them.

Each year millions of taxpayers call the IRS for assistance with account-related issues or to obtain tax law related information needed to file tax returns. There were approximately 46 million customers seeking live assistance during FY 2012.

We have increased the total number of IRS toll-free customers served each year from 69.3 million in 2004 to over 90 million in 2012, a 29.9 percent increase. This is due, in large part, to a significant increase in the number of customers served through automation, which increased from 33.8 million in 2007 to over 59 million in 2012. While we recognize that personal service is highly valued by many of our customers, automated service is more efficient and provides services that are consistent, reliable, and available at all hours. And because of changing customer demographics, automation is becoming the preferred contact channel for many of our customers seeking answers to tax law questions and those with less complicated account issues. By providing automated options for these customers, our assistors are available to concentrate on more complex inquiries, and we are able to serve a larger number of customers overall.

Overall demand has increased in recent years. In FY 2008, economic stimulus legislation prompted an unprecedented number of taxpayers to call the IRS, which had a significant negative impact on CSR LOS. After FY 2009, demand for toll-free service subsided but did not return to pre-stimulus levels. In FY 2012, demand was 50 million, about five million higher than the levels experienced between FY 2004 and FY 2007. This level of demand appears to be the "new normal."

Just as we explore ways to improve telephone service, we also continually look at ways to improve service to our customers who contact us via correspondence. Accounts Management currently utilizes an extensive suite of correspondence metrics to effectively track volume, timeliness, and case priority.

• The IRS uses the Correspondence Imaging System inventory report to monitor weekly overage work and priority inventory, and track closed cases compared to the overall inventory.

• In FY 2011, Accounts Management implemented a new Site Level Indicators and Measures Report, which includes the tracking of cycle time and average days to close correspondence at the site as well as the aggregate levels, enabling the IRS to monitor timely service to the taxpayer.

• We utilize the Embedded Quality Timeliness measure to determine the timeliness and accuracy of responses to taxpayer correspondence and whether employees follow established timeframes and proper workload management guidelines.

Our Field Collection Areas have led the way in reaching out to our customers to improve case quality. For example, Field Collection recently took steps to keep their customers apprised as to the status of their case by developing and implementing case closing letters. These letters let many of our customers know when their case has been closed or resolved. They also continually strive to reduce time spent on a case by improving the quality of our initial contacts and educating taxpayers on their important role in case resolution.

In addition, many Collection Areas hold quarterly Collection Liaison meetings with local practitioners. At these meetings, local practitioners meet with Territory Managers, Group Managers, and Revenue Officers. During these meetings, presentations are given on various topics relating to the collection process and practitioners are always given the opportunity to discuss their concerns in a non-confrontational atmosphere. This outreach has received much praise from the practitioner community and is expected to grow.

The IRS is pleased to partner with TAS on the Service Priority Project, which will quantify the value of service tasks by service channel (i.e., face-to-face, assisted and automated telephone, and online), based on government and taxpayer value criteria. The service tasks are defined at a broad level, e.g., providing general tax law assistance and information and providing tax account assistance.

The ranking tool is still under development. The IRS will use the ranking tool as guidance along with other relevant information when making decisions about changes to taxpayer services. Additionally, the IRS will incorporate the three criteria proposed by TAS into the ranking tool as data become available. In the meantime, information available about these criteria will be included as addenda to the services' score sheets. This ranking tool is a tool in the decision-making process; therefore, the information in the addenda will inform the decisions.

The IRS will modify existing surveys in order to collect data that will populate the data gaps in the current model. These modifications will be constrained by budget considerations. For example, an increased sample size necessary to collect the detailed data for the model will increase the survey cost.

The ranking tool is not designed to provide information about the impact of specific changes in service attributes (e.g., hours of operation, wait time, etc.). The IRS will evaluate the cost-effectiveness of conducting research that will provide the detailed data that would be needed to quantify the changes in service attributes (e.g., level of service, hours of operation).

The National Taxpayer Advocate has recommended that the IRS collect data related to service and satisfaction levels in a global manner to understand needs and assess metrics. The IRS currently collects an extensive suite of telephone and correspondence performance metrics. The data collected is used to assess taxpayer needs and identify improvement actions. Although there is currently an extensive suite of correspondence metrics in place which effectively track volume, timeliness, and case priority, the IRS is constantly striving to improve the customer experience. The IRS has tools in place to monitor cycle time, average days to close correspondence, weekly overage work and priority inventory, and track closed cases compared to the overall inventory. We also utilize the Embedded Quality Review System timeliness measure to evaluate whether caseworkers took timely case action. The IRS places high importance on customer service and will continue to review, update, and augment the current suite of metrics for the correspondence program, as needed.

Finally, the National Taxpayer Advocate has recommended that the IRS conduct studies to identify unnecessary correspondence and take action to minimize taxpayer burden caused by unnecessary correspondence. In an effort to reduce taxpayer burden and better understand the taxpayer decision-making process of contacting the IRS in response to Information Only (IO) notices, W&I Research and Analysis (WIRA) identified eight high-impact, high-volume notices that do not require a response from the taxpayer. WIRA conducted twelve focus groups with taxpayers and IRS Customer Service Representatives (CSRs) in May and June 2012. WIRA found that a taxpayer's main motivation for calling the IRS in response to IO notices is to obtain information. WIRA obtained a number of suggestions for improving the notices.

Taxpayer Advocate Service Comments

Providing quality service to a large and varied taxpayer population is crucial to the IRS mission. The National Taxpayer Advocate is pleased that the IRS recognizes the value of improving the customer experience. TAS fully supports the expansion of electronic tools for IRS telephone assistors and taxpayers to decrease burden and shorten the time needed to resolve problems.⁴²

While automated options are an important component of a comprehensive taxpayer service strategy, the IRS cannot rely solely on these options to close gaps. As the tax code grows more complex, taxpayer issues become increasingly difficult and less suitable for automation. Additionally, the IRS knows that certain segments of the taxpaying public are unable or unwilling to use automation, and that it must provide them with quick, efficient phone service.

The National Taxpayer Advocate is pleased that the IRS is looking at a set of Information Only notices to improve the quality of existing notices and decrease the need for taxpayers to call the IRS in response. This is a first step, but the IRS not addressing the other underlying issues that drive unnecessary taxpayer contacts. For instance, the IRS declined to comment on the possibility of using its own records to correct simple math errors, such as a transposed Social Security number for a dependent, which would remove the need to even correspond with the taxpayer. Elimination of unnecessary "action required" notices will reduce phone calls and correspondence as well as taxpayer burden.

Finally, the National Taxpayer Advocate also is pleased that the IRS has agreed to incorporate TAS criteria in its jointly-developed service ranking tool and will use this tool to make future taxpayer service decisions. However, the IRS must remain aware of the taxpayer perspective as it decides how to deliver services. Failing to fully populate the ranking tool data before changing its taxpayer service strategy will cause the IRS to continue making decisions in a vacuum. The IRS must commit to recognizing the importance of the taxpayer experience with IRS services, and use internal and external research to fully understand the impact and consequences of service changes. It should be a budget priority to complete the research and data collection necessary to make the ranking tool effective. While populating the tool will require an investment upfront, it will enable the IRS to make better decisions and target resources more appropriately in the long run.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

² IRS, Wage & Investment (W&I) Business Performance Review, 3rd Quarter, 20 (Aug. 15, 2012).

³ IRS, Joint Operations Center, Snapshot Report, September 30, 2012. Customer Account Services (CAS)/Accounts Management (AM) telephone lines included 29 toll-free lines in 2012). The IRS received 107,815,335 net call attempts to the CAS or AM lines in FY 2012, of which 30,788,921 were answered by a customer service representative (CSR). A total of 35,986,931 calls were answered by IRS automated call lines. The CSR level of service (LOS) is 67.6 percent.

⁴ Certain IRS inventories must be worked within a specific timeframe to be considered timely. If not closed in that timeframe, the inventory item will be classified as "overaged." IRS, Accounts Management Inventory Report: National Inventory Age Report, (Sept. 29, 2012). IRS, Joint Operations Center Reports, Accounts Management Inventory FY 2012. In FY 2012, 47.8 percent of the unresolved correspondence was considered overaged.

⁵ IRS, W&I Business Performance Review, 24 (Aug. 15, 2012).

⁶ IRS, Joint Operations Center, Snapshot Reports, September 30, 2005 and September 30, 2012. Figures for 29 CAS/AM lines.

⁷ IRS, Joint Operations Center, Executive Summary Report, Accounts Management Rollup FY 2012. Unique number information is based on all calls placed to IRS on CAS or AM lines. IRS Enterprise received 154,728,573 calls from 77,177,476 unique phone numbers in FY 2012. Unique phone numbers may be understated due to multiple callers from one private branch exchange or phone number.

⁸ IRS, Joint Operations Center, Snapshot Reports FY 2004-2012.

⁹Id. The actual data was provided in seconds and converted to minutes. In FY 2004, average phone wait time was 158 seconds (2.6 minutes) and in FY 2012, it was 1001 seconds (16.7 minutes).

¹⁰ Certain IRS inventories must be worked within a specific time to be considered timely. If not closed in that period, the inventory item will be classified "overaged." IRS, Joint Operations Center, Accounts Management Inventory Reports FY 2004-2012. In FY 2004, 11.5 percent of correspondence was classified as overage compared to 47.8 percent in FY 2012.

¹¹ A math error notice is a computer generated notice informing the taxpayer that the IRS changed the taxpayers return based on an error identified in the processing of the return.

¹²See Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

¹³ The TAP is a federal advisory committee comprised of a group of citizen volunteers who work to improve IRS services by providing the taxpayers' perspective to various IRS operations. The National Taxpayer Advocate and TAS's Research and Systemic Advocacy staffs supported the design, compilation, and analysis of the survey. TAP volunteers returned 664 completed surveys from 33 different TAC offices. While these results are not statistically representative of all TAC visitors, they represent the needs and activities of a sizable number of TAC customers during one week in the tax filing season. Percentages shown are out of all 664 respondents. Some respondents did not answer every question.

¹⁴ IRS, Joint Operations Center, Snapshot Report FY 2012; IRS, Joint Operations Center, Accounts Management Reports, FY 2008-2012 Inventories. In FY 2012, the CAS/AM toll free lines received 107,815,335 net call attempts, of which 30,788,921 were answered by a CSR. A total of 35,986,931 calls were answered by IRS automated call lines. The CSR LOS is 67.6 percent. The AM function received 10,471,205 pieces of correspondence.

¹⁵ For a full discussion of the National Taxpayer Advocate's concerns regarding the IRS' notice clarity, see National Taxpayer Advocate 2011 Annual Report to Congress 3-14 (Most Serious Problem: The IRS Is Not Adequately Funded to Serve Taxpayers and Collect Taxes).

¹⁶ IRS, Joint Operations Center, Snapshot Reports FY 2011-2012. There were 107,815,396 attempts to reach a CSR assistor in FY 2012; in FY 2011, there were 98,438,779. In FY 2012, the CAS phone lines were renamed to AM. The AM summary includes calls from 29 toll-free lines including xxx-xxx-1040, 4933, 1954, 0115, 8374, 0922, 0582, 5227, 1778, 9887, 9982, 2942, 4184, 7388, 0452, 0352, 7451, 9946, 5084, 5215, 3536, 4059, 4778, 4259, 8482, 1000, 1099, 5500, 4490.

¹⁷ Department of Defense and Full-Year Continuing Appropriations Act, 2011, Pub. L. No. 112-10, § 1119, 1125 Stat. 38, 107 (2011). These figures represent all personnel funded under the Taxpayer Service appropriation for PP 20B. Other possible budget categories include Enforcement, Operations Support, BSM, or HITCA.

¹⁸ H.R. 2055, Consolidated Appropriations Act, 2012, Division C, Title I (112th Cong.).

¹⁹ IRS, W&I Business Performance Review, (Aug. 15, 2012). In FY 2011, W&I Taxpayer Services had 20,042 permanent employees compared to 18,919 employees at the beginning of FY 2012. This represents a 5.6 percent decline in permanent employees. Taxpayer Services includes areas such as Submission Processing, AM, and TACs.

²⁰See Most Serious Problem: The IRS is Significantly Underfunded to Serve Taxpayers and Collect Tax, supra.

²¹ IRS, Joint Operations Center, Snapshot Reports FY 2004-2012.

²²Id. CSR LOS is the percentage of callers seeking live assistance who reach a live assistor.

²³ IRS, Joint Operations Center, Snapshot Reports FY 2004-2012. The actual data was provided in seconds and converted to minutes. In FY 2004, average phone wait time was 158 seconds (2.6 minutes) and in FY 2012, it was 1001 seconds (16.7 minutes).

²⁴ IRS, Joint Operations Center, Snapshot Reports FY 2004-2012. The actual data was provided in seconds and converted to minutes. In FY 2004, average phone wait time was 158 seconds (2.6 minutes) and in FY 2012, it was 1001 seconds (16.7 minutes).

²⁵ SB/SE and W&I Automated Collection System phone lines have maintained fairly consistent LOS and ASA since FY 2004. IRS, Joint Operations Center, Snapshot and Product Line Detail Reports FYs 2004-2012.

²⁶ The National Taxpayer Advocate Hotline is staffed by W&I CSRs. The TE/GE LOS has increased since FY 2004, but declined since FY 2010. IRS, Joint Operations Center, Product Line Detail Reports FY 2004-2012,

²⁷ IRS, Practitioner Priority Service, available at http://www.irs.gov/Tax-Professionals/Practitioner-Priority-Service-%C2%AE (last visited Nov. 1, 2012).

²⁸ IRS, Joint Operations Center, Product Line Detail Reports FY 2004-2012. ASA in FY 2004 was 1.85 minutes, compared to 22.05 minutes in FY 2012.

²⁹ IRS, Joint Operations Center, Product Line Detail Reports FY 2004-2012. In FY 2004, LOS was 93.3 percent and in FY 2012, it was 73.4 percent. For a full discussion of the National Taxpayer Advocate's concerns about service to practitioners, see Most Serious Problem: IRS Processing Flaws and Service Delays Continue to Undermine Fundamental Taxpayer Rights to Representation, infra.

³⁰Id.

³¹Id.

³²Id. In FY 2009 ASA on the TE/GE line was 5.23 minutes compared to 16.35 minutes in FY 2012. For further discussion of the National Taxpayer Advocate's concerns regarding TE/GE customer service, see Most Serious Problem: Overextended IRS Resources and IRS Errors in the Automatic Revocation and Reinstatement Process Are Burdening Tax-Exempt Organizations, supra.

³³ IRS, Joint Operations Center Reports, Accounts Management Inventory Report FY 2004-2012.

³⁴ Certain IRS inventories must be worked within a specific time to be considered timely. If not closed in that period, the inventory item will be classified "overaged." Id. In FY 2004 11.5 percent of correspondence was classified as overage, compared to 47.8 percent in FY 2012.

³⁵Id.

³⁶ IRS, Joint Operations Center, Accounts Management Inventory Report FY 2004-2012.

³⁷ IRS, W&I Business Performance Review, (Aug. 15, 2012).

³⁸ For a full discussion of the National Taxpayer Advocate's concerns regarding the IRS' notice clarity, see National Taxpayer Advocate 2011 Annual Report to Congress 74-92 (Most Serious Problem: Expansion of Math Error Authority and Lack of Notice Clarity Create Unnecessary Burden and Jeopardize Taxpayer Rights). See also National Taxpayer Advocate 2011 Annual Report to Congress Volume II 113-144 (Study: Math Errors Committed on Individual Tax Returns: A Review of Math Errors Issued on Claimed Dependents).

³⁹ 2011 National Taxpayer Advocate Annual Report to Congress, (Study: Math Errors Committed on Individual Tax Returns: A Review of Math Errors Issued for Claimed Dependents, Table 9, 138). The median time to resolve this math error notice is four weeks.

⁴⁰ A complete list of tools for individual taxpayers can be found at http://www.irs.gov/uac/Tools (last visited December 31, 2012). See Treasury Inspector General for Tax Administration, Ref. No. 2012-40-036, Interim Results of the 2012 Filing Season (Mar. 30, 2012). For further discussion of the National Taxpayer Advocate's concerns about Internet services and the progress the IRS has made, see Most Serious Problem: The IRS is Striving to Meet Taxpayers' Increasing Demand for Online Services, Yet More Needs to Be Done, infra.

⁴¹ We have also made this recommendation in the Most Serious Problem: The IRS Lacks a Servicewide Strategy the Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

⁴² In the most recent IRS, W&I Business Performance Review, 26 (Nov. 14, 2012), the IRS has revised its goal for Level of Service to 70 percent from 63 percent,

⁴³ We have also made this recommendation in the Most Serious Problem: The IRS Lacks a Servicewide Strategy the Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra.

Peggy Bogadi, Commissioner, Wage and Investment Division

Carol Campbell, Director, Return Preparer Office

DEFINITION OF PROBLEM

Taxpayers today have an array of options for filing their returns, but not all taxpayers have the ability to prepare and e-file their returns for free. Low and middle-income taxpayers typically lack the knowledge and skills needed to prepare their own returns. Many cannot afford to pay for return preparation, and depend upon the free services of IRS employees at Taxpayer Assistance Centers (TACs), volunteers at Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) sites, and online products and services offered by the Free File Alliance (FFA).¹ In addition, many taxpayers who do have the skills to prepare their own returns do not qualify for or know about Free File, leaving them to pay for private-sector software products. Reliance on the private sector for return preparation creates vulnerabilities, including a lack of consistency among commercial products in incorporating recently enacted or infrequently applied tax provisions. Moreover, a recent TAS evaluation of the information provided by IRS telephone assistors revealed the IRS failed to provide VITA site accessibility information in 90 percent of the calls, and failed to provide language availability at VITA sites nearly 60 percent of the time.²

In 1998, Congress directed the IRS to develop a return-free tax filing alternative.³ Many other countries now use alternative tax systems (e.g., "return free" and "pre-populated" return systems) to simplify tax administration.⁴ The rationale for doing so is compelling. These systems often require real-time information reporting, which provide greater accuracy, improved compliance, and reduced taxpayer burden.⁵ The Government Accountability Office (GAO) has estimated that by adopting a similar system, the IRS could free tens of millions of taxpayers from the requirement to prepare returns, saving taxpayers over 155 million hours of tax preparation time and hundreds of millions of dollars in return preparation fees.⁶ The IRS could use the tens of millions of dollars it now spends resolving problems on incorrectly prepared returns to increase return preparation assistance for underserved taxpayers.⁷ In 2010, TAC sites prepared electronic returns for only slightly more than one tenth of one percent of the eligible taxpayers, and less than half that number in 2012.⁸

The National Taxpayer Advocate is concerned about the way the IRS administers its return filing operations, specifically:

• The IRS has not developed a comprehensive plan that will give all taxpayers the option to prepare and e-file their returns for free;

• The IRS has not implemented the "Return-Free" tax system Congress directed it to develop in 1998.

• TACs increasingly turn away taxpayers seeking return preparation assistance, directing them to volunteers, commercial software, and paid preparers; and,

• The IRS relies on VITA for return preparation, but continues to give taxpayers inaccurate or incomplete information about site locations and provides the volunteer programs with tax software embedded with a costly commercial product.

Background

Basic principles of sound tax administration focus on improving taxpayer services and compliance.⁹ It is widely recognized that, in furtherance of these principles, the tax administrator bears the ultimate responsibility for providing free return preparation and electronic filing.¹⁰ However, as shown in Figure__ below, U.S. taxpayers filed more than 136 million individual income tax returns during the 2012 filing season, through September 2012 (tax year 2011 returns), and over 75 million taxpayers (roughly 55 percent) used paid preparers.¹¹ If the IRS provided an electronic version of the paper Form 1040 on its website, and equipped it with computational capability, links to IRS publications, forms, instructions, and worksheets, all individual taxpayers could prepare and e-file their returns for free if they chose.

 

FIGURE 1.13.1, Breakdown of Individual Returns for Tax Years 2010

 

and 2011¹²

 

 

 

The IRS attempts to fulfill its responsibility with respect to tax preparation through a disjointed array of services and providers that has evolved over many years:

• IRS employees prepare returns for eligible taxpayers at TAC sites;¹³

• National and local partner organizations coordinate the annual training and IRS certification of thousands of dedicated VITA and TCE volunteers who prepare and e-file returns for eligible taxpayers throughout the United States;¹⁴ and

• IRS Free File provides a host of free tax products and services to eligible taxpayers under an agreement with the Free File Alliance.¹⁵

While e-file now supports the most common federal forms, Free File companies are not required to and do not offer all IRS forms and schedules.¹⁷ To find forms and schedules not listed on the Free File website, the IRS directs taxpayers to the vendors' websites to find out if the forms are available. Free Fillable Forms now supports over 140 forms,¹⁸ but does not support prior year returns and is not available for e-filing year-round. For example, in 2012, taxpayers could e-file via Free Fillable Forms from January 17 through October 15. Those who e-filed on or before October 15 were allowed until October 19 to correct and resubmit a rejected return. Taxpayers filing after that date had to file paper returns.¹⁹ The IRS could bridge these gaps in services with a government-provided, electronic version of its Form 1040 with computational capability that supports e-filing for all 1040 series forms and schedules.

The National Taxpayer Advocate has previously addressed the significant limitations of IRS Free File. While Free File purports to offer free filing for up to 70 percent of individuals, vendors can and do impose additional eligibility criteria that vary from one vendor to another. This can make choosing a vendor confusing for taxpayers. Moreover, some products do not inform taxpayers that they are ineligible for free e-filing until after they have completed the bulk of the return.²⁰ Finally, some private vendors have been unwilling to incorporate late-enacted tax provisions into their Free File product.²¹

A government-provided electronic Form 1040 could also be designed to make returns easier to prepare by allowing taxpayers to directly import third-party data.²² Taxpayers who feel they need professional help to prepare their returns could obtain it in much the same way taxpayers have done for years. Those who prefer to use the more sophisticated commercial software products, including those that link to bookkeeping, payroll, and accounting software, could continue to do so. The private sector could continue to receive fees for services and products such as consultation, training, sophisticated off-the-shelf commercial software, design of government-provided forms and services, and individualized advice on more complex returns.²³

In developing an electronic Form 1040, the IRS could collaborate with the private sector by soliciting bids or renegotiating its existing agreement with the Free File Alliance for a comprehensive Fillable Forms Utility. However, the IRS would need to set the terms of any agreement and control the content and detailed specifications of what an electronic 1040 must contain. The IRS also would need to ensure the specifications meet the needs of taxpayers, and should not be constrained by the existing Free File limitations. Contracting with an outside vendor would allow the IRS to benefit from the expertise of the private sector yet retain control over the products for future changes.

The IRS has Not Implemented the "Return-Free" Tax System Congress Directed it to Develop in 1998.

In a 1987 study, the IRS reported that a "tax agency reconciliation system" was not feasible because of the time it took to process and correct third-party data, but could become viable in the future once more payers filed their information returns electronically.²⁴ By 1996, the

GAO found at least 36 countries had adopted a "return free" tax system as an alternative approach to tax simplification.²⁵ GAO estimated that as many as 51 million U.S. taxpayers (or about 45 percent) of the 114 million filers in 1992 would not have had to prepare returns if the IRS had established a voluntary tax agency reconciliation system.²⁶ Taxpayers could have saved up to 155 million hours on tax preparation tasks and millions of dollars in return preparation fees,²⁷ while the IRS could have saved an estimated $15.1 million from not having to work over 850,000 underreporting cases.²⁸ In 1998, Congress directed the IRS to develop procedures for a "return free" system for appropriate individuals by 2007. The legislation stated:

The IRS should develop a secure, online portal (i.e., electronic gateway) to a government-maintained database that would allow taxpayers to access information reported by third parties (e.g., wages reported by employers on Forms W-2), as Congress directed it to do in 1998.³⁰ The legislation stated:

Providing taxpayers with direct access to their data would also improve the accuracy of returns, freeing up increasingly scarce IRS resources for more return preparation assistance at TAC sites. It also would free up critical VITA and TCE resources for tax preparation in other areas, such as for low income small businesses and self-employed individuals.

TAC Sites Increasingly Turn Taxpayers Away, Directing them to Volunteers, Commercial Software, and Paid Preparers for Return Preparation Assistance.

Most Eligible Taxpayers Do Not Have Year-Round Access to Free Return Preparation Assistance at TAC Sites.

Free tax preparation help has never been more critical, yet because of limited IRS resources, only a small percentage of low-to-middle income taxpayers who need direct return preparation assistance now receive it from TACs. While the IRS provides year-round tax preparation services at these sites, where employees prepare current year returns as well as prior year amended returns for eligible taxpayers, the availability of these services is limited and declining due to budgetary constraints.³² Return preparation is limited to certain days, which the IRS determines on a "TAC-by-TAC" basis. And beginning with the 2012 filing season, TAC sites no longer schedule appointments for return preparation.³³

As shown in Figure __, below, this reduction in direct services has nearly halved the number of e-filed returns accepted at TACs from approximately 129,000 in 2010 to less than 56,000 in 2012, even while the target population for services (i.e., low income, elderly, disabled,) has remained steady, averaging 91 million in the 2010 through 2012 filing seasons (i.e., tax years 2009 through 2011). In other words, TAC sites prepared electronic returns for slightly more than one tenth of one percent of the eligible taxpayers in 2010, and less than half that number in 2012.

 

FIGURE 1.13.2, Trend Comparison of TAC E-Filed Return v. Eligible

 

Taxpayers, 2010-2012³⁴

 

 

 

The IRS is Attempting to Reach More Eligible Taxpayers Using Facilitated Self Assistance.

In response to the increasing need for return preparation services, the IRS developed the Facilitated Self Assistance (FSA) model to reach more taxpayers and help them become self-sufficient by incorporating taxpayer education into return preparation. IRS employees at certain TAC sites, and certified VITA/TCE volunteers, help taxpayers prepare their own returns, serving as facilitators and answering questions. This enables assistors to work with multiple taxpayers simultaneously. Taxpayers benefit by learning to use a computer to prepare their returns, and receive free online access to tax software from the FFA vendors.³⁷

IRS research confirms that lack of access to computers and fast Internet connections is a significant barrier to taxpayers filing their own returns, and that an estimated 16 million more taxpayers would use FSA if the IRS made it more readily available.³⁸ To its credit, the IRS has worked closely with partners to identify the VITA and TCE sites best suited to the FSA model (e.g., colleges and universities with "tech-savvy" populations that fall within the income limits of the program), pinpointing its marketing effort on "self-sufficiency and learning about taxes." In 2012, all 50 states had access to FSA software.³⁹ Although approximately 1,000 VITA/TCE sites applied for Site Identification Numbers (SIDN), only slightly more than 500 sites transmitted the more than 10,500 returns self-prepared in 2012.⁴⁰ Moreover, despite the reported success at these volunteer sites, the IRS has installed FSA capability at only 37 of its 401 TACs.⁴¹ The IRS should accelerate the deployment of FSA terminals to its TACs and encourage more VITA/TCE sites to take advantage of them. This would improve services at TAC sites and produce the same benefits the IRS and taxpayers are realizing at some VITA/TCE sites (i.e., the ability to help more taxpayers prepare returns, reduced wait times, access to free tax software, fast Internet connections, and help from experienced IRS employees).⁴²

Assisting Taxpayers who Seek Direct Return Preparation Assistance Should Be a Central Component of IRS Service Delivery.

Many taxpayers in the target population for TAC return preparation assistance (e.g., low income, elderly, disabled, and limited English proficiency) cannot wait long times to be served or be turned away. The IRS should adopt a policy that allows taxpayers to make appointments and accepts walk-in customers for FSA or direct return preparation assistance. Terminals could be reserved and experienced employees could serve as "floaters," attending to taxpayers as they arrive.⁴³

The National Taxpayer Advocate applauds the outstanding work of the many dedicated volunteers who serve each year preparing returns, but remains concerned about the IRS's continuing shift away from assisting taxpayers who want direct IRS help. VITA sites are stretched to their limits and the IRS does not provide nearly enough support and oversight to its volunteer programs to ensure accuracy and confidentiality. Moreover, the IRS itself has imposed limitations on what volunteer programs can do. For example, the IRS directed VITA sites not to handle returns for taxpayers in the region where Hurricane Katrina struck, presumably because it believed the returns would be too complex for volunteers to prepare accurately.⁴⁴ Improving customer service, as well as enforcement, is essential to achieving a high rate of compliance. Assisting taxpayers who seek help computing their tax liabilities and preparing their returns should continue to be a central component of taxpayer service.

The IRS Relies on VITA for Return Preparation But Continues to Give Inaccurate or Incomplete Information About Site Locations, and Provides Tax Software Embedded with a Costly Commercial Product.

IRS Employees Have Provided Inaccurate or Incomplete Information About VITA Sites to Callers for Nearly a Decade.

The IRS's growing reliance on volunteers allows it to serve more taxpayers with fewer employees.⁴⁵ However, the Treasury Inspector General for Tax Administration (TIGTA) has repeatedly addressed concerns about the way IRS telephone assistors provide VITA site information to taxpayers. TIGTA reported that assistors at 45 percent of IRS call sites tested provided inaccurate information⁴⁶ that did not always include accurate site locations, hours of operation, and services offered for 33 percent of VITA sites.⁴⁷ TAS's own evaluation of the services provided by IRS assistors revealed that they continue to give taxpayers incomplete information about VITA. For example, the IRS did not provide information about site accessibility in nearly 90 percent of the calls, and did not provide language availability at VITA sites nearly 60 percent of the time.⁴⁸ This shows that the IRS is failing to assist taxpayers by not giving them the information to determine whether services are actually available. The IRS also may not have all the current information about each VITA site. This failure is significant because the IRS is using VITA and TCE as the primary points of face-to-face return preparation.

Tax Software the IRS Provides to VITA/TCE Organizations Contains an Embedded Commercial Debit Card Product that Imposes Costly Fees.

The private sector plays an important role in tax administration, but there is a need for greater standardization and control over the content of commercial tax software for consistency, and to avoid potential conflicts of interest. In the 2011 filing season, almost all of the roughly 12,000 VITA and TCE sites offered debit cards to taxpayers with refunds.⁴⁹ Although the IRS claims that it does not endorse any one commercial product over another, the software it provides to VITA and TCE sites -- CCH TaxWise -- contains an embedded Western Union product that charges fees for using the debit cards used to issue refunds (e.g., for ATM cash withdrawals) that are higher than the fees charged by some of its competitors.⁵⁰

The National Taxpayer Advocate raised this issue in her 2011 Annual Report to Congress. However, the IRS has not taken action to protect taxpayers. The incorporation of the Western Union Money Wise prepaid card in the TaxWise software the IRS provides to VITA and TEC sites free of charge creates an unfair advantage, and essentially represents an indirect endorsement of this product by the IRS. When the National Taxpayer Advocate first raised the issue, the IRS represented that the debit card feature had not been incorporated into the software at the time the IRS entered into the contract with CCH. The National Taxpayer Advocate urged the IRS to eliminate all references to the commercial product in the TaxWise software, but CCH has yet to remove the product. The TaxWise monthly activity report the IRS receives from CCH has revealed that over 4,000 taxpayers using VITA have purchased the product. The National Taxpayer Advocate, again, urges the IRS to avoid any appearance of a conflict of interest by renegotiating the contract agreement with CCH and demanding that CCH remove the Western Union product from TaxWise.⁵¹

CONCLUSION

The National Taxpayer Advocate preliminarily recommends that the IRS:

• Develop a government-provided electronic version of the Form 1040 that allows taxpayers to e-file all 1040 series forms and schedules, with computational capability and with links to forms, instructions, related worksheets, and publications.

• Develop a portal to a government-controlled database from which taxpayers can import third-party data.

• Allow taxpayers to make appointments for return preparation, and accommodate walk-in customers.

• Accelerate the deployment of FSA terminals to TACs, and encourage more VITA and TCE sites to use them.

• Reassess procedures for maintaining VITA site information and for ensuring assistors provide the information callers need to access services, and implement measures to improve accuracy.

• Renegotiate the contract with CCH to remove the Western Union debit card product from the TaxWise software, and solicit competitive bids for a debit card product.

The IRS supports the goal of ensuring no-cost filing alternatives for taxpayers in need of such services to meet their filing obligations. The IRS does this in many different ways. In a limited fashion, the IRS is able to provide these services directly in its Taxpayer Assistance Centers. The IRS has added Facilitated Self-Assistance to many TAC locations to further support taxpayers and is piloting Virtual Service Delivery. The IRS is able to support a greater number of taxpayers through its partnerships with VITA sites and TCE sites. To expand free self-return preparation access to the more than 16 million taxpayers who qualify for free tax preparation services, the IRS developed and implemented its FY 2013 Alternative Filing Strategy which includes a "You Choose" model where partners and taxpayers select between eight vendors to deliver free self tax preparation services at a virtual or physical location. The IRS continually evaluates these methods and emerging ideas for providing low-income taxpayers with no cost alternatives for meeting their tax return filing obligations.

TACs. Delivering excellent customer service is a priority of the IRS. The TACs are one of the vital resources available to taxpayers. TAC assistors provide a variety of services to taxpayers who visit the 397 TAC locations throughout the country. The TAC program provides face-to-face assistance to taxpayers who cannot resolve their problem over the telephone or through correspondence, need a document issued to them in a reasonable period of time, or prefer face-to-face contact. In FY 2012, this type of live assistance was provided to seven million taxpayers.

As noted above, the IRS is able to provide these free tax preparation services for a limited number of taxpayers directly in its TACs. Specifically, TAC sites prepare tax returns for walk-in clients several days per week throughout the year on a first-come, first-served basis. Appointments are available to taxpayers with special needs, such as those with disabilities, at the discretion of local TAC management, although return preparation is generally offered on a first-come, first-served basis each day until capacity is reached. The IRS has concluded that the scheduling of appointments for return preparation would reduce resources available to provide services to taxpayers who are awaiting other services that only the IRS can provide.

FSA. As also noted above, the IRS has added FSA to many TAC locations to further support taxpayers and is piloting VSD. FSA is a new approach that incorporates tax education into the tax preparation process. Certified volunteers assist taxpayers in preparing their own returns. Since the role of the volunteer is that of a teacher or facilitator, multiple taxpayers can be assisted simultaneously. In a limited resource environment, this model can provide expanded access to additional taxpayers at minimal cost to the IRS. For FY 2012, all 50 states will have access to software for an FSA site. The IRS has developed a partnership with the Department of Education to promote and provide outreach to an estimated four million college students, parents, and educators on FSA. Additionally, the IRS is collaborating with other federal agencies, the military, and educational and faith-based institutions to promote FSA. The targeted audience is for taxpayers that meet VITA requirements but cannot access a traditional site or do not need one-on-one assistance. This year, more than 210 employees have been trained on all aspects of FSA to ensure successful implementation. The additional trained staff allows IRS to provide more hands-on guidance to taxpayers and partners as they use the new tools at alternative filing sites. The IRS will continue to seek funding to expand FSAs to additional TACs.

VSD. During FY 2012, the IRS completed the VSD pilot in the TACs, and it was deemed successful serving almost 17,000 taxpayers through the end of September. The report showed that the vast majority (87 percent) of taxpayers using VSD reported that they received resolution for their main issue. An even larger number of respondents (91 percent) reported that they would be willing to use video assistance again during a future visit. The IRS will be expanding the VSD program in FY 2013. Planning is underway to deploy virtual service in six TACs and six partner sites for the 2013 filing season.

Referral to VITA/TCE. When TAC assistors are unavailable to prepare returns during the days offered and FSA or VSD do not meet sufficiently the needs of a taxpayer, TAC employees will educate that taxpayer on all other free filing options. These options include directing taxpayers to local IRS-sponsored VITA sites or TCE sites and to other available free electronic filing options (IRS Free File and IRS Free Fillable Forms) that could possibly reduce their time waiting for return preparation services in TACs. Many VITA and TCE sites receive grants from the IRS to prepare returns with the low-income, elderly, disabled, and those that speak limited English, with some open year-round.

The IRS has reassessed procedures for maintaining VITA site information and for ensuring assistors provide the information callers need to access services, and implement measures to improve accuracy. In 2012, the IRS released the VITA locator available on IRS.gov. This tool, which has been shared with IRS phone assistors, allows assistors and taxpayers to locate available VITA sites within the taxpayer's community. External VITA and TCE partners share data with the IRS concerning the availability of their sites during and after the filing season. This ensures that site information such as locations and hours of operation are timely updated on the IRS.gov VITA Site Locator, a new online tool that allows assistors and taxpayers to locate available VITA sites within the taxpayer community. The tool is updated twice per week to ensure that new information is recorded in a timely manner. Providing this information informs taxpayers regarding free tax preparation services available in their respective communities.

For many years, IRS has partnered and financially supported the development of VITA and TCE sites around the country to ensure that there are sufficient no cost tax preparation services. In these settings, the IRS trains volunteers who become certified to prepare taxpayer returns in face-to-face meetings using a standard intake sheet, interview and quality review process. Last year, VITA and TCE volunteers prepared returns with a 92 percent rate of accuracy. Recently, we have developed, through the expanded use of technology, Virtual VITA and TCE, which functions in the same manner except that modern technology is used to connect the volunteer and the taxpayer in lieu of an in person meeting. Technology typically includes broadband Internet, fax, and video conference. Although this may be more necessary in remote locations where it is difficult to find a traditional VITA/TCE site, the approach can also be expanded in urban settings to supplement traditional VITA/TCE assistance.

With respect to the Western Union debit card product from the TaxWise software, we do not endorse any commercial financial product offered by VITA/TCE partners. As we noted in last year's Annual Report, TaxWise did not include a debt card feature at the time the IRS entered into a software contract with this provider. The debit card feature will not be available for use during the TY 2012 filing season. The new 2014 contract will also include a prohibition on offering a debit card product in software purchased by the IRS.

Finally, and very importantly, the IRS has never denied service to any disaster area or directed volunteers to discontinue tax preparation services in a disaster area. The MSP incorrectly asserts that "IRS directed VITA sites not to handle returns for taxpayers in the region where Hurricane Katrina struck, presumably because it believed the returns would be too complex for volunteers to prepare accurately." The IRS firmly believes that VITA and TCE sites offered tax preparation service to Katrina victims and should and will continue to provide such services to any qualifying taxpayer within the scope of the VITA/TCE program, regardless of location.

Free File Alliance. The IRS provides Free File Fillable Forms (FFFF) through its public partnership with the Free File Alliance. The Free File program supports 70 percent of taxpayers using an income threshold to ensure that this goal is achieved. No member of the Free File Alliance is allowed to make its free offer available to more than 50 percent of this population to promote and ensure adequate market competition among the members of the Free File Alliance. The Free File Alliance ensures that there is at least one offer listed on IRS.gov for eligible taxpayers to file their return. There are no gaps in coverage for qualified taxpayers. Free File Fillable Forms, which is accessed from IRS.gov, represents an electronic version of the paper Form 1040. IRS publications and instructions are included with the FFFF program.

The IRS provides a government-provided electronic version of the Form 1040 through its public and private partnership with the Free File Alliance. IRS publications and instructions are included with the Free File Fillable Forms program. As currently developed, there is no cost to the federal government for software development and maintenance.

In 1998, Congress recommended in Public Law 105-206 that the IRS cooperate with and encourage the private sector by encouraging competition to increase electronic filing of such returns. In 2003, the Treasury Department issued Report on Return Free Tax Systems: Tax Simplification is a Prerequisite as requested under the 1998 statute. The report found "that moving to a return-free tax system without first simplifying the income tax code would require substantive changes in tax administration. Added burden would be placed on employers and other payers of income who would be required to accelerate reporting of W-2s and 1099s, and the IRS and SSA would have to speed up the processing and editing of these income reporting documents to avoid significant delays in refunds."

In April 2007, the GAO published the report, Taxpayer Services State Experiences Indicate IRS Would Face Challenges Developing an Internet Filing System with Net Benefits. The study reported that states with direct state filing systems showed low usage.

The development, delivery, and support of software to a broad market is already in place in the private industry. In 2012, IRS reached a milestone of achieving the 80 percent e-file objective for 1040 returns through its strong partnership with private industry.

With respect to the concerns expressed regarding Free File, taxpayers give Free File high customer satisfaction ratings. According to a 2009 survey by Russell Research, 95 percent of taxpayers using Free File intended to use the program the following year. Ninety-eight percent would recommend Free File to others, and 96 percent would recommend Free File Fillable Forms to others. Also, according to Russell Customer Satisfaction survey, 97 percent of those surveyed found the process of selecting a free file company either Very Easy or Somewhat Easy. In 2012, IRS took additional steps to simplify the offers by making the information easier to understand. Additionally, taxpayers may find the company that works best for them by selecting the IRS created interactive tool, Help me choose a company at www.IRS.gov/freefile. By answering a few simple questions, the application narrows the number of companies available to meet that taxpayer's needs.

In addition, there are a number of examples where the Free File Alliance has stepped up to meet urgent requests of IRS and the needs of the American taxpayer as a result of late-passed congressional tax legislation.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS recognizes the need for no-cost filing alternatives to improve voluntary filing compliance, and that TAC sites should make it a priority to deliver excellent customer service. We agree that the TACs play a vital role helping the low and middle-income taxpayers who prefer to visit the IRS in person to satisfy their filing obligations. We commend the IRS for the inroads it is making in using Facilitated Self-Assistance to encourage and assist taxpayers who seek to become more self-reliant, by integrating tax education with return preparation assistance. We are encouraged by the Virtual Service Delivery pilot program and commend the IRS for making the software accessible in all 50 states in FY 2012. We also hope to see the IRS realize VSD's full potential in bridging the geographical divide that now prevents taxpayers in outlying rural areas from accessing the free services they need, by using it to increase direct return preparation assistance at TACs and volunteer sites in 2013.

However, the National Taxpayer Advocate is disappointed that the IRS has concluded it cannot afford to schedule appointments at the TACs for taxpayers who ask the IRS for help in preparing their returns. The IRS says it has chosen to serve only a limited number of taxpayers because to do otherwise would reduce the resources available for taxpayers who need "other" services that "only the IRS can provide." The implication here seems to be that delinquent taxpayers with balance due accounts and taxpayers who have not filed delinquent returns are more important than those who are trying to remain compliant. We understand the IRS is struggling to reach as many taxpayers as it can, with limited resources, and that "in extreme or emergency circumstances, Group Managers will have the discretion to authorize the preparation of returns."⁵² However, we believe this approach is shortsighted and counterproductive, and that a better approach would be to allocate more resources to helping compliant taxpayers prepare their returns, by providing appointments for those who request them, and by offering return preparation to walk-in taxpayers. Improving both customer service and enforcement is essential to achieving a high rate of compliance. We continue to believe that assisting taxpayers who seek help computing their tax liabilities and preparing their returns should be a central component of taxpayer service and that the IRS needs to do more to satisfy the needs of these taxpayers.

The IRS contends that it has reassessed the procedures for maintaining VITA site information, and for ensuring that its telephone assistors provide callers the information they need to access VITA services. The National Taxpayer Advocate is pleased that the IRS has installed a new online locator tool (which the IRS indicates is updated twice weekly) that allows taxpayers and assistors to find VITA sites in their communities, and that VITA and TCE volunteers prepared returns with a 92 percent accuracy rate during the 2012 filing season.⁵³ However, we remain concerned that the IRS has elected not to address the findings from TAS's own evaluation of the services provided by telephone assistors, which revealed that in 2012 assistors failed to provide site accessibility information in 90 percent of the calls, and failed to provide language availability at VITA sites nearly 60 percent of the time.⁵⁴ We believe that while updating the locator on the IRS website is critical, it is not enough. Assistors responding to callers must convey the site information as well and, therefore, it seems clear they are not using the new locator tool correctly. The IRS should make it a requirement to use the locator, and should perform quality reviews, including checking the contact recordings, to make certain assistors are providing complete and correct information. The IRS has not addressed this failure in its response.

The National Taxpayer Advocate is pleased that the IRS plans to adopt the recommendation we made in the 2011 Annual Report to remove the Western Union debit card product from its TaxWise software. We applaud the IRS for this step and look forward to reviewing the TY 2012 software and 2014 licensing agreement.

The IRS asserts that it has never denied service to any disaster area or directed volunteers to discontinue tax preparation services in a disaster area, and that it ". . . firmly believes that VITA and TCE sites offered tax preparation service to Katrina victims and should and will continue to provide such services to any qualifying taxpayer within the scope of the VITA/TCE program, regardless of location." As we have reported, when the National Taxpayer Advocate testified before Congress, in April of 2006, she stated "The IRS must remain open for business to taxpayers who seek assistance from the government in preparing their returns," noting, ". . . the IRS directed VITA sites not to prepare returns in the zone where Hurricane Katrina struck, presumably because it believed the returns would be too complex for volunteers to prepare accurately." In late 2005, the IRS reported that it had contemplated working casualty losses at its volunteer sites, but the complexity of the law in this area posed a significant risk to the quality of services that volunteer preparers could provide, and that they would not complete these returns (i.e., "Casualty losses are out of scope for the entire VITA program.").⁵⁵

The IRS contends that it provides an electronic version of Form 1040 through its agreement with the Free File Alliance (i.e. Free File and Free Fillable Forms), and that there are no gaps in this delivery system for "qualified" taxpayers. However, we believe the existing system needs improvement. It does not support electronic filing for all forms and schedules in the 1040 series, does not leverage the computational capability of today's computers, with fillable worksheets that could transfer computations to the fillable forms, and is not currently available to 100 percent of U.S. taxpayers. As we explained in the report, and as the National Taxpayer Advocate stated in her 2006 testimony, the government should make it possible for all taxpayers -- not just "qualified" taxpayers -- to file their returns electronically without having to pay a fee.⁵⁶ If the IRS developed a government-provided electronic version of the Form 1040 -- that would allow taxpayers to e-file any of the 1040 series forms and schedules, with computational capability and with links to forms, instructions, worksheets, and publications -- all individual taxpayers could prepare and e-file their returns for free.

Finally, the IRS asserts that, in 1998, Congress recommended that it cooperate with the private sector, and encourage competition to increase electronic filing, and that moving to a return free tax system without first simplifying the tax code would require substantive changes in tax administration. However, the National Taxpayer Advocate would point out that, at the same time, in the same law, Congress required the IRS to develop a return free tax system. Moreover, given that we are now discussing the need for accelerated, real-time, tax information for fraud prevention, as well as for improved accuracy, the National Taxpayer Advocate believes the IRS has presented a feeble, archaic, response, one grounded in 20th Century tax administration and technology.

Recommendations

In conclusion, the National Taxpayer Advocate recommends that the IRS:

² TAS, VITA Site Survey (April 2012).

³ Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 98), Pub. L. No. 105-206 title II, § 2004, Pub. L. No. 105-206 title II, 112 Stat. 726 (Jul. 22, 1998).

⁴ In 2006, the Organization for Economic Cooperation and Development (OECD) studied the following countries that use prepopulated returns: Denmark, Estonia, Finland, Iceland, Norway, Sweden, Chile, and Spain. See OECD, Forum on Tax Administration: Using Third Party Information Reports to Assist Taxpayers Meet their Return Filing Obligations -- Country Experiences With the Use of Pre-Populated Returns 4-5, 13 (Mar. 2006).

⁵See id; see also General Accounting Office (GAO, now the Government Accountability Office), GAO/GGD-97-6, Tax Administration: Alternative Filing System 1, 4 (Oct. 1996).

⁶ These figures are based on tax year 1992 data. Since then, millions more taxpayers have become eligible for certain refundable credits (e.g., Earned Income Tax Credit, Additional Child Tax Credit) and must file returns. See GAO, GAO/GGD-97-6, Tax Administration: Alternative Filing System 2, 4, 8, 11, 20 (Oct 1996).

⁷Id. at 41-42 (Oct 1996).

⁸ TAS Research, Compliance Data Warehouse, IRTF_F1040 table, data (Drawn Oct. 17, 2012). See also, IRS, Field Assistance E-File Report (April 2012); National Taxpayer Advocate FY 2012 Objectives Report to Congress 44. For an in-depth discussion of TAC Operations, see Most Serious Problem: The IRS Lacks a Servicewide Strategy That Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra/supra.

⁹ "A full-fledged and vastly expanded program of taxpayer assistance in the preparation of returns would drastically reduce audit requirements and in the long run be projective of substantially increased revenue." See Jt. Comm. on Int. Rev. Tax'n, INVESTIGATION OF THE BUREAU OF INT. REV. 37 (Washington, DC: Gov't Printing Office, 1948).

¹⁰ OECD, Forum on Tax Administration: Taxpayer Service Sub-group, Survey of Trends and Development in the Use of Electronic Services for Taxpayer Service Delivery 12 (Mar. 2010).

¹¹ TAS Research, Compliance Data Warehouse, ITRF_F1040 Table, data includes returns filed through September 2012, data drawn (Nov. 6, 2012). For tax year 2010, there were 80.1 million preparer-prepared returns, 58.4 self-prepared returns, and 3.1 million VITA/TCE-prepared returns, totaling 141.6 million returns.

¹² TAS Research, Compliance Data Warehouse, ITRF_F1040 Table, data drawn (Nov. 6, 2012). During the 2012 filing season (tax year 2011), approximately 84 percent of individuals e-filed their returns and 16 percent filed paper returns. TAS Research, Compliance Data Warehouse, ITRF_Entity Table, data drawn (Nov. 6, 2012). Of the more than 3.5 million individuals who used the IRS's E-file with Free File Programs in 2012, 3.1 million taxpayers used IRS Free File, and 475,000 taxpayers used IRS Free Fillable Forms. IRS TAC sites transmitted slightly more than 100,000 returns. IRS, Field Assistance E-File Report (Nov. 2012). More than 21 million taxpayers filed paper returns, and roughly 62 percent of those taxpayers used tax preparation software but then mailed their returns instead of filing electronically (the IRS refers to these as V-Coded returns). TAS Research, Compliance Data Warehouse, IRTF_Entity Table, data drawn (Nov. 7, 2012).

¹³ IRM 21.3.4.10.2 (Apr. 18, 2012). GAO, GAO-08-38, Tax Administration, 2007 Filing Season Continues Trend of Improvement, but Opportunities to Reduce Costs and Increase Tax Compliance Should be Evaluated Highlights (Nov. 2007).

¹⁴ IRS response to TAS information request, item 5 (Jul. 19, 2012). In 2012, the IRS reported it had 63,222 VITA volunteers and 35,662 TCE volunteers.

¹⁵ IRS Free File, available at http://www.irs.gov/uac/Free-File:-Do-Your-Federal-Taxes-for-Free (last visited Nov. 8, 2012); IRS, Advancing E-File Study Phase 2 Report Executive Summary: An Examination of Options to Increase Electronic Filing of Individual Returns 14 (Dec. 15, 2010).

¹⁶See http://www.irs.gov/uac/Free-File%3A-Do-Your-Federal-Taxes-for-Free (last visited Oct. 17, 2012).

¹⁷ For a list of forms supported by all Free File companies see, http://www.irs.gov/uac/Free-File--Most-Commonly-Filed-Federal-Forms-are-Available (last visited Oct. 16, 2012).

¹⁸See http://www.irs.gov/uac/List-of-Available-Free-File-Fillable-Forms (last Visited October 16, 2012).

¹⁹ In 2012, taxpayers could not e-file returns using Free Fillable Forms if they were required to file any unsupported forms and schedules (e.g., Form 8283, Noncash Charitable Contributions, when taxpayers must file Form 8283 with Form 1098C, Contributions of Motor Vehicles, Boats, and Airplanes; Forms W-2 or 1099 with a foreign address; and Schedule D, Capital Gains and Losses with Expired or Worthless Securities). Form 8839, Qualified Adoption Expenses, currently is not supported by Modernized e-File (MeF); Form 8453, U.S. Individual Income Tax Transmittal for and IRS e-file Return is a Legacy e-file system (ELF) form, which is not supported by MeF. Beginning with TY 2012 (filing season 2013), Free File Fillable Forms is expected to support Forms 1040 with a foreign address. See IRS response to TAS 7-day check for factual inaccuracies, Item 10 (Nov. 21 2012); Free File Fillable Forms FAQs & Limitations 1-2, 4 (April 6, 2012). See also IRS Free Fillable Forms and Limitations available at http://www.irs.gov/pub/irs-utl/2012_4f_faqs.pdf (last visited Oct. 16, 2012). See also IRS Report to Congress, Progress on the Implementation of the Taxpayer Assistance Blueprint 39 (Oct. 2009). The IRS plans to update its FAQs to reflect the most recent changes.

²⁰ Some FFA companies do not offer free service to mature taxpayers (e.g., age 50+) or those under 19. Some impose a maximum AGI threshold of less than $57,000 (the FFA limit for tax year 2012), and some have a minimum AGI threshold, as well. Others use military service as an eligibility criterion, and some products do not support state returns, while vendors whose products do support state returns often charge extra. See Advancing E-File Study Phase 1 Report 18, 27, 124-125 (Sept. 30, 2008).

²¹ TAS's evaluation of 20 Free File Sites revealed that only seven sites supported the benefits available to Hurricane Katrina victims. As a result, taxpayers using sites that have not incorporated late-enacted tax provisions into their free file product may be unknowingly overpaying their taxes by not claiming the tax benefits Congress specifically created for them. See Tax Return Preparation Options: Hearing before the S. Comm. on Finance, 108th Cong. 12-16 (2006) (Statement of Nina E. Olson, National Taxpayer Advocate).

²² For more information on obtaining and using tax data in time for the tax filing season, see Most Serious Problem: The Preservation of Fundamental Taxpayer Rights is Critical As the IRS Develops a Real-Time Tax System, infra/supra; National Taxpayer Advocate 2011 Annual Report to Congress 288-290.

²³ Advancing E-File Study Phase 1 Report 18, 27, 124-125 (Sept. 30, 2008).

²⁴ GAO, GAO/GGD-97-6, Tax Administration: Alternative Filing System 1-3, 7, 8, 11, 13, 20, 41 (Oct 1996). Other countries use two alternative filing systems. In one, the "tax agency reconciliation system," the taxing authority prepares (or populates) the returns with information for the taxpayers. In the other type, the "return free" filing system, the taxpayer's income tax is withheld at the source and remitted to the taxing authority. It is also referred to as a "final withholding" filing system. Department of Treasury Report to Congress, Return-Free Tax Systems: Tax Simplification Is a Prerequisite 15 (Dec. 2003). For a discussion of electronic access to real-time transcript data and downloading third party data into an electronic return, see Most Serious Problem: The Preservation of Fundamental Taxpayer Rights is Critical As the IRS Develops a Real Time Tax System, infra/supra. See also National Taxpayer Advocate 2004 Annual Report to Congress 471-477 (Key Legislative Recommendation: Free Electronic Filing for All Taxpayers); National Taxpayer Advocate 2009 Annual Report to Congress 338-345 (Key Legislative Recommendation: Direct the Treasury Department to Develop a Plan to Reverse the "Pay Refunds First, Verify Eligibility Later" Approach to Tax Return Processing).

²⁵ GAO, GAO/GGD-97-6, Tax Administration: Alternative Filing System 4 (Oct 1996); Department of Treasury Report to Congress, Return-Free Tax Systems: Tax Simplification Is a Prerequisite 7 (Dec. 2003).

²⁶ A voluntary tax agency reconciliation system is equivalent to a pre-populated return.

²⁷ GAO, GAO/GGD-97-6, Tax Administration: Alternative Filing System 4 (Oct 1996); Department of Treasury Report to Congress, Return-Free Tax Systems: Tax Simplification Is a Prerequisite 7 (Dec. 2003).

²⁸Id. at 2, 8, 20; Department of Treasury Report to Congress, Return-Free Tax Systems: Tax Simplification Is a Prerequisite 15 (Dec. 2003).

²⁹ RRA 98, Pub. L. No. 105-206 title II, § 2004, Pub. L. No. 105-206 title II, 112 Stat. 726 (Jul 22, 1998). See also OECD Forum on Tax Administration Taxpayer Services Subgroup, Survey of Trends and Developments in the Use of Electronic Services For Taxpayer Service Delivery 107 (Mar. 2010). If the IRS implemented an alternative tax system, such as the one taxpayers currently use in Spain, for example, U.S. taxpayers could opt for a pre-populated return by simply ticking a box on a government-provided electronic version of the Form 1040.

³⁰ RRA 98, Pub. L. No. 105-206 title II, § 2005, Pub. L. No. 105-206 title II, 112 Stat. 726 (Jul 22, 1998). National Taxpayer Advocate 2011 Annual Report to Congress 288-290. For a discussion of electronic access to real-time transcript data and downloading third party data into an electronic return, see Most Serious Problem: The Preservation of Fundamental Taxpayer Rights is Critical As the IRS Develops a Real-Time Tax System, infra/supra. See also National Taxpayer Advocate 2004 Annual Report to Congress 471-477 (Key Legislative Recommendation: Free Electronic Filing for All Taxpayers).

³¹ For a discussion of online services, see Most Serious Problem: The IRS is Striving to Meet Taxpayers' Increasing Demand for Online Services, Yet More Needs to be Done, infra/supra.

³² SPEC FY 2012 Program Guide 1; IRS, Field Assistance, Taxpayer Assistance Centers (TAC) Services, 2012 Post Filling Season (Apr. 18, 2012). http://win.web.irs.gov/field/fadocs/TAC_Services_Post_Filing_Season_2012.pdf (last visited Aug. 8, 2012); See also, GAO-8-38, 2007, Filing Season Continues Trend of Improvement, but Opportunities to Reduce Cost and Increase Compliance Should be Evaluated 27-28 (Nov. 2007).

³³ For an in-depth discussion of TAC operations, see Most Serious Problem: The IRS Lacks a Servicewide Strategy that Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra/supra. For an in-depth discussion of SPEC and Stakeholder Liaison, see Most Serious Problem: The IRS is Substantially Reducing Both the Amount and Scope of its direct Education and Outreach to Taxpayers and Does Not Measure the Effectiveness of its Remaining Outreach Thereby Risking Increased Noncompliance, infra/supra. For more information on obtaining and using tax data in time for the tax filing season, see Most Serious Problem: The Preservation of Fundamental Taxpayer Rights is Critical As the IRS Develops a Real-Time Tax System, infra/supra.

³⁴ TAS Research, Compliance Data Warehouse, IRTF_F1040 table, FY 2010-2012, data drawn (Nov. 2, 2012), and IRS, Field Assistance E-File Reports (April 2010-2012). The IRS defines TAC eligible taxpayers as individuals filing Form 1040 series returns with AGI of $50,000 dollars or less. For an in-depth discussion of TAC Operations, see Most Serious Problem: The IRS Lacks a Servicewide Strategy That Identifies Effective and Efficient Means of Delivering Face-to-Face Taxpayer Services, infra/supra.

³⁵ IRM 21.3.4.10.2 (Apr. 18, 2012); IRM 22.30.1.5.1.1 (Oct. 1, 2011) available at http://win.web.irs.gov/field/fadocs/TAC_Services_Post_Filing_Season_2012.pdf (last visited July 25, 2012). VITA offers free return preparation and e-filing services to individuals with low-to-moderate income, seniors, Native Americans, individuals with disabilities, and those with limited proficiency in English. IRM 22.30.1.3.1 (Oct. 1, 2011). The IRS defines taxpayers as low to moderate income by reference to the threshold for claiming the Earned Income Tax Credit (i.e., those with total income of $50,000, or less). See IRM 21.3.4.10.2 (Apr. 18, 2012). TCE authorizes the IRS to distribute grants under a cooperative agreement with eligible organizations that provide no-cost tax assistance to elderly taxpayers age 60 or older. Section 163, Revenue Act of 1978, Public Law No. 95-600, 92 Stat. 2810 (Nov. 6, 1978). See also IRM 22.30.1.3.1.3 (Oct. 1, 2011). For an in-depth discussion of SPEC and Stakeholder Liaison, see Most Serious Problem: The IRS is Substantially Reducing Both the Amount and Scope of its direct Education and Outreach to Taxpayers and Does Not Measure the Effectiveness of its Remaining Out-reach Thereby Risking Increased Noncompliance, infra/supra.

³⁶ IRM 21.3.4.10.2 (Apr. 18, 2012). See IRS, Field Assistance TAC Services, 2012 Post Filing Season (Apr. 18, 2012). See http://win.web.irs.gov/field/fadocs/TAC_Services_Post_Filing_Season_2012.pdf (last visited Sept. 14, 2012).

³⁷ IRS Free File, Alternative Filing Methods (FAST and Alternative VITA/TCE Site Model) 8 (Aug 3, 2011). As of October 30, 2012, FFA offers services to 22 states that have cooperative free file programs. It also offers services to seven states that do not have a state income tax. See IRS response to TAS 7-day check for factual inaccuracies, Item 10 (Nov. 21 2012).

³⁸ IRM 22.30.1.3.1.1.1 (Oct. 1, 2011); IRS Publication 4671, VITA, Program Overview and Requirements 3; SPEC, FY 2012 Program Guide 7. In FY 2012, the IRS expanded FSA capability to all 50 states. In FY 2011, taxpayers prepared more than 4,000 returns at over 100 sites. See IRS, Annual Report to Congress: Progress on the Implementation of The Taxpayer Assistance Blueprint 20-21 (Mar. 14, 2012). IRS Response to TAS Request for Information, Item 7 (Jul. 19, 2012).

³⁹ SPEC FY 2012 Program Guide 6.

⁴⁰ IRS response to TAS information request, item 7 (June 19, 2012). In 2011, approximately 400 sites applied for Site Identification Numbers (SIDN), with 106 sites reporting 4,200 self-prepared returns. In 2012, approximately 1,000 sites applied for SIDNs, with 504 sites filing 10,586 self-prepared returns.

⁴¹ GAO-12-176, 2011 Processing Gains, but Taxpayer Assistance Could Be Enhanced by More Self Service Tools 18 (Dec. 2011).

⁴² IRS Publication 4907, IRS Freefile Introduces Free Assisted Self-Service Tax Preparation (Dec. 2010).

⁴³ For an in-depth discussion of TAC operations, see Most Serious Problem: The IRS Lacks a Serivcewide Strategy that Identifies Effective and Efficient Maens of Delivering Face-to-Face Taxpayer Services, infra/supra.

⁴⁴Tax Return Preparation Options: Hearing Before the S. Comm. on Finance, 108th Cong. 5 (2006) (Statement of Nina E. Olson, National Taxpayer Advocate).

⁴⁵ SPEC FY 2012 Program Guide 3.

⁴⁶ TIGTA, Ref. No. 2006-40-004, Significant Improvements Have Been Made in the Oversight of the Volunteer Income tax Assistance Program, but Continued Effort Is Needed to Ensure the Accuracy of Services Provided 3, 17, 22 (Nov. 2005).

⁴⁷ TIGTA Ref. No. 2006-40-125, Oversight and Accuracy of Tax Returns Continue to Be Problems for the Volunteer Income Tax Assistance Program 18, 21 (Aug. 31. 2006).

⁴⁸ TAS, VITA Site Survey (April 2012). TAS made 398 calls to the VITA Assistance Line from mid-March to mid-April, 2012. We recorded how long assistors took to answer calls, and whether they provided complete and accurate VITA site information (e.g., nearest site location, days and hours of operation, site accessibility information for taxpayers with disabilities, foreign language services for taxpayers with limited proficiency in English, etc.). The survey results are statistically valid for the timeframe sampled at a 95 percent confidence level, and a margin of error no greater than +/- 4.86 percent.

⁴⁹ GAO-11-481, 2011, Tax Filing: IRS Dealt with Challenges to Date but Needs Additional Authority to Verify Compliance 31 (March 2011).

⁵⁰See IRS response to TAS information request, Item 12 (June 19, 2012). The IRS does not require VITA/TEC sites to use the software it provides (TaxWise); however, it prohibits VITA/TCE grant recipients from using grant funds to purchase other commercial tax software. See also IRS response to TAS 7-day check for factual inaccuracies, Item 18 -- Prepaid Card Comparison (Nov. 21 2012).

⁵¹ National Taxpayer Advocate 2011 Annual Report to Congress 405, 410, 413, 417-418. For a detailed discussion of the debit cards, see Most Serious Problem: A Proactive Approach to Developing a Government-Issued Debit Card to Receive Tax Refunds Will Benefit Unbanked Taxpayers, infra/supra.

⁵² FY 2012 Return Preparation in Taxpayer Assistance Centers (TACs), Field Assistance 6 (Jan. 23, 2012).

⁵³ TIGTA, Ref. No. 2012-40-088. Ensuring the Quality Review Process Is Consistently Followed Remains a Problem for the Volunteer Program: Highlights 1 (July 27, 2012).

⁵⁴ TAS, VITA Site Survey (April 2012).

⁵⁵Tax Return Preparation Options: Hearing Before the S. Comm. on Finance, 108th Cong. 5 (2006) (Statement of Nina E. Olson, National Taxpayer Advocate); Hurricane Katrina National Partner Conference Call, Speaker Notes 4 (Nov. 29, 2005); SPEC Nationwide Hurricane Katrina Conference Call, Minutes 3 (Oct. 26, 2005); Alert: AM IMF/BMF 07057, Scheduling pro-bono assistance for taxpayers affected by Hurricanes Katrina, Rita and Wilma (Nov. 22, 2007). The IRS reported that it would no longer be taking referrals for scheduling pro bono assistance due to Hurricanes Katrina, Rita, and Wilma, noting that all VITA sites have closed with the passing of the October 16 extension deadline. CARE no longer has the ability to refer these requests to the practitioner community. "If taxpayers or their representatives request assistance, please advise them this assistance is no longer available."

⁵⁶Tax Return Preparation Options: Hearing Before the S. Comm. on Finance, 108th Cong. 2 (2006) (Statement of Nina E. Olson, National Taxpayer Advocate).

Rajive Mathur, Office of Online Services

DEFINITION OF PROBLEM

Taxpayers increasingly use online services to perform a variety of tasks in their daily lives, including financial transactions. Surveys show that the average U.S. taxpayer spends approximately 15.5 hours per week using the Internet.¹ In addition, approximately 30 percent of U.S. taxpayers use mobile Internet services for advanced activities, including mobile banking, at least monthly.²

The IRS is striving to meet this growing demand by creating more online products. The Office of Online Services (OLS) is responsible for developing technology for taxpayers, practitioners, and IRS employees across a variety of channels, including the traditional web, mobile technology, and social media. We commend the IRS for establishing this office, which has a clear mission with a research-based strategy to meet taxpayer demand in incremental steps.³ The organization has had success with the development and enhancement of several taxpayer assistance applications, including IRS.gov, various calculator tools, and other popular applications such as "Where's My Refund."⁴

We applaud the IRS, specifically the Office of Online Services, for the development of popular self-assistance tools as well as a research-based strategy to meet the needs of taxpayers and tax administration. However, we believe the IRS still has a long way to go to provide taxpayers with the types of services they demand and are accustomed to receiving from other sources. For example, the IRS would benefit from an online account access program that would initially allow taxpayers to view the status of their accounts and eventually enable them to interact directly with the IRS. While such projects involve upfront development and implementation costs, the IRS would realize savings in the short term from decreased call volume and in the long term from improved tax compliance and a reduction in costly enforcement contacts for basic issues.

ANALYSIS OF PROBLEM

Background

The Office of Online Services treats each current or potential service as a business. In consultation with the appropriate IRS function(s), OLS identifies the taxpayer demand, segments the audience, assesses the impact of the service on existing IRS processes, develops the design, priority, and a roadmap, creates a launch pad and marketing plan, and measures results.⁵ OLS has a five-year strategy to enable taxpayers to get everything they need online. Specifically, the strategy aims to allow taxpayers to do the following, launched in incremental steps over the next five years:

• Correspond with the IRS digitally, such as through secure messaging and live chat;

• Easily search for actionable information on basic tax questions through IRS.gov;

• Access all online services through mobile technology;

• Make all payments online;

• Access account-related information, such as viewing transcripts and tracking amended return status, through online self-service tools;

• Manage all tax forms electronically; and

• Leverage third-party tools.

Time Homebuyer Credit Account Look-up;⁹ Mobile m.irs.gov;¹⁰ and IRS2Go Revision 2.¹¹ Other projects in various stages of development include:¹²

The IRS is Moving Toward the Vision of Electronic Service Delivery Set Forth in the Taxpayer Assistance Blueprint.

In response to a congressional mandate in 2005, the IRS delivered to Congress in 2007 the Taxpayer Assistance Blueprint (TAB) Phase 2 report, a five-year strategic plan for improving taxpayer services. The Taxpayer Assistance Blueprint team conducted extensive research on the needs, preferences, and behaviors of individual taxpayers. The data indicated that individual taxpayers generally prefer self-assisted services, such as those found on the IRS website, for transactional tasks. However, the data also showed that taxpayers preferred assisted services, such as those available on the telephone or in-person at Taxpayer Assistance Centers (TACs), for more complex interactive tasks like responding to a notice. Telephone and Internet service channels accounted for more than 85 percent of all taxpayer contacts with the IRS, especially with respect to tax refund account inquiries and responses to notices. Thus, the TAB envisioned an IRS that is an "interactive and fully integrated, online tax administration agency" with the capability "for any exchange or transaction that currently occurs face-to-face, over the phone, or in writing to be completed electronically."²¹

In a 2011 follow-up survey (the TAB Conjoint Update), participants clearly preferred to use the website, either browsing or using an interactive tool, for each of the following needs:

The IRS Can Learn from the Electronic Service Delivery Experiences of Other International Revenue Bodies.

A 2009 survey conducted by the Centre for Tax Policy and Administration of the Organization for Economic Co-Operation and Development (OECD) provided insights on overall trends, progress, and likely directions of revenue bodies around the world with respect to electronic services for taxpayers. Most of the surveyed revenue bodies gave primary emphasis in their plans to reducing taxpayer compliance burden, with improved operational efficiency as a clear secondary goal. In addition, a majority of those countries surveyed stated that their number one priority is increasing the range, quality, and take-up of their Internet-based services.²³ As compared to the last survey in 2004, the report found considerable progress in the provision of basic electronic tax transaction capabilities and access to personal taxpayer information.²⁴

Further, a 2012 OECD report provided the following recommendations on structuring smarter tax administrations:²⁵

Online Account Access and Management Would Reduce Taxpayer Burden.

In her 2009 Annual Report to Congress, the National Taxpayer Advocate urged the IRS to provide taxpayers with electronic access to their accounts, as recommended by the 2006 TAB Phase 2 Report.²⁶ Such access would allow taxpayers to monitor their accounts and potentially take the initiative to correct any perceived problems without the need for prompting by the IRS. In the past, the IRS attempted to develop an online customer account program called Internet Customer Account Services (ICAS), also known as My IRS Account Application (MIRSA). However, the IRS put the project on hold in 2009 for several reasons, including the need to first focus on portal and e-authentication strategies and the IRS's perception of low take-up rates for a similar program in Canada.²⁷

Despite the IRS's reasons for discontinuing MIRSA, the National Taxpayer Advocate recommended that the IRS continue to develop an online account program. If even a small percentage of taxpayers could detect and address account problems early in the process, they and the IRS would avoid more costly consequences. With a user-friendly interface, account access would also "demystify" the tax system for some taxpayers, leading more of them to take more ownership in the system when they see firsthand the results of their interactions with the agency. In addition, a taxpayer who receives a notice from the IRS could potentially fix the problem without hiring a paid practitioner.

The IRS response to the 2009 recommendation stated: "We believe that an online account capability may ultimately be part of a suite of services provided to taxpayers." However, the IRS then raised low take-up rates in similar applications developed by other countries and stated that e-authentication remained a barrier to development.²⁸

The National Taxpayer Advocate understands that the design and implementation of an online account access and management system is a complex undertaking. However, several countries have successfully developed different variations of these applications, which the IRS should further evaluate, then build on their lessons learned.²⁹ In addition, the TAB Conjoint Update clearly shows that taxpayers prefer to interact with the IRS online to check the status of transactions and find out more about IRS letters and notices.³⁰ Further, based on the plans provided by the Office of Online Services, the IRS is working toward a goal of electronic interaction with taxpayers, by developing a way for the parties to communicate and exchange documents electronically.³¹ We believe such a capability will reduce taxpayer burden and can serve as the first step toward online account management.

CONCLUSION

Both the IRS and taxpayers will benefit from the expansion of online self-service. Studies have shown that taxpayers are demanding online service channels at an increasing rate, while the OECD and its member countries have realized the benefits of prioritizing online service delivery. The IRS is moving forward with a strategy to improve IRS.gov as well as provide more self-assist applications. We applaud the IRS's progress but realize that it has a long way to go to reach the state envisioned by the TAB Phase 2: an "interactive and fully integrated, online tax administration agency" with the capability "for any exchange or transaction that currently occurs face-to-face, over the phone, or in writing to be completed electronically."³²

IRS COMMENTS

The IRS appreciates the report's recognition of our progress in the area of online services. We have made a number of significant improvements in this area and are working to make additional enhancements for the future.

In August 2012, the IRS took an important foundational step toward its future vision of improving web-based taxpayer service through the re-launch of IRS.gov with improved functionality. We migrated existing content and applications on the site to a more current operating platform that includes a content management system and portal display products. These critical tools give the IRS increased flexibility and control in the continuous updating of the site as well as the look and feel.

IRS.gov was redesigned so that navigation is mapped according to frequently used taxpayer activities (i.e., filing returns, paying taxes, checking refund status). These changes have made taxpayer experience more efficient and more meaningful. The IRS continuously monitors new data analysis and reporting tools to identify areas for modification and improvement. In a similar way, the home page and banner were updated to promote organizational goals such as improving e-Filing and PTIN application renewal. We are proud to report that IRS.gov received over 372 million visits, resulting in over 1.7 billion page views, in fiscal year 2012.

Also in 2012, the IRS developed and implemented a number of meaningful enhancements and applications which improved taxpayer service on IRS.gov, including the following:

The IRS continually stays aware of online service offerings of foreign and state administrations to identify those that might translate well and quickly to the IRS environment. We have reviewed the online service offerings of several foreign and state tax administrations. It is important to mention that the U.S. taxpayers are afforded important protections which may not exist in other areas. As a result, the best practices of other taxing entities may not always fit the needs of IRS's customers. We do consider these sources to be informative and will consider aspects of these services along with other IRS priorities in future online strategies. The IRS, along with its business and technology partners, will continue to research, develop, and implement new self-service transactional web applications to meet the continuously evolving needs of taxpayers.

The IRS recognizes the value in the delivery of account or account-like services to taxpayers and has taken some preliminary steps in that direction. Most notably, the IRS recently developed this type of account functionality in a limited way through discrete applications on the website through Where's My Refund and What Was My Stimulus Payment. Online account capability may ultimately be part of the suite of services provided to taxpayers. Nonetheless, security and resource challenges exist in full implementation of this goal. Authentication is key to any online service strategy. As the information or services provided and the transactions involved increase in terms of sensitivity, the level of certainty about the identity of the individual who has logged on to perform the tasks grows. While the IRS has simple forms of authentication for specific functions which do not contain highly sensitive data (Where's My Refund), our systems currently do not support more sophisticated forms of authentication that would be required to provide taxpayers with the ability to access and resolve account issues online.

While the IRS is working on developing these more challenging forms of authentication, it is important to note that we must be mindful that these types of authentication may restrict the willingness of taxpayers to use the service. For example, several other countries have found that taxpayers are much more likely to use a service if they can log on and use it immediately by providing some basic information or shared secrets. When the authentication requirements are more burdensome and cannot be completed in the same session, the uptick in taxpayer use falls dramatically. Even when taxpayers are willing to authenticate by waiting for a confirmatory code or PIN in the mail, recent experience suggests that taxpayers often allow these codes or PINs to lapse which results in additional work for the IRS and taxpayer to revalidate.

Moreover, evidence from foreign and state governments suggests that taxpayer online accounts may not enjoy the kind of usage associated with similar applications in the private sector, such as online banking. In fact, these examples, as well as the IRS's own limited experience, suggest much larger numbers of taxpayers may be served by simple, direct "utilities" that take care of specific activities taxpayers desire. An example of this might be an application that allows taxpayers to send "certified" copies of IRS transcripts to third parties (e.g., to mortgage or education lenders who need recent tax data). For these reasons, we agree that more research is needed on these issues as part of our larger assessment of e-services strategy.

These complexities underscore the need for the IRS to test and evaluate taxpayer reactions and make deliberate and thoughtful technology investment decisions with our finite resources. The IRS will continue to conduct data-driven analysis and build taxpayer-focused processes to develop online approaches and strategies that will serve the overall best interests of taxpayers.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends the IRS for its continued commitment to meeting the increasing taxpayer demand for online services. As discussed in detail in its response, the IRS has made significant progress in the development and enhancement of many online tools and applications to provide quality taxpayer service. We are particularly impressed with the researched-based strategy of the Office of Online Services to meet taxpayers' needs across a variety of service channels.

We understand the real obstacles facing the IRS in developing an online account program. Authentication for such a comprehensive service is much more difficult than that required for existing discrete online services. We also understand the burden imposed on taxpayers as they try to navigate complex authentication processes. However, we believe the IRS should continue to develop this program once it has overcome some of the authentication challenges through improvements in technology. Taxpayers will benefit substantially from being able to electronically monitor the status of their accounts and interact with the IRS to resolve their tax issues. While the stricter authentication may be annoying to taxpayers, it can also be reassuring. Over time, taxpayers will learn that gaining access to one's account online can be much better than sitting on the phone for 15 minutes only to get transferred to the wrong person.

Authenticated access to online accounts is only one step in the road to a comprehensive online presence. Once the taxpayer gains access to the actual site, his or her experience must be worthwhile. That is, the IRS must provide meaningful and useful content. To do this, the IRS needs to develop the in-house capability to present content.

Finally, the National Taxpayer Advocate is pleased that the IRS stays informed of the online services offered by domestic and foreign jurisdictions. We understand that the IRS must comply with strict requirements, especially with respect to privacy and security, which make it difficult to model our applications after those offered by other agencies. However, IRS technology continues to advance in this area and the IRS has committed in its response to work with industry partners to research and develop new applications to meet the continually evolving needs of taxpayers. Accordingly, we believe the IRS can strive to provide top-quality online service offerings as it learns from the experiences of other jurisdictions.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

²Id., Slide 36 (Dec. 22, 2011). In a more specific survey question, approximately 12 percent of U.S. taxpayers responded that they check financial accounts on their primary cell phone or handheld wireless device at least monthly. Forrester Research, The Taxpayer Advocate Service: Omnibus Analysis, From North American Technographics Omnibus Mail Survey, Q2 2011, Slide 38 (Dec. 22, 2011).

³ IRS Office of Online Services, IRS Online Strategy 7 (Sept. 2012).

⁴ A complete list of tools for individual taxpayers can be found at http://www.irs.gov/uac/Tools?portlet=105 (last visited Nov. 8, 2012).

⁵ IRS Online Services, Governance Kickoff 3 (Nov. 29, 2011).

⁶ Application enables individuals to order an account or return transcript online. The application's effectiveness and efficiency is limited by the fact that the transcript currently cannot be emailed to the taxpayer and instead must be mailed to the address on record for the taxpayer. See http://www.irs.gov/Individuals/Order-a-Transcript (last visited Dec. 21, 2012).

⁷ Where's My Refund was enhanced for Filing Season 2012. In general, the application enables taxpayer to check the status of a refund. See http://www.irs.gov/Refunds/Where's-My-Refund-It's-Quick,-Easy,-and-Secure (last visited Dec. 21, 2012).

⁸ The VITA Site Locator provides taxpayers with the location of a Volunteer Income Tax Assistance (VITA) or Tax Counseling for the Elderly (TCE) site within the stated parameters provided by the taxpayer. The tool provides address, phone number, languages spoken, hours, and appointment requirements. See http://irs.treasury.gov/freetaxprep/ (last visited Dec. 21, 2012).

⁹ The First-Time Homebuyer Credit Account Look-up application allows taxpayers to see the total credit received, the balance, amount repaid to date, and the annual installment repayment amount. See http://www.irs.gov/Individuals/First-Time-Homebuyer-Credit-Account-Look-up (last visited Nov. 8, 2012).

¹⁰ Mobile m.irs.gov enables taxpayers to use any mobile browser to access IRS.gov. IRS Online Services, Governance Kickoff 6 (Nov. 29, 2011).

¹¹ IRS2Go Revision 2 includes updates to the smartphone application that allows taxpayers to check refund status, order transcripts and get video updates. See IRS, New IRS2Go Offers Three More Features, available at http://www.irs.gov/uac/New-IRS2Go-Offers-Three-More-Features (last visited Nov. 8, 2012).

¹² IRS Online Services, Governance Kickoff (Nov. 29, 2011); IRS, Office of Online Services, IRS Online Strategy (Sept. 2012).

¹³ This enhancement of IRS.gov will enable taxpayers to access video on IRS.gov search results and will develop additional video content on IRS.gov to support high-traffic informational queries. IRS Online Services, Governance Kickoff 6 (Nov. 29, 2011).

¹⁴ This application will enable a taxpayer to check the status of an amended return filing. Id.

¹⁵ The application would allow an individual or business taxpayer to check their official name on record. Id.

¹⁶ This application would allow business taxpayers to file Forms 941 and 944 on IRS.gov and pay in one step. Id. at 6 (Nov. 29, 2011).

¹⁷ This application would allow taxpayers to easily make a payment on the IRS website using ACH Debit or debit cards. Id.

¹⁸ This is a basic interactive calculator to assist taxpayers in determining eligibility for an Offer in Compromise prior to calling a customer service representative. Id. While the National Taxpayer Advocate is generally supportive of this application, the devil is in the details. The success of this application depends on the IRS programming appropriate questions into the program, so that low income and middle income taxpayers, and small business taxpayers, are not discouraged from submitting an offer because the application projecting payment amounts that would be much lower if the taxpayer spoke to an IRS assistor.

¹⁹ This application would enable taxpayers and the IRS to interact electronically by communicating as well as sending and receiving documents. Id.

²⁰ IRS Publication 4579, 2007 Taxpayer Assistance Blueprint Phase 2, 44 (Apr. 2007), available at http://www.irs.gov/pub/irs-pdf/p4579.pdf (last visited Aug. 6, 2012).

²¹ IRS Publication 4579, 2007 Taxpayer Assistance Blueprint Phase 2, Executive Summary 2-4, 35 (Apr. 2007), available at http://www.irs.gov/pub/irs-pdf/p4579.pdf (last visited Aug. 6, 2012). The TAB also acknowledged that some taxpayers will continue to require in-person or telephone assistance. Id. at 5 ("Low income, LEP, and elderly taxpayers tend to report a somewhat higher preference for the TAC channel and a lower preference for the electronic channel than the majority of taxpayers as a whole.").

²² Wage and Investment Research & Analysis, TAB Conjoint Update: Final Report for Wage and Investment Research and Analysis Director, Project No. 2-10-09-S-058, 8 (Feb. 2012).

²³ Centre for Tax Policy and Administration of the Organisation for Economic Co-Operation and Development (OECD): Forum on Tax Administration: Taxpayer Services Sub-Group, Survey Report: Survey of Trends and Developments in the Use of Electronic Services for Taxpayer Service Delivery 77 (Mar. 2010), available at http://www.oecd.org/ctp/taxadm/45035933.pdf (last visited Aug. 6, 2012).

²⁴Id.

²⁵ OECD, Forum on Tax Administration, Information Note: Working Smarter in Structuring the Administration, in Compliance, and Through Legislation 27, 51 (Jan. 2012) (emphasis added).

²⁶ IRS Publication 4579, 2007 Taxpayer Assistance Blueprint Phase 2, Executive Summary 2-4 (Apr. 2007), available at http://www.irs.gov/pub/irs-pdf/p4579.pdf (last visited Aug. 6, 2012).

²⁷ TIGTA, Ref. No. 2009-20-102, Changing Strategies Led to the Termination of the My IRS Account Project (Aug. 12, 2009); IRS, IMRS Q&A View (Intranet site on file with the IRS).

²⁸ National Taxpayer Advocate 2009 Annual Report to Congress 104-105.

²⁹ For detailed descriptions of the online account applications offered by various OECD countries, see Centre for Tax Policy and Administration of the OECD: Forum on Tax Administration: Taxpayer Services Sub-Group, Survey Report: Survey of Trends and Developments in the Use of Electronic Services for Taxpayer Service Delivery 40, 109-110 (Mar. 2010), available at http://www.oecd.org/ctp/taxadministration/45035933.pdf (last visited Aug. 6, 2012).

³⁰ Wage and Investment Research & Analysis, TAB Conjoint Update: Final Report for Wage and Investment Research and Analysis Director, Project No. 2-10-09-S-058, 8 (Feb. 2012). Specifically, 38 percent preferred to get information about a notice received through an interactive website and 41 percent preferred such a tool to check the status of a transaction.

³¹ IRS Online Services, Governance Kickoff 3 (Nov. 29, 2011).

³² IRS Publication 4579, 2007 Taxpayer Assistance Blueprint Phase 2, Executive Summary 23-4, 40 (Apr. 2007), available at http://www.irs.gov/pub/irs-pdf/p4579.pdf (last visited Aug. 6, 2012); Conjoint Update: Final Report for Wage and Investment Research and Analysis Director, Project No. 2-10-09-S-058, 5 (Feb. 2012). However, the National Taxpayer Advocate continues to believe that certain taxpayers will require face-to-face or telephone services and the IRS should not abandon these service delivery channels to meet their needs. Rather, certain categories of transactions may be better served through multiple service channels.

Heather Maloy, Commissioner, Large Business & International Division

Peggy Bogadi, Commissioner, Wage and Investment Division

DEFINITION OF PROBLEM

In recent years, the IRS has devoted substantial resources to improving international tax administration and responding to the challenges of globalization.¹ However, the IRS continues to focus on stepped-up enforcement without adequate servicewide coordination, and with no corresponding increase in service to millions of individual international taxpayers.² The National Taxpayer Advocate's 2011 Annual Report to Congress identified six serious problems facing these taxpayers in understanding and meeting their federal tax obligations.³

A 2012 IRS research study of international taxpayers shows that this group remains underserved, desires self-service options, and may experience a higher rate of post-filing problems than the general taxpayer population.⁴ Among those who file, many do not have an adjusted gross income (AGI) high enough to generate a tax liability. About 82 percent of U.S. taxpayers abroad did not have a U.S. liability.⁵ Others are afraid to file, being uncertain about filing requirements or intimidated by the complexity of U.S. tax laws. Confusion and frustration about U.S. tax requirements, the risk of heavy penalties, and the corresponding compliance burden may cause some taxpayers to give up their U.S. citizenship. Expatriations increased more than sixfold between calendar years (CYs) 2008 and 2012.⁶

While international taxpayers grapple with compliance challenges and inadequate service, the IRS has been slow in taking specific steps to meet their needs and ease their compliance burdens, saving enforcement resources to address egregious noncompliance. We have identified the following problems with the IRS's approach to improving international taxpayer service:

• Delays in developing specific recommendations to improve service based on cross-functional team findings;

• The lack of a strategic plan to address persistent compliance challenges;

• The absence of a timeline to implement recommendations of the 2012 IRS research study;

• The insufficient use of modern technology as a more efficient method of delivering services and providing information, including virtual face-to-face (VFTF) assistance and online services; and

• The lack of simplified filing and self-correction options for international taxpayers.

Background

In recent years, globalization has pushed an increasing number of individual taxpayers (including entrepreneurs and small businesses) to seek economic opportunities abroad. It also has increased competition among tax administration agencies for tax bases and sources of revenue. Both taxpayers and the government can benefit from tax systems that are simple to administer and have high rates of compliance.⁷ For this reason, 33 countries lowered the tax burden and made compliance easier by introducing or enhancing electronic systems and reducing the frequency of filing or merging or eliminating duplicative reporting.⁸ In contrast, World Bank studies consistently rank the United States between 65th and 69th in time spent to comply among 183 countries surveyed.⁹

The complexity of international tax law, combined with the administrative burden placed on international taxpayers, creates an environment where taxpayers who are trying their best to comply simply cannot. For some U.S taxpayers abroad, the requirements are so confusing and the compliance burden so great that they give up their U.S. citizenship.¹⁰ Overall, nearly 7,000 U.S. citizens renounced citizenship from calendar year (CY) 2005 through third quarter of CY 2012.¹¹ The number of expatriations increased over sixfold from 231 in CY 2008 to about 1,800 in CY 2011, as shown on Figure 1.15.1 below. Expatriations dramatically increased after CY 2009, coinciding with increased IRS enforcement of the Foreign Bank Account Report (FBAR) penalty and confusing offshore voluntary disclosure initiatives that appeared overly harsh to taxpayers who inadvertently violated the rules.¹²

 

FIGURE 1.15.1, Expatriations in CYs 1998-2011

 

 

 

In response to concerns the National Taxpayer Advocate expressed in prior Annual Reports to Congress, and in support of the IRS Multiyear Servicewide Approach to International Tax Administration, Wage and Investment Research & Analysis (WIRA) in 2012 completed a comprehensive study (hereinafter "WIRA Research Study") of the service needs and filing issues of international individual taxpayers.¹³ The study found that in comparison to the general filing population, international taxpayers (defined for the purposes of the study as individuals living outside the U.S.) reported lower income, fewer refund returns, and a larger number of zero balance due returns.¹⁴ Wage earners, however, reported significantly higher levels of income than all international filers.¹⁵ The study indicates that approximately 64 percent of all international taxpayers reported an adjusted gross income (AGI) of $25,000 or less with a median AGI of $11,770, as shown on Figure 1.15.2 below.¹⁶

 

FIGURE 1.15.2, Adjusted Gross Income of Total International

 

Returns for Tax Year 2010¹⁷

 

 

 

The Creation of a Cross-Functional International Individual Taxpayer Assistance Team May Help to Better Coordinate International Taxpayer Service.

In June 2012, the IRS's Large Business & International Division (LB&I), Wage & Investment Division (W&I), and TAS created the International Individual Taxpayer Assistance Team (IITA) to develop international taxpayer service initiatives based on the National Taxpayer Advocate's recommendations and the 2012 WIRA study.²⁰ The IRS Office of Online Services joined the group in August 2012. IITA has the following objectives:

• Identify international taxpayer groups with similar characteristics;

• Identify needs of these groups;

• Identify existing channels for assistance for these groups;

• Identify service gaps for these groups;

• Identify risk factors for service gaps;

• Prioritize taxpayer groups and service gaps based upon risk factors;

• Develop solutions and sort them in a priority order based on importance and resources; and

• Involve LB&I and IRS Office of Chief Counsel experts on tax treaties and international law issues.