National Taxpayer Advocate Submits 2008 Annual Report to Congress

Internal Revenue Code (IRC) § 7803(c)(2)(B)(ii)(III) requires the National Taxpayer Advocate to describe at least 20 of the most serious problems encountered by taxpayers. This year's report begins by identifying the five most serious problems and then divides the remaining problems into four categories -- taxpayer service issues, compliance issues, examination issues, and general tax administration issues. The report also contains a status update on the IRS's Private Debt Collection program. Each of the most serious problems includes the National Taxpayer Advocate's description of the problem, the IRS's response, and the National Taxpayer Advocate's final comments and recommendations (with the exception of the first problem, which does not contain an IRS response because it does not involve IRS action). This format provides a clear picture of which steps have been taken to address the most serious problems and which additional steps the National Taxpayer Advocate believes are required.

The issues described in the report are as follows:

Internal Revenue Code (IRC) § 7803(c)(2)(B)(ii)(VIII) requires the National Taxpayer Advocate to propose legislative recommendations to resolve or mitigate problems encountered by taxpayers. This year's report makes the following 17 recommendations, most of which are designed to reduce taxpayer burden by simplifying the tax code:

Internal Revenue Code (IRC) § 7803(c)(2)(B)(ii)(X) requires the National Taxpayer Advocate to identify the ten tax issues most often litigated in the federal courts and to classify those issues by the category of taxpayer affected. The cases we reviewed were decided during the 12 months that began on June 1, 2007, and ended on May 31, 2008. In addition, the report contains a discussion of certain judicial decisions that did not involve one of the ten most frequently litigated issues but were significant because of their holdings.

Volume Two of the report contains in-depth studies that TAS has conducted or commissioned on important tax administration issues. This year's report contains a detailed assessment of the tax code's penalty regime and two research studies.

I respectfully submit for your consideration the National Taxpayer Advocate's 2008 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. Thus, the statute requires that the report focus on problems and areas in need of improvement.

Indeed, with a tax system as complex as ours, there are inevitably many problems and areas in which improvements can be made, and I will address the major ones in detail. For context, however, I note that 2008 marks the ten-year anniversary of the enactment of the Internal Revenue Service Restructuring and Reform Act of 1998, and this therefore seems like an appropriate time to point out that the IRS has improved substantially over the past decade. It is more responsive to taxpayers than it was in 1998. It has also made strides in improving its technology. This year we watched as the IRS delivered a successful filing season despite numerous changes in law that were enacted late in 2007 and delivered economic stimulus checks to about 119 million taxpayers with just a few months to plan.¹ These two challenges required the IRS to make trade-offs, which included a reduction in the level of service on its tollfree lines from 82 percent in fiscal year 2007 to 53 percent in Fiscal Year (FY) 2008,² but in light of the hand the IRS was dealt, it performed extremely well. I think it is important to take stock of how much the IRS has improved before proceeding to discuss taxpayer problems.

The IRS and the Current Economic Environment

This report is published as a new Administration and a new Congress arrive to address the daunting challenges facing the U.S. economy. Tax administration and the Internal Revenue Service have an important role to play in furthering the nation's recovery -- not just because the IRS collects about 96 percent of the federal government's revenue but also because burdensome tax policies, inadequate customer service, and inappropriate enforcement actions drive up compliance costs for all taxpayers, including small businesses, and thereby impede economic growth.

Thus, in this year's report -- presented in two volumes -- we focus on challenges to tax administration in the 21st century, especially during economic downturns. First and foremost among the most serious problems facing taxpayers is the complexity of the tax code, followed by the IRS's enforcement activity toward taxpayers who are experiencing economic hardships and by the tax treatment of cancellation of debt income. In the Legislative Recommendations section of this report, we pick up the discussion about complexity. We reprise our call for simplification in several major areas of tax law, including the Alternative Minimum Tax (AMT), education and retirement savings incentives, and the family status provisions.³ We also submit several new recommendations for your consideration, including proposals to reform the worker classification regime and to revamp the current penalty provisions in the Internal Revenue Code. Finally, Volume II of this report presents three research studies of importance to tax administration in economically challenging times: (1) a comprehensive review of the Code's penalty regime; (2) an automated method to identify taxpayers who are experiencing economic hardship so the IRS can systemically screen them from automated levies; and (3) a second installment in our series of research studies on the impact of tax preparers on taxpayer compliance.

A Call for Tax Reform and Simplification

In earlier Annual Reports to Congress, we have highlighted the "confounding complexity of the Internal Revenue Code" as one of the most serious problems facing taxpayers.⁴ We do so again this year. While in past reports we have focused on the Alternative Minimum Tax as the primary example of this complexity,⁵ this year the "poster child" for complexity is Cancellation of Debt Income (CODI).⁶ This issue -- which has received very little attention in the media -- threatens to undermine any nascent recovery by homeowners facing loan restructuring or foreclosures, not to mention by taxpayers who find themselves unable to pay their automobile or credit card debts as a result of declining economic conditions. Although Congress provided partial relief to taxpayers with home mortgages in the Mortgage Forgiveness Debt Relief Act, CODI problems persist. The Act provided that taxpayers may exclude CODI resulting from taxable mortgage debt cancellation where the proceeds were used to acquire or improve their principal residence. But it appears that the majority of homeowners who took out subprime mortgages used a portion of the loan proceeds for other purposes, including paying off car loans, credit card balances, student loans, and medical bills. Thus, if these taxpayers either work out a debt reduction agreement with their lenders or abandon or lose their homes in foreclosure, they will have CODI unless some other exclusion -- such as insolvency -- applies.⁷

Moreover, lenders are required to report CODI to the IRS on Form 1099-C, Cancellation of Debt, and the IRS generally may assume any reported CODI is taxable unless the taxpayer files a form with his tax return to claim an exclusion. Very few taxpayers know to file this form, and as a result, taxpayers may be unnecessarily targeted for examination and tax assessment in tens of thousands of cases. It is probably safe to say that taxpayers facing eviction from their homes and the resulting disruption of their financial and personal lives will not be thinking about CODI. These taxpayers and those who are able to arrange debt reduction will find, a few years down the road when they are about to achieve some measure of financial stability, that they owe the IRS a sizable sum. In our report, we make several administrative recommendations and one legislative recommendation that should mitigate this problem and prevent millions of taxpayers from getting ensnared in this incredibly complex, burdensome, and devastating regime.

Of course, we haven't let up on our advocacy for repeal or reform of the Alternative Minimum Tax, either. Over the last eight years we have championed the need for AMT reform, and while there is now widespread agreement that reform is needed, the sheer scope of the revenue impact paralyzes all efforts other than one-year fixes. Today, we have reached a point where even one-year fixes are extremely expensive⁸ -- and the perniciousness and invasiveness of the AMT is demonstrated by the fact that it will cost more in 2009 to repeal the AMT than it would cost to repeal the regular income tax rules and leave the AMT in place. Absent continual one-year patches, almost a quarter of all individual taxpayers will have to navigate the AMT. That is a sad statement about the complexity of our tax system, and that fact alone should compel the new administration and Congress to undertake the fundamental tax reform necessary to repeal the AMT.⁹ It is simply inexcusable for a tax system to impose this kind of burden on millions of taxpayers.

As if CODI and AMT were not enough to demonstrate the current complexity of the Internal Revenue Code, consider this: the number of civil tax penalties has increased from about 14 in 1954 to more than 130 today.¹⁰ Many of these penalties are rarely applied, and some contribute little to the generally accepted premise that civil tax penalties should primarily serve to promote voluntary compliance. In our legislative proposal for penalty reform and the accompanying study in Volume II, we lay out some basic principles for penalty provisions, including horizontal equity, proportionality, and procedural fairness. We highlight one penalty, IRC § 6707A, in a separate legislative recommendation. As currently designed, IRC § 6707A violates the basic proposition that a penalty should be proportional to the harm that occurs. The purpose of the penalty is to combat tax shelters by requiring taxpayers who enter into transactions deemed by the IRS as aggressive to make special disclosures. As written, however, Section 6707A requires the IRS to impose a penalty of $200,000 per entity per year and $100,000 per individual per year even if the taxpayer had no knowledge that the IRS deemed the transaction aggressive and even if the taxpayer derived no tax savings from the transaction. In the case of a "listed transaction," the IRS must impose the full amount of the penalty and may not waive or rescind it under any circumstances.

A final illustration of how complex our tax system has become. Although few people enjoy paying taxes, most understand that "taxes are what we pay for a civilized society."¹¹ But it adds insult to injury that more than 80 percent of taxpayers today find tax filing so complicated that they feel compelled to pay transaction fees simply to pay their taxes. About 60 percent of taxpayers pay preparers to do the job, and another 22 percent purchase tax software to help them perform the calculations themselves. In the long run, we recommend that Congress simplify the tax code so that taxpayers can compute and pay their taxes far more simply.

In addition, we advocate an immediate step to assist taxpayers who seek return preparation assistance. Since 2002, we have recommended that Congress protect taxpayers who use preparers by requiring unenrolled preparers to pass a minimum competency test, register with the IRS, and satisfy continuing professional education requirements. Oregon has had success with a similar system, and recent "shopping visits" to unenrolled preparers conducted by the Government Accountability Office, the Treasury Inspector General for Tax Administration, and most recently and dramatically, the New York State Department of Taxation and Revenue,¹² have shown significant deficiencies in the competence and professional standards of unenrolled preparers. The Senate has previously approved legislation to regulate preparers, and the House Ways and Means Subcommittee on Oversight has held a hearing focused in part on the subject. In this report, we reiterate our recommendation that Congress act to professionalize the return preparation industry.

Taxpayer Service and Enforcement in Challenging Economic Times

During economic downturns, the IRS is placed in a difficult position. On the one hand, more taxpayers are experiencing economic setbacks -- loss of jobs, loss of homes, losses on investments -- and thus are more likely to be unable to pay all their taxes. On the other hand, as the budget deficit grows, the IRS comes under subtle pressure to collect more federal revenue and close the tax gap. In addition, as the administration and Congress look for ways to reduce federal spending, the IRS's annual appropriation becomes an attractive target for budgetary savings.

All of the most serious problems of taxpayers that we identify in this year's report address the delicate balance the IRS must achieve between these competing pressures. We note that the IRS must change some of its practices to avoid exacerbating the financial distress of taxpayers who are already experiencing economic difficulties. We note that the IRS's own studies show that more enforcement actions -- liens and levies -- do not translate into commensurate increases in revenue collection. For example, while the number of levies issued by the IRS increased by an astonishing 1,608 percent from FY 2000 to FY 2007 -- from 220,000 levies to about 3.76 million -- the increase in total collection yield during this period was slightly less than 45 percent.¹³ We note that current IRS guidance provides little direction to help IRS employees identify taxpayers who are experiencing economic hardship and prevent undue economic burden on affected taxpayers. We also show that the IRS underutilizes collection alternatives, particularly offers in compromise and partial pay installment agreements, currently available to resolve taxpayer liabilities. For example, the number of accepted offers in compromise has decreased by over 72 percent from FY 2001 to FY 2008.¹⁴ While it is commendable that the IRS is now talking about how it wants to help taxpayers who are experiencing economic difficulties,¹⁵ the IRS has always possessed the tools to help these taxpayers, and training its employees to utilize these tools properly and flexibly would go a long way toward improving tax compliance, especially in challenging economic times.¹⁶

Effecting Culture Change in the IRS

This year, in an effort to better identify where there is agreement and clarify where there is disagreement between the National Taxpayer Advocate and the IRS, we identified our tentative recommendations in the initial section of each "Most Serious Problem" discussion so that the IRS could address our tentative recommendations in its responses. As a result of this procedure, we have been able to narrow issues, and our final recommendations are more discrete, actionable, and fewer than in earlier reports. In many instances, the IRS either identified or committed to initiatives in its responses that, if properly administered, will address our concerns. The National Taxpayer Advocate's final recommendations, however, often reflect a fundamental philosophical disagreement between TAS and the IRS -- particularly in the area of looking at IRS actions from the taxpayer's perspective. The good news is that there is lots the IRS is currently doing to improve its operations. The not-so-good-news is that there is lots more work to do -- particularly in the area of internal culture change -- before the IRS achieves its potential as a disciplined but compassionate tax administration.

What appears to be driving this disconnect is the sense, in the IRS responses to the Most Serious Problems included in this report, that the IRS is so hampered by the requirements of its work that it simply doesn't have the time, resources, or energy to look at itself critically and ask fundamental questions about how it is doing its job. In responses to discussions of taxpayer service, collection, examination, and local compliance initiatives herein, the IRS resists questioning whether it is measuring the right actions to improve voluntary compliance, resists exploring new methods of providing face-to-face service to taxpayers, resists measuring the impact of its centralization initiatives on voluntary compliance, resists making real changes to its examination strategy to address the difficulties taxpayers face in responding to correspondence exams, and resists establishing a world-class, 21st century think tank to explore what actions and initiatives help taxpayers achieve and maintain tax compliance.¹⁷

If the IRS is not able to make the case for itself that with the proper funding it will deliver world class tax administration, who will? If the IRS is unwilling to challenge the status quo with respect to its way of doing business in these challenging times, who will support its current funding? Well, to some extent this report makes that case. As the National Taxpayer Advocate, I believe (and describe in the report that follows) that -- right here, right now -- the IRS has the tools it needs to help taxpayers be compliant. And I believe the IRS has the talent available to it -- right here, right now -- to challenge its entrenched assumptions about service and enforcement and become a truly world class tax administrator. And I believe it is essential to the economic well-being of the United States that the new Administration and the new Congress invest in the IRS so that it can better serve the taxpayers who provide the lifeblood of government, in good times and in bad times alike.

As the agency that collects about 96 percent of all federal revenue and the agency that more Americans interact with each year than any other, the IRS has an important and demanding job to do. I hope Members of Congress and their staffs find this report helpful as you consider how to best assist the IRS in collecting revenue while simultaneously protecting taxpayer rights and minimizing taxpayer burden.

²See Internal Revenue Service Fiscal Year 2008 Enforcement Results (Slide 7: Taxpayer Service), at http://www.irs.gov/pub/irs-news/2008_enforcement.pdf.

³ The family status provisions include filing status (IRC § 1), personal and dependent exemptions (IRC § 151), the child tax credit (IRC § 24), the earned income tax credit (IRC § 32), the child and dependent care credit (IRC § 21), and the separated spouse rules (IRC § 7703(b)).

⁴See National Taxpayer Advocate 2004 Annual Report to Congress 2-7.

⁵See National Taxpayer Advocate 2001 Annual Report to Congress 166-77; National Taxpayer Advocate 2003 Annual Report to Congress 5-19; National Taxpayer Advocate 2004 Annual Report to Congress 383-85; and National Taxpayer Advocate 2006 Annual Report to Congress 3-5.

⁶ When a borrower is unable to pay a debt and the creditor cancels some or all of it, the amount of loan cancellation is generally treated as taxable income to the debtor. IRC § 61(a)(12).

⁷ The Mortgage Forgiveness Debt Relief Act expressly provided that CODI is excludable under this provision only to the extent that the amount of debt cancellation exceeds the amount used for these "non-qualified" purposes.

⁸ The cost of the AMT patch for 2008 is estimated at $78.9 billion. Some revenue will be recouped in subsequent years, resulting in an estimated ten-year cost of $64.1 billion. Joint Committee on Taxation, Estimated Budget Effects of the Tax Provisions Contained in an Amendment in the Nature of a Substitute to H.R. 1424, Scheduled for Consideration on the Senate Floor on October 1, 2008 (Oct. 1, 2008).

⁹ Absent any changes in law, it is now projected that in 2010, 33 million individual taxpayers will be subject to the AMT. Tax Policy Center, Aggregate AMT Projections, 2008-2018, Table T08-0248 (Nov. 4, 2008), available at http://www.taxpolicycenter.org/numbers/Content/PDF/T08-0248.pdf. Most observers believe that Congress, at a minimum, will pass another "patch" that limits the growth in the AMT by increasing the AMT exemption amounts.

¹⁰ For a list of about 130 current law penalties, see Vol. II, A Framework for Reforming the Penalty Regime, Appendix A, infra.

¹¹See Compania General De Tabacos De Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100 (1927) (Holmes, J., dissenting).

¹² Tom Herman, New York Sting Nabs Tax Preparers, Wall Street Journal (Nov. 26, 2008).

¹³ IRS, Small Business/Self-Employed Division (SB/SE) Research, Liens, Levies, Seizures, and Total Yield: 10 Year Filing Trend, (Aug. 19, 2005), supplemented with data from various SB/SE Collection Activity Reports and Statistics of Income (SOI) Data Book information for FY 1999 to FY 2007.

¹⁴ SB/SE Collection Activity Report, No-5000-108 (FY 2001-FY 2008). In FY 2001, the IRS accepted 38,643 offers compared to 10,677 in FY 2008.

¹⁵ IRS News Release, IRS Speeds Lien Relief for Homeowners Trying to Refinance, Sell, IR-2008-141 (Dec. 16, 2008).

¹⁶ In this report, we also note that it is important for the IRS to maintain balance in its approach to collecting unpaid employment tax liabilities. The IRS has come under pressure to ramp up its collection of unpaid employment tax liabilities. This pressure stems, in part, from a recent GAO report which found that unpaid employment tax liabilities increased from $49 billion in 1998 to $58 billion in 2008. While that may be a true statement, it is critical that observers interpret the data correctly. Inflation increased by 30 percent over that period, so the employment tax gap has seemingly shrunk in real (inflation-adjusted) terms. Department of Labor, Bureau of Labor Statistics, Consumer Price Index -- All Urban Consumers (CPI-U) (Dec. 29, 2008). As well, the $58 billion figure represents a multi-year, cumulative total, and the majority of that total consists of interest and penalties rather than tax itself. For a detailed discussion of the IRS response to unpaid employment taxes, see Most Serious Problem, Employment Taxes, infra.

¹⁷See Most Serious Problems, Customer Service Within Compliance; Taxpayer Service: Bringing Service to the Taxpayer; The Impact of IRS Centralization on Tax Administration; Customer Service Issues in the IRS's Automated Collection System (ACS); The IRS Needs to More Fully Consider the Impact of Collection Enforcement Actions on Taxpayers Experiencing Economic Difficulties; The IRS Correspondence Examination Program Promotes Premature Notices, Case Closures, and Assessments; Suitability of the Examination Process; and Local Compliance Initiatives Have Great Potential But Face Significant Challenges, infra.

Internal Revenue Code (IRC) § 7803(c)(2)(b)(ii)(III) requires the National Taxpayer Advocate to prepare an Annual Report to Congress which contains a summary of at least 20 of the most serious problems encountered by taxpayers each year. For 2008, the National Taxpayer Advocate has identified, analyzed, and offered recommendations to assist the IRS in resolving 20 such problems. This year's report also includes a status update on the IRS's Private Debt Collection (PDC) initiative, which reiterates the National Taxpayer Advocate's prior recommendation that the initiative be discontinued.¹

As in previous 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. Our tax system and the Code have grown to a point where the IRS employs more than 100,000 workers and collects in excess of $2 trillion each year from individuals, small and large businesses, and tax-exempt entities. This state of affairs inevitably creates problems that may not be transparent but nonetheless merit the attention of the National Taxpayer Advocate and the IRS. 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 for Determining the Most Serious Problems

The National Taxpayer Advocate considers a number of factors in identifying, evaluating, and ranking the most serious problems encountered by taxpayers. The 20 issues and the status update 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 the TAMIS. The top 25 case issues, which are listed in Appendix 1, reflect TAMIS receipts based on taxpayer contacts in fiscal year (FY) 2008, a period spanning October 1, 2007 through September 30, 2008.

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. These responses appear unedited, under the heading "IRS Comments," followed by the National Taxpayer Advocate's own comments and recommendations.

Use of Examples

The examples presented in this report illustrate issues raised in cases handled by the 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.

The Complexity of the Tax Code

Definition of Problem

The most serious problem facing taxpayers is the complexity of the Internal Revenue Code.

Analysis of Problem

The largest source of compliance burdens for taxpayers -- and the IRS -- is the overwhelming complexity of the tax code.¹ The only meaningful way to reduce these burdens is to simplify the tax code enormously.

Consider the following:

• According to a TAS analysis of IRS data, U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with the filing requirements of the Internal Revenue Code.² And that figure does not even include the millions of additional hours that taxpayers must spend when they are required to respond to an IRS notice or an audit. (For a breakdown of hours by tax form and information reporting document, see Table 1.1.1 at the end of this section.)

• If tax compliance were an industry, it would be one of the largest in the United States. To consume 7.6 billion hours, the "tax industry" requires the equivalent of 3.8 million full-time workers.³

• Compliance costs are huge both in absolute terms and relative to the amount of tax revenue collected. Based on Bureau of Labor Statistics (BLS) data on the hourly cost of an employee, TAS estimates that the costs of complying with the individual and corporate income tax requirements in 2006 amounted to $193 billion -- or a staggering 14 percent of aggregate income tax receipts.⁴

• Since the beginning of 2001, there have been more than 3,250 changes to the tax code, an average of more than one a day, including more than 500 changes in 2008 alone.⁵

• The Code has grown so long that it has become challenging even to figure out how long it is. A search of the Code conducted in the course of preparing this report turned up 3.7 million words.⁶ A 2001 study published by the Joint Committee on Taxation put the number of words in the Code at that time at 1,395,000.⁷ A 2005 report by a tax research organization put the number of words at 2.1 million, and notably, found that the number of words in the Code has more than tripled since 1975.⁸

• Tax regulations, which are issued by the Treasury Department to provide guidance on the meaning of the Internal Revenue Code, now stand about a foot tall.⁹ The CCH Standard Federal Tax Reporter, a leading publication for tax professionals that summarizes administrative guidance and judicial decisions issued under each section of the Code, now comprises 25 volumes and takes up nine feet of shelf space.¹⁰ Two companies publish newsletters daily that report on new developments in the field of taxation; the print editions often run 50-100 pages and the electronic databases contain substantially more detailed information.¹¹

• The complexity of the Code leads to perverse results. On the one hand, taxpayers who honestly seek to comply with the law often make inadvertent errors, causing them either to overpay their tax or to become subject to IRS enforcement action for mistaken underpayments of tax. On the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities.

• Individual taxpayers find the return preparation process so overwhelming that more than 80 percent pay transaction fees to help them file their returns. About 60 percent¹² pay preparers to do the job,¹³ and another 22 percent purchase tax software to help them perform the calculations themselves.¹⁴

• The Code contains no comprehensive Taxpayer Bill of Rights that explicitly and transparently sets out taxpayer rights and obligations.¹⁵ Taxpayers do have rights, but they are scattered throughout the Code and the Internal Revenue Manual and are neither easily accessible nor written in plain language that most taxpayers can understand.¹⁶

• Excessive Number of Education and Retirement Savings Incentives. The Code currently contains at least 11 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.¹⁷ The Code also contains at least 16 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.¹⁸ Taxpayers wishing to choose the optimal vehicle to save for college must know the difference between a Section 529 plan, a Coverdell Education Savings Account, and the Hope and Lifetime Learning Credits, among other alternatives. Taxpayers wishing to choose the optimal plan in which to save for retirement must know the difference between a traditional IRA, a Roth IRA, a Section 401(k) plan, a Section 403(b) plan, and a SARSEP, among others.

• The Alternative Minimum Tax (AMT). The AMT concept, originally enacted in response to a report that 155 high-income taxpayers had paid no tax for the 1966 tax year,²⁰ now effectively requires taxpayers to compute their taxes twice -- once under the regular rules and again under the AMT regime -- and then to pay the higher of the two amounts.²¹ The AMT was originally conceived to prevent wealthy taxpayers from escaping tax liability through the use of tax-avoidance transactions. However, most of the significant tax loopholes that enabled taxpayers to escape tax at the time the AMT was written have long since been closed, and it is now estimated that about 77 percent of the additional income subject to tax under the AMT is attributable simply to family size or residing in a high-tax state.²² 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 how those actions are treated. Yet government has become so dependent on AMT revenue that Congress to date has been unwilling to make permanent changes in law to curtail the AMT, and it is not likely that such changes will be made outside the context of major tax reform.²³

• Tax Consequences of Mortgage Foreclosures and Canceled Debts. Most financially distressed individuals who lose their homes to foreclosure or cannot pay off their car loans, credit card balances, student loans, or medical bills probably do not realize that their delinquency may increase their tax liabilities, but it often does. If a creditor writes off a debt, the tax code generally treats the amount of the canceled debt as taxable income to the debtor.²⁴ Congress has carved out a number of exclusions, including a recently enacted exclusion to help homeowners whose mortgage debts are canceled when their houses are foreclosed upon and sold.²⁵ However, taxpayers do not receive the benefit of these exclusions automatically. A taxpayer must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to claim an exclusion. Form 982 is extremely complex, and very few taxpayers or preparers are familiar with it. The IRS estimates that it takes business taxpayers ten hours and 43 minutes to complete the form,²⁶ and the form is not included in many tax software packages available to taxpayers.

• Earned Income Tax Credit (EITC) Complexity. About 22 million low income taxpayers claim the EITC each year.³⁰ The eligibility requirements and computations are complex, yet EITC recipients are relatively less able to understand complex rules and less likely to speak English as their primary language, creating a recipe for confusion.³¹ EITC complexity leads to improper claims by taxpayers -- some intentional but many inadvertent -- and to improper denials by the IRS. A 2004 TAS study surveyed cases in which the IRS denied an EITC claim on audit but the taxpayer asked the IRS to reconsider its findings. Despite the initial IRS denials, the study found that taxpayers ultimately obtained some or all of the EITC amount they had claimed on their returns in 43 percent of the cases (and they received, on average, 94 percent of the amount they had originally claimed).³²

• Proliferating Tax Sunsets. The tax code contains more than 100 provisions that are temporary and set to expire soon, up from about 21 in 1992. Tax benefits have increasingly been enacted for a limited number of years in order to reduce their cost for budget-scoring purposes. Although most such benefits are periodically renewed, some are not. For example, the AMT patch and the deductions for state and local taxes and for tuition and fees paid to a post-secondary institution are generally renewed for one or two years at a time, but the extensions are not guaranteed and the amount of the AMT patch is generally changed with each renewal. If taxpayers do not know whether a tax benefit will remain in the Code, the incentive is less likely to influence their decision-making, thereby undermining its purpose. The uncertainty associated with an expiring tax benefit also makes it difficult for taxpayers to estimate their tax liabilities and pay the correct amount of estimated tax, potentially subjecting them to penalties and causing disillusionment with the tax system.³⁴

• Phase-out Complexity. More than half of all individual income tax returns filed each year are affected by the phase-out of certain tax benefits. A common phase-out relates to the deduction allowed for personal exemptions. For example, a married couple with two minor children is generally allowed to claim four personal exemptions if they file a joint return, with each deduction worth $3,500 ($14,000 in the aggregate) in tax year 2008.³⁵ If the family's adjusted gross income (AGI) exceeds a certain threshold, however, the exemption amount is phased out at a rate of two percentage points for each additional $2,500 (or fraction thereof) of income. Thus, under permanent law, the benefits of the personal exemptions would fully phase out over a $125,000 income range. But under a temporary provision that will sunset after 2009, the phase-out is capped at one-third of the exemption amount. Thus, the phase-out may not reduce the exemption amount below $2,333 per family member ($9,332 in the aggregate).³⁶ This computation is not obvious to the average taxpayer, and as noted, there are about 100 phase-outs that operate in this manner. Like tax sunsets, phase-outs are largely used to reduce the cost of tax provisions for budget-scoring purposes. However, phase-outs add substantial complexity and 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. This inequity is largely hidden by the complexity of the phase-out calculations.³⁷

• Unclaimed Telephone Excise Tax Refunds. In 2006, taxpayers were permitted to claim a one-time tax credit for telephone excise taxes that the government concluded it had improperly collected in the past.³⁸ The amount of the credit ranged from $30 to $60, depending on the number of personal exemptions the taxpayer was entitled to claim on the return.³⁹ No substantiation was required unless a taxpayer claimed a larger amount, so this credit was essentially free money. Yet IRS data show that 28 percent of eligible taxpayers (37 million out of 133.2 million) did not claim the credit.⁴⁰ The only plausible explanation is that taxpayers missed the credit because of the complexity of the law and the tax forms.⁴¹

• Burgeoning Penalties. The number of civil penalties in the Code has grown from about 14 in 1954 to approximately 130 today.⁴² Penalties should be designed to enhance voluntary tax compliance, but they also should be reasonable and can only influence future taxpayer behavior if taxpayers are aware that the penalties exist. As a consequence of "penalty creep," some penalties are obscure or unduly harsh. For example, Section 6707A of the Code, which was enacted in 2004 to combat tax shelters, imposes a minimum penalty of $100,000 per individual per year and $200,000 per entity per year for a failure to disclose a "listed transaction."⁴³ The penalty reflects strict liability -- the IRS must impose the penalty even if the taxpayer derived little or no tax benefit, even if the taxpayer had no reason to know the transaction was questionable, and even if the transaction was not "listed" until years after the taxpayer's return was filed and the transaction was complete. Taxpayers cannot challenge this penalty in court. As a result, an individual who does business as an S corporation and who entered into a transaction that he did not know was listed and that provided little or no tax savings would face an automatic $300,000 penalty per year. In addition, the usual three-year statute of limitations on tax assessments does not apply in the case of listed transactions,⁴⁴ so if the taxpayer entered into a listed transaction that was reflected on his return for ten years, he would face an automatic $3 million penalty overall. TAS has about 40 cases in its inventory involving non-rescindable Section 6707A penalties,⁴⁵ and we understand the IRS is considering this penalty in hundreds of additional cases. If Congress does not change the law quickly, this penalty may bankrupt middle-class families that had no intention of entering into a tax shelter.⁴⁶

• Small Business Burdens. Small business taxpayers face a particularly bewildering array of laws, including a patchwork set of rules that governs the depreciation of equipment, numerous and overlapping filing requirements for employment taxes, and a vague set of factors that govern the classification of workers as either employees or independent contractors and that can keep businesses and the IRS battling each other for years with no obvious "correct" answer.⁴⁷

The National Taxpayer Advocate recommends that Congress substantially simplify the Internal Revenue Code.

America's taxpayers deserve a simpler and less burdensome tax system that enables them to comply with their tax obligations expeditiously -- not one that requires them to spend 7.6 billion hours filing their returns every year, thereby consuming the equivalent of 3.8 million full-time workers. Taxpayers deserve a tax system that enables them to prepare their returns cheaply -- not one that requires them to pay practitioners for help, as nearly 61 percent of individual taxpayers and 74 percent of unincorporated business taxpayers do today. Taxpayers deserve more clarity about their rights and obligations under the tax code in the form of a Taxpayer Bill of Rights. Taxpayers deserve a tax system that enables them to make wise choices about education and retirement savings -- without having to wade through the details of at least 27 tax-favored alternatives. Taxpayers deserve a tax system that enables them to compute their tax liabilities fairly and transparently -- not one that effectively requires them to compute their tax liability under two sets of rules (the regular rules and the AMT rules) and often to pay more tax under the AMT regime simply because they engaged in the "tax-avoidance behavior" of having children or living in a high-tax state.

Taxpayers deserve better than a tax system so complex that honest taxpayers often overpay while sophisticated taxpayers often find loopholes, and so complex that 37 million taxpayers could fail to claim a tax credit because they did not know it was available. Taxpayers deserve better than a tax system that gives financially distressed taxpayers a tax break when they default on their mortgage or other consumer debts and the debts are cancelled -- but then makes claiming the tax break so burdensome that many and probably most eligible taxpayers do not claim it. Low income taxpayers deserve a simpler set of rules by which determine EITC eligibility.

Taxpayers deserve certainty about which provisions will remain in the tax code so they can plan accordingly -- without having to regularly grapple with uncertainty because more than 100 provisions sunset regularly and may or may not be renewed or modified. Taxpayers deserve to understand exactly how their tax liabilities are computed -- not provisions like phase-outs, which make the computations seem impenetrable and subject lower income taxpayers to higher marginal tax rates than upper income taxpayers. Taxpayers deserve simplicity and proportionality in the penalty rules; it is not reasonable that a taxpayer who claims minimal or even no tax savings may face a mandatory, non-waivable $300,000 penalty per year for failing to file a disclosure form that he may not even know he is required to file.

These are a few aspects of a system that requires pervasive reform. The good news is that there is widespread agreement on the need for tax simplification. The National Taxpayer Advocate has previously identified the complexity of the tax code as the most serious problem facing taxpayers,⁴⁸ members of Congress regularly complain about the complexity of the Code, and in 2005, an advisory panel created by President Bush to study the federal tax system delivered a detailed report with substantive recommendations.⁴⁹ The bad news is that despite widespread agreement on the need for tax simplification, there has not yet been sustained action to make it happen.

To assist the Congress in pursuing tax simplification, we offer a number of proposals in the Legislative Recommendations section of this report, including recommendations to streamline the education and retirement savings incentives, repeal the AMT, allow taxpayers to exclude modest amounts of canceled debts from income without filing Form 982, simplify the family status provisions of the Code, reduce tax sunset and phase-out provisions, and revise the penalty structure.

The National Taxpayer Advocate continues to view tax simplification as essential and urges the new administration and the new Congress to make it a priority. In doing so, she recommends that emphasis be given to six core principles:

² The TAS Research function arrived at this estimate by multiplying the number of copies of each form filed in tax year 2006 by the average amount of time the IRS estimated it took to complete the form. While the IRS data is the most authoritative available, the amount of time the average taxpayer spends completing a form is difficult to measure with precision. TAS cannot determine the margin of error of existing estimates. Apart from the inherent imprecision of measuring time burdens for the "average" taxpayer, this TAS estimate may be low because it does not take into account all forms and 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. The TAS estimate includes both the time individual and business taxpayers spend filling out their tax returns and the time businesses spend generating information reporting documents like Forms W-2 and Forms 1099. Other published estimates generally have not included the time spent generating information reporting documents.

³ 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).

⁴ The IRS and several outside analysts have attempted to quantify the costs of compliance. For an overview of previous studies, see Government Accountability Office (GAO), GAO-05-878, Tax Policy: Summary of Estimates of the Costs of the Federal Tax System (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 Code. The TAS estimate of the cost of complying with individual and corporate income tax requirements (and thus excluding the time spent complying with employment, estate and gift, and excise tax requirements) was made by multiplying the total number of such hours (7.0 billion) by the average hourly cost of a civilian employee ($27.54), as reported by the BLS. See BLS, U.S. Department of Labor, Employer Costs for Employee Compensation -- December 2006, USDL: 07-0453 (Mar. 29, 2007) (including wages and benefits), at http://www.bls.gov/news.release/archives/ecec_03292007.pdf. The TAS estimate of compliance costs as a percentage of total income tax receipts for 2006 was made by dividing the income tax compliance cost as computed above ($193 billion) by total 2006 income tax receipts ($1.4 trillion). See Office of Management and Budget, Budget of the United States Government -- Fiscal Year 2009, Historical Tables, Table 2-1. TAS's estimate that compliance costs amount to about 14 percent of aggregate income tax receipts falls within the range of previous estimates. For example, Professor Joel Slemrod has computed that compliance costs constitute about 13 percent of income tax receipts, while the Tax Foundation has 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), at http://www.taxreformpanel.gov/meetings/meeting-03032005.shtml; J. 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.

⁵ Unpublished CCH data provided to TAS.

⁶ To determine the number of words in the Internal Revenue Code, a librarian in the IRS Office of Chief Counsel 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. She 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 she used was dated Jan. 3, 2007, so the count does not reflect legislation passed during the 110th Congress. The Code contains certain information, such as a description of amendments that have been adopted, effective dates, cross references, and captions, that do not have the effect of law. It is possible that other attempts to determine the length of the Code have attempted to exclude some or all of these components, but there is no clearly correct methodology to use, and there is no easy way to selectively delete information from a document of this length.

⁷See Staff of the Joint Committee on Taxation, 107th Cong., Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 1986 (vol. I), at 4 (Comm. Print 2001).

⁸ J. 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.

⁹See CCH Income Tax Regulations (which runs 11,700 pages in six volumes) or RIA Federal Tax Regulations (which runs five volumes).

¹⁰ CCH Standard Federal Tax Reporter (2008).

¹¹ These publications are Highlights & Documents (published by Tax Analysts) and the Daily Tax Report (published by BNA). According to the Federal Editor in Chief of Tax Analysts, Tax Notes Today (the electronic publication that serves as the main source for stories in Highlights & Documents) contains an average of 50-70 items a day.

¹² Among unincorporated business taxpayers, about 74 percent use preparers. IRS Compliance Data Warehouse, Individual Returns Transaction File (Tax Year 2006).

¹³ In tax year 2007, about 62 percent of returns were prepared by preparers. IRS Compliance Data Warehouse, Individual REturns Transaction File (tax year 2007). To complete the percentage prepared for a fee, we subtracted the number of returns prepared by Volunteer Income Tax Assistance (VITA) sites.

¹⁴ The number of individual taxpayers who purchase tax software was computed by starting with the number of On-Line File and Self V-Code returns (33.2 million), subtracting the number of Free File returns (3.9 million), and dividing the result (29.3 million) by the total number of returns (134.4 million). IRS Office of Research, Analysis, and Statistics, Response to TAS Information Request (Dec. 17, 2008); 2007 Free File Weekly Snapshot Report Week 40. This data relates to Tax Year 2006.

¹⁵ Congress has enacted several pieces of legislation that bear the title, "Taxpayer Bill of Rights," but those pieces of legislation contain discrete provisions rather than an overarching list of core rights. See Technical and Miscellaneous Revenue Act, Pub. L. No. 100-647 (1988) (containing the Omnibus Taxpayer Bill of Rights, also known as "TBOR 1"); Taxpayer Bill of Rights 2, Pub. L. No. 104-168 (1996) (also known as "TBOR 2"); and Internal Revenue Service Restructuring and Reform Act, Pub. L. No. 105-206 (1998) (containing the Taxpayer Bill of Rights 3, also known as "TBOR 3").

¹⁶ The National Taxpayer Advocate has previously recommended that Congress enact a Taxpayer Bill of Rights that sets out taxpayer rights and obligations. See National Taxpayer Advocate 2007 Annual Report to Congress 478-89 (Legislative Recommendation: Taxpayer Bill of Rights and De Minimis "Apology" Payments).

¹⁷ Tax benefits for past educational expenses include the deduction for interest on education loans in IRC § 221 and an income exclusion for the cancellation of student loan debt in IRC § 108(f). Tax incentives for current expenses include the Hope and Lifetime Learning Credits in IRC § 25A, the above-the-line deduction for qualified tuition and related deductions in IRC § 222, the income exclusion for qualified scholarships in IRC § 117, and the income exclusion for employer education assistance programs in IRC § 127. Tax incentives for future education expenses include the exclusion of interest income from U.S. Savings Bonds used to pay education tuition and fees in IRC § 135, the income exclusion for early distributions to pay qualified higher education expenses from Roth IRAs in IRC § 408A, Qualified Tuition Programs in IRC § 529, and Coverdell Education Savings Accounts in IRC § 530.

¹⁸ Types of retirement plans available under the Internal Revenue Code include traditional IRAs, nondeductible IRAs, nonworking spousal IRAs, Roth IRAs, rollover IRAs, Savings Incentive Match Plan for Employees (SIMPLE) IRAs, IRC § 401(k) plans, profit-sharing plans, money purchase plans, employer-funded defined benefit plans for private employers, Simplified Employee Pensions (SEPs), Salary Reduction Simplified Employee Pension Plans (SARSEPs), SIMPLE 401(k) plans used by small employers, IRC § 403(b) tax-sheltered annuity plans for IRC § 501(c)(3) organizations and public schools, IRC § 414(d) governmental plans, and IRC § 457(b) deferred compensation plans for state and local governments.

¹⁹ This report contains legislative recommendations to streamline the multitude of education and retirement incentives. See Legislative Recommendation, Simplify and Streamline Education Tax Incentives, and Legislative Recommendation, Simplify and Streamline Retirement Savings Tax Incentives, infra. For more detailed recommendations proposed in a prior report, see National Taxpayer Advocate 2004 Annual Report to Congress 403-22 (Key Legislative Recommendation, Simplification of Provisions to Encourage Education) and National Taxpayer Advocate 2004 Annual Report to Congress 423-32 (Key Legislative Recommendation, Simplification of Provisions to Encourage Retirement Savings).

²⁰ Congress acted after learning that 155 taxpayers with adjusted gross incomes above $200,000 had paid no federal income tax for the 1966 tax year. See 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). The forerunner of the AMT was an "add-on" minimum tax enacted in 1969.

²¹ The AMT rules are contained in IRC §§ 55-59.

²²See Tax Policy Center, Tax Facts: AMT Preference Items 2002, 2004-2006 (citing unpublished tabulations from the Office of Tax Analysis, Department of the Treasury), at http://www.taxpolicycenter.org/taxfacts/Content/PDF/amt_preference.pdf. With respect to personal exemptions, the AMT disallows the personal exemptions that are allowed under the regular tax rules to reflect the additional costs of maintaining a household and raising a family. With respect to state and local taxes, the AMT disallows the deduction for the payment of state and local income, sales, and property taxes that taxpayers are allowed to claim under the regular tax rules to reduce "double taxation" at the federal and state levels on the same income.

²³ This report contains a legislative recommendation to repeal the AMT. See Legislative Recommendation, Repeal the Alternative Minimum Tax for Individuals, infra. 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 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 383-85 (Key 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 166-77 (Key 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 (Mar. 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).

²⁴ IRC § 61(a)(12).

²⁵ IRC § 108(a)(1).

²⁶ The IRS does not provide a separate estimate of the amount of time individual taxpayers spend completing Form 982.

²⁷ IRS Document 6961, Table 2 (showing that the IRS expects to receive about 1.9 million Forms 1099-C in 2008 and about 2.1 million Forms 1099-C in 2009).

²⁸ This report identifies the tax treatment of canceled debts as one of the most serious problems facing taxpayers and contains a legislative recommendation designed to ensure that more taxpayers who are entitled to exclusions are able to obtain them. See Most Serious Problem, Understanding and Reporting the Tax Consequences of Cancellation of Debt Income, and Legislative Recommendation, Simplify the Tax Treatment of Cancellation of Debt Income, infra. The National Taxpayer Advocate also identified the tax treatment of canceled debts as a serious problem in her 2007 report. See National Taxpayer Advocate 2007 Annual Report to Congress 13-34 (Most Serious Problem, Tax Consequences of Cancellation of Debt Income).

²⁹ The IRS receives Forms 1099-C, Cancellation of Debt, from lenders reporting the amount of each canceled debt. The IRS document-matching program compares each Form 1099-C it receives against the tax return of the taxpayer with the same taxpayer identification number. If a canceled debt is reported to the IRS on Form 1099-C and the amount is not reported on the taxpayer's return, the discrepancy will be flagged and the taxpayer may face IRS examination and tax assessment.

³⁰ IRS Compliance Data Warehouse, Individual Returns Transaction File (Tax Year 2006).

³¹ This report contains a recommendation to restructure and simplify the family status provisions in the Code, including the EITC. See Legislative Recommendation, Simplify the Family Status Provisions, infra. For a previous recommendation to simplify the family status provisions in the Internal Revenue Code, see National Taxpayer Advocate 2005 Annual Report to Congress 397-406 (Key Legislative Recommendation, Tax Reform for Families: A Common Sense Approach).

³² National Taxpayer Advocate 2004 Annual Report to Congress, vol. 2 (Research Report, Earned Income Tax Credit (EITC) Audit Reconsideration Study).

³³ IRS Compliance Data Warehouse, Individual Returns Transaction File (Tax Year 2006).

³⁴ This report contains a legislative recommendation to reduce the procedural incentives for Congress to enact tax sunsets. See Legislative Recommendation, Eliminate (or Reduce) Procedural Incentives for Lawmakers to Enact Tax Sunsets, infra.

³⁵ IRC § 151(d).

³⁶See IRS Form 1040 Instructions at 36 (2008).

³⁷ This report contains a legislative recommendation to reduce the number of phase-outs in the Internal Revenue Code. See Legislative Recommendation, Eliminate (or Simplify) Phase-Outs, infra. To the extent that phase-outs are intended to increase the tax burden on higher income taxpayers, the same result can be achieved by adjusting the marginal tax rates, a more straightforward approach that is simpler and avoids the problem of marginal rate bubbles.

³⁸See IRS Notice 2006-50, 2006-1 C.B. 1141. Unlike the other examples cited in this section, the telephone excise tax refunds were authorized by the Department of the Treasury and did not involve congressional action.

³⁹ IRS News Release, IRS Announces Standard Amounts for Telephone Tax Refunds, IR-2006-137 (Aug. 31, 2006).

⁴⁰ IRS Office of Research, Analysis, and Statistics, Response to TAS Information Request (Dec. 17, 2008).

⁴¹ One might assume that tax preparers would know about the credit. Yet IRS data show that 16 percent of practitioner-prepared returns failed to claim the credit as well. IRS Office of Research, Analysis, and Statistics, Response to TAS Information Request (Dec. 17, 2008).

⁴² This estimate excludes criminal penalties and certain excise tax penalties. For a list of penalties and additional information about how the list was compiled, see A Framework for Reforming the Penalty Regime, in volume 2 of this report.

⁴³ IRC § 6707A.

⁴⁴ IRC § 6501(c)(10).

⁴⁵ TAS, Taxpayer Advocate Management Information System (keyword and history search performed in December 2008).

⁴⁶ This report contains a legislative recommendation to modify IRC § 6707A to mitigate the harsh results the penalty can produce. See Legislative Recommendation, Modify Internal Revenue Code § 6707A to Ameliorate Unconscionable Impact, infra. This report also contains a comprehensive set of recommendations to simplify the penalty provisions of the Code overall. See Legislative Recommendation, Reforming the Penalty Regime, infra, and an accompanying study, A Framework for Reforming the Penalty Regime, in volume 2 of this report.

⁴⁷ This report contains a legislative recommendation to simplify worker classification determinations. See Legislative Recommendation, Worker Classification, infra. In addition, the National Taxpayer Advocate previously proposed a package of legislative recommendations designed reduce the tax burdens on small business. See National Taxpayer Advocate 2004 Annual Report to Congress 386-402 (Key Legislative Recommendation, Small Business Burdens).

⁴⁸See National Taxpayer Advocate 2004 Annual Report to Congress 2-7 (Most Serious Problem, The Confounding Complexity of the Tax Code).

⁴⁹ Report of the President's Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System (Nov. 2005), at www.taxreformpanel.gov.

⁵⁰ The National Taxpayer Advocate previously articulated these principles in a presentation to the President's Advisory Panel on Federal Tax Reform. See Public Meeting of the President's Advisory Panel on Federal Tax Reform (Mar. 3, 2005) (statement of Nina E. Olson, National Taxpayer Advocate), at http://www.taxreformpanel.gov/meetings/meeting-03032005.shtml. For more detail, see National Taxpayer Advocate 2005 Annual Report to Congress 375-80 (Key Legislative Recommendation, A Taxpayer-Centric Approach to Tax Reform).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

For the last eight years, the National Taxpayer Advocate has criticized the IRS for its continuing failure to fully and properly utilize alternatives to collection enforcement actions.¹ In light of the recent downturn in the United States economy, it is imperative for the IRS to consider the circumstances of taxpayers facing economic hardship before initiating enforcement actions. In today's economic environment, taxpayers who previously were able to pay their taxes find themselves unemployed, behind on housing payments, and unable to meet their basic living expenses. Thus, the ranks of taxpayers who are unable to meet their tax obligations will swell.

The IRS is entrusted with a wide variety of powerful enforcement tools (e.g., federal tax liens, levies, property seizures, suits to foreclose the federal tax lien, and summonses) to collect delinquent tax revenue. The National Taxpayer Advocate recognizes the need for appropriate enforcement action against uncooperative or evasive taxpayers. However, when the IRS too quickly initiates "hard line" enforcement, regardless of the taxpayer's level of cooperation and compliance, and without careful consideration of the facts and circumstances and the full impact of these actions, the end result will likely be undue economic hardship on the taxpayer. This might ultimately lessen the ability of the taxpayer to resolve the debt and remain in compliance with future tax obligations.

The National Taxpayer Advocate has identified the following concerns with the IRS's current collection strategy, which, if left unchecked, will create far more problems than it resolves -- worsening the financial woes of many American taxpayers, while recovering much less revenue than the IRS could potentially realize through more cooperative payment arrangements:

• Current IRS enforcement initiatives do not reflect a proper balance between service and enforcement;

• Increased enforcement actions such as liens and levies do not necessarily translate into increased collection revenue;²

• Current IRS guidance provides little direction to prevent undue economic hardship for affected taxpayers; and

• The IRS has multiple collection alternatives at its disposal, such as installment agreements (IA) and offers in compromise (OIC), but fails to properly utilize them. For example, the number of accepted offers has decreased by over 72 percent from fiscal year (FY) 2001 to FY 2008.³

Analysis of Problem

Background

Congress Has a Long History of Emphasizing the Need for Restraint in the Use of IRS Collection Tools.

Section 6331(a) of the Internal Revenue Code (IRC) authorizes the IRS to collect taxes "by levy upon all property and rights to property" belonging to a person who "neglects or refuses to pay" any tax, and IRC § 6331(b) defines "levy" as including "the power of distraint and seizure by any means." However, over the past 30 years, Congress has enacted several key pieces of legislation to properly restrain the IRS's awesome collection powers. Most recently, the IRS Restructuring and Reform Act of 1998 (RRA 98) had a profound impact on the IRS's approach to enforcement actions.⁷ This important legislation placed a renewed emphasis on customer service and taxpayer rights. For example, RRA 98 significantly changed the management and oversight structure of the IRS. It also strengthened and enhanced the rights and protections applicable to taxpayers, such as:

• Establishing collection due process (CDP) hearing rights;⁸

• Requiring that the IRS receive the written approval of a U.S. District Court judge or magistrate prior to seizure of a principal residence;⁹

• Requiring an administrative review and appeal of any rejected OIC or IA;¹⁰ and

• Realigning the IRS's method of measuring its employees' performance to encourage and achieve an even-handed approach to tax administration, particularly as it relates to enforcement activities.¹¹

• Policy Statement P-5-1, which states, "The Service is committed to educating and assisting taxpayers who make a good faith effort to comply . . . In determining the appropriate enforcement action to take, factors such as the taxpayer's delinquency history should be considered. Promotion of long-term voluntary compliance is a basic goal of the Service, and in reaching this goal, the Service will be cognizant not only of taxpayers' obligations under our system of taxation but also of their rights."¹²

• Policy Statement P-5-34, which states, "The facts of a case and alternative collection methods must be thoroughly considered before determining seizure of personal or business assets is appropriate. Taxpayer rights must be respected. The taxpayer's plan to resolve past due taxes while staying current with all future taxes will be considered. Opposing considerations must be carefully weighed, and the official responsible for making the decision to seize must be satisfied that other efforts have been made to collect the delinquent taxes without seizing. Alternatives to seizure and sale may include an installment agreement, offer in compromise, notice of levy, or lien foreclosure. Seizure action is usually the last option in the collection process."¹³

• Policy Statement P-5-2, which states, "Case resolution, including actions such as lien, levy seizure of assets, installment agreement, offer in compromise, substitute for return, summons, and IRC 6020(b), are important elements of an effective compliance program. When it is appropriate to take such actions, it should be done promptly, yet judiciously, and based on the facts of each case."¹⁴

IRS Enforcement Initiatives Do Not Reflect a Proper Balance Between Service and Enforcement.

In recent years, the tone of communications from the IRS Commissioner's office began to drift from the guidance drafted after RRA 98, by focusing more on enforcement than service. As former Commissioner Mark Everson noted in a 2004 speech to the Internal Revenue Service Advisory Council (IRSAC), "The word 'enforce' is one that people didn't even like to use when I turned up here. That's not the case anymore."¹⁶ Not surprisingly, the IRS's use of enforcement tools has significantly increased each year since the lows in the years following the implementation of RRA 98. For example,

• Levies have increased by 1,608 percent (220,000 issued in FY 2000 compared to 3,757,190 in FY 2007);¹⁷

• Notice of federal tax lien (NFTL) filings have increased by 308 percent (167,867 filed in FY 1999 compared to 683,659 in FY 2007);¹⁸ and

• Seizures have increased by 320 percent (161 conducted in FY 1999 compared to 676 in FY 2007).¹⁹

The National Taxpayer Advocate has maintained a vigilant watch on these trends and devoted a large portion of her 2006 and 2007 Annual Reports to Congress to the IRS's collection strategy and programs.²³ In response to the issues raised and recommendations proposed in these reports, the IRS agreed to collaborate with TAS on several collection task forces. TAS and the IRS established five such working groups in February 2008 to address the IRS's application of allowable living expense (ALE) standards, collection payment alternatives (OIC and IA), the levy program, and early intervention techniques.²⁴ More recently, the IRS Chief of Collection agreed to collaborate with the National Taxpayer Advocate to develop training for collection employees on taxpayer rights and the proper use of collection alternatives.

While these joint task forces are a step in the right direction, the National Taxpayer Advocate has still noted an emerging trend in TAS cases involving collection issues. TAS is now seeing an IRS inclination to use enforcement very early in the case, rather than as a last resort. Local TAS offices and practitioners confirm the Collection function is more frequently requiring taxpayers to liquidate equity in assets, including personal residences and retirement accounts, to pay delinquent tax bills or the IRS will use its powerful collection tools to do so. IRS consideration of the current economy and the hardship consequences of these actions are not evident in many of these cases. We believe the dilemma facing these taxpayers is often a "false choice" -- liquidate your assets or the IRS will do it for you. As a result, we have seen an increase in the need for TAS involvement and the use of Taxpayer Assistance Orders to provide relief in these situations.²⁵

Increased Enforcement Actions Such as Liens or Levies Do Not Necessarily Translate Into Increased Collection Revenue.

As the nation faces a period of economic decline, with a corresponding decrease in tax revenues and an increase in the federal budget deficit, it is natural for the IRS to ramp up efforts to ensure all taxpayers pay their fair share of taxes. Intuitively, it seems to follow that a significant increase in the use of the IRS's more powerful collection tools would lead to a corresponding increase in collected revenue. Surprisingly, an analysis of data representing IRS enforcement actions and results does not support this assumption. In the years immediately following RRA 98, the use of traditional IRS collection enforcement actions fell substantially, primarily because of the need to implement the changes brought about by the new law. This decline eventually led to a perception that the IRS tax enforcement programs were underutilized and "out of balance." Interestingly, IRS studies have shown the total Collection yield was actually higher from FY 2000 to FY 2002 (the years when, according to many sources, IRS Collection went "out of business") than in FY 1995 and FY 1996, the peak years for levies and seizures.²⁶

For example, the number of levies issued by the IRS increased by 1,608 percent (from 220,000 to roughly 3.76 million) from FY 2000 to FY 2007. The increase in total collection yield during this period was only about 45 percent. An analysis of this relationship on a year-to-year basis shows no direct correlation between the volume of levies issued and the corresponding collection yield. As the following chart reveals, from FY 1998 to FY 2000, IRS levies decreased from over 2.5 million to 220,000. Yet, collection yield during this period actually increased! From FY 2001 to FY 2002, the use of IRS levies almost doubled (increased by 91 percent), yet collection yield increased by only two percent. An IRS research study has concluded that although traditional enforcement actions declined substantially post-RRA 98, "total collection yield was not dramatically impacted by RRA 98," and actually increased in every year but one after RRA 98!²⁷

 

CHART 1.2.1, Total Collection Yield and Levies Issued

 

FY 1995 -- FY 2007

 

 

 

IRS Guidance Provides Little Direction to Prevent Undue Economic Hardship on Affected Taxpayers.

TAS has reviewed the IRS procedural guidance to Collection employees that governs the nature of enforcement actions, in order to identify the degree to which an overly aggressive approach to enforcement may be facilitated, or even encouraged, by system design or emphasis. In general, we have found that the Collection portions of the Internal Revenue Manual (IRM) pertaining to enforcement actions provide little or no direction to IRS employees regarding proper pre-decisional consideration of economic hardship issues. Economic hardship is derived from IRC § 6343; however, the IRM procedures provide very little actual guidance about applying this concept to actual case decisions, particularly in the areas governing enforced collection. IRM 5.19.4.4.10(j) does include an adequate explanation of economic hardship, but this guidance is for consideration after the IRS issues a levy, not before.

Policy Statement P-5-71 states that, "A hardship exists if the levy action prevents the taxpayer from meeting necessary living expenses. In each case a determination must be made as to whether the levy would result in actual hardship, as distinguished from mere inconvenience to the taxpayer."²⁹ Yet, the most commonly used enforcement action -- a levy of a taxpayer's salary, wages, or bank account -- is predominantly issued via automation. Thus, the IRS requires little to no human intervention to make a distinction of hardship or "mere inconvenience."³⁰ Similarly, the IRS's Automated Collection System's (ACS) current process of systemically filing an NFTL on cases that are "shelved" or placed into the queue (regardless of whether the IRS made or initiated contact with the taxpayer), has the potential for further economic harm in today's economic times.³¹ At a time when so many homes are in foreclosure, the IRS should use caution when issuing federal tax liens, which are often more damaging than bankruptcy to taxpayers' attempts to secure credit.

Bankruptcy Does Not Always Provide a "Fresh Start" for Taxpayers with IRS-Related Debts -- Even When the Tax Debts Are Discharged.

It seems that obvious economic hardship is most likely in situations where IRS enforcement actions will cause the loss of a taxpayer's home or retirement assets. The loss of a home invariably will affect the ability of a typical taxpayer to meet today's necessary living expenses, and in many cases, the loss of retirement assets will have a significantly negative impact on the taxpayer's ability to meet future living expenses. Yet, consider current IRS procedures involving taxpayers who have filed for bankruptcy protection utilizing Chapter 7 of the United States Bankruptcy Code (11 USC), commonly known as a "liquidating bankruptcy." In Chapter 7 proceedings, a debtor may claim certain property as "exempt." The trustee cannot liquidate such property, nor can it be used to satisfy a debt, except in the case of alimony, security interests, non-dischargeable tax debts, and dischargeable taxes secured by an NFTL.³² A common asset claimed as "exempt" is the debtor's home. Other types of property are considered "excluded" from the bankruptcy estate. Generally, "excluded" property involves retirement assets (e.g., Employment Retirement Income Security Act (ERISA) qualified pension plans and Individual Retirement Accounts).³³ In these situations, the ability of debtors to retain their homes and retirement assets are a critical component of the "fresh start" concept that is a key element of the bankruptcy process.³⁴

The IRC, on the other hand, allows the IRS to pursue assets claimed as "exempt" or "excluded" in the bankruptcies, provided the prepetition tax lien encumbering those assets survived the bankruptcy even where the taxes have been discharged. Unlike exempt property where an NFTL must have been filed prepetition for a lien to survive bankruptcy, an NFTL need not be filed prepetition in order for the IRS to take collection action against excluded property, as the statutory lien under IRC § 6321 survives bankruptcy and is sufficient to allow the IRS to collect the discharged taxes from excluded property.³⁵

In recent years, the IRS has placed greater emphasis in pursuing collection on cases where a prepetition federal tax lien had been filed involving tax periods that were discharged in a Chapter 7 bankruptcy, and the taxpayer claimed a home or retirement accounts as exempt or excluded assets. Once identified, the IRS mails a letter to this taxpayer requiring him or her to either pay in full the outstanding lien interest in the property, or pay an amount equal to the available equity in the asset.³⁶ Otherwise, the IRS may initiate enforcement action -- typically a suit to foreclose on real property or a notice of levy on retirement accounts. In some situations, the IRS may forego immediate collection from exempt property and allow the NFTL to remain on file in the prospect of collecting dischargeable taxes at some future date.³⁷

In reviewing IRS procedural guidance in this area, we found very little recognition that the IRS demands on these taxpayers could create an economic hardship. Yet, these taxpayers have already been found insolvent by a bankruptcy court, which certainly would indicate they might have difficulty paying their liabilities. Particularly in light of the current U.S. economy, and the substantial tightening of the credit markets, a requirement for taxpayers to turn over to the IRS an amount equal to the equity in their homes is essentially requiring them to sell their homes in a deflated, stalled market.

We have found no evidence that SB/SE has established management controls to monitor the number of these demand letters or the volume and nature of enforcement actions initiated in these types of insolvency cases. Nor could we obtain reliable data on the number of suit to foreclose recommendations that Collection employees have made in these situations.³⁸ We have seen firsthand in TAS casework the serious economic harm these actions can create for taxpayers because of these suit recommendations. Consequently, we are very concerned that the increase of enforcement activity in this area, without adequate safeguards and controls or guidance to employees to fully consider the economic harm to taxpayers, may very well create negative consequences for many taxpayers who were seeking a "fresh start" through the insolvency process.

IRS Guidance Lacks Distinction as to What Constitutes a "Won't Pay" Taxpayer.

Another area in which IRS guidance fails to recognize the effects of the current economic environment is its consideration of whether a taxpayer is a "won't pay" or a "can't pay." Presently, only one IRM section contains any reference to the differing characteristics of such taxpayers.³⁹ Examples of "won't pay" taxpayers include:

• Taxpayers who have the ability to remain current and resolve their delinquent taxes through an alternative collection method but will not do so;

• Taxpayers who do not have the ability to remain current and resolve their liabilities, but have assets in excess of exempt amounts that will yield net proceeds to apply to the liabilities and are unwilling or unable to borrow on or liquidate these assets; and

• Taxpayers who will not cooperate with the IRS (e.g., those that evade contact or withhold financial information).

Moreover, in many situations where taxpayers have met our three criteria (cooperation, current compliance, and good faith efforts), the IRS uses the noncompliance that led to the taxpayer's deficiencies, and other past behavior, to justify seizure or enforcement action. In general, a taxpayer's current level of cooperation and willingness to find a way to resolve the liabilities should be judged as the standard and in such instances, the IRS should explore a viable collection alternative. This is particularly true in situations where the IRS has devoted little or no effort to contacting the delinquent taxpayers in a timely manner, and has allowed the tax problems to fester -- sometimes for many years.⁴⁰

The IRS Has Multiple Collection Alternatives at its Disposal But Fails to Use Them Properly.

Although they are not widely considered as such, IAs and OICs are in fact collection tools and not resolutions of last resort. As IRS Policy Statement P-5-2 makes clear, IAs and OICs are as useful as a lien, levy, or seizure of assets when trying to collect tax.⁴¹ Further, Policy Statement P-5-34 provides that, "Collection enforced through seizure and sale of the assets occurs only after thorough consideration of all factors and of alternative collection methods."⁴² Moreover, the statement reminds employees "the official responsible for making the decision to seize must be satisfied that other efforts have been made to collect the delinquent taxes without seizing . . . Seizure is usually the last option in the seizure process."⁴³ However, TAS cases suggest the IRS is taking the position that the taxpayer must sell all assets with equity (including personal residences) or secure financing before the IRS will consider any other collection option, which seems to be contrary to IRS policy.

For example, if a taxpayer has significant equity in assets as well as the ability to make monthly payments but cannot fully pay his or her liabilities prior to expiration of the Collection Statute Expiration Date (CSED), the IRS has several potential collection alternatives at its disposal.⁴⁴ The American Jobs Creation Act of 2004 amended IRC § 6159 to clarify that the IRS is authorized to enter into IAs that do not provide for full payment of the taxpayer's liability over the life of the agreement.⁴⁵ These agreements are known as Partial Payment Installment Agreements (PPIA). IRS guidance states that, "Before a PPIA may be granted, equity in assets must be addressed, and if appropriate, be used to make payment. In most cases taxpayers will be required to use equity in assets to pay liabilities."⁴⁶ However, the same guidance also provides that, "A PPIA may be granted if a taxpayer does not sell or cannot borrow against assets with equity because . . . it would impose an economic hardship on the taxpayer to sell property, borrow on equity in property, or use a liquid asset to pay the taxes."⁴⁷ Given today's economic conditions (e.g., a slumping real estate market, strict lending requirements, poor credit histories, and a lack of funds to service equity loans), a taxpayer's ability to "cash in" on the equity in his or her assets may be limited. In such cases, it makes good business sense for the IRS to enter into IAs or PPIAs to collect at least those funds that are immediately available, while addressing taxpayers' economic hardship. Yet, the IRS continues to underuse PPIAs. In the past two Annual Reports to Congress, the National Taxpayer Advocate has urged the IRS to increase awareness and usage of PPIAs.⁴⁸ In FY 2008, the IRS granted 22,555 PPIAs, which accounts for less than one percent of all IAs granted.⁴⁹ An even more useful and successful collection payment alternative is the streamlined IA. The IRS may approve a streamlined IA where the aggregate unpaid balance of tax liabilities is $25,000 or less, and can be fully paid within 60 months or prior to the CSED, whichever comes first.⁵⁰ These agreements do not require detailed financial analysis or approval by IRS managers, and may be granted even when a taxpayer could pay the full balance sooner.⁵¹ Yet, the IRS has recently restricted the use of streamlined IAs by requiring loan denial letters from taxpayers who would otherwise qualify if financial information reveals potential equity in assets.⁵²

Although RRA 98 promoted the use of IAs as a viable collection tool, the number of agreements granted by the IRS also declined in the years after the law took effect. From 1998 to 2001, IAs decreased by over 680,000. From 1999 to 2002, the IRS experienced a corresponding decrease in revenue dollars collected through IAs -- approximately $485.8 million.⁵³ The IRS Office of Chief Counsel's position, which questioned the authority of the IRS to enter into IAs that would not fully pay the outstanding tax liabilities, may have contributed significantly to these reductions.⁵⁴ Not until the American Jobs Creation Act of 2004 was the IRS able to resume granting IAs that would only partially pay the outstanding tax liabilities, known as PPIAs. However, as noted above, the number of PPIAs granted since the legislative change represents only a fraction of the decrease in IA activity and revenue dollars collected. We continue to question whether the IRS's overly cautious use of the PPIA represents lost opportunities to collect a significant amount of additional revenue, and afford many more taxpayers reasonable payment solutions for their tax debts.

In RRA 98, Congress encouraged the IRS to be flexible in its use of OICs.⁵⁵ Yet since the 2001 centralization of offer processing, both the number of offers submitted and the number of offers accepted have declined. Over this period, the IRS introduced many strict procedural requirements aimed at greater "efficiencies" in processing, and narrowly interpreted requirements imposed by Congress.⁵⁶ Not surprisingly, this approach has substantially chilled the submission of "good" OICs, with accepted offers declining by over 72 percent from FY 2001 to FY 2008.⁵⁷ As a result, and as the following chart vividly illustrates, taxpayers and practitioners no longer view the IRS offer program as a viable collection alternative.

 

CHART 1.2.2, IRS OIC Program, FY 2000 -- FY 2008⁵⁸

 

 

 

Conclusion

The IRS has many powerful enforcement tools at its disposal to help administer the nation's tax laws. However, effective tax administration calls for the IRS to reserve the more intrusive of these tools for situations involving uncooperative taxpayers who refuse to voluntarily comply with their filing and payment requirements and who will not work with the IRS to establish reasonable payment plans. The line between "won't pay" and "can't pay" is a fine one, especially in today's tough economic times when taxpayers feel desperate. As more and more taxpayers suddenly find themselves struggling to make ends meet, it is incumbent upon the IRS to take into account the economic realities of the day. In fact, there is nothing new about this duty -- it is already incorporated into many of the IRS's longstanding policy statements. When the IRS moves too quickly to collect revenue and fails to consider each taxpayer's specific circumstances, an imbalance between customer service, taxpayer rights, and enforcement is the unnecessary byproduct.

To more effectively deal with taxpayers in these difficult economic times, the IRS should consider taking the following actions: clarify or develop a new uniform policy statement that defines the concept of economic hardship; provide specific guidance requiring predecisional consideration of the concept of economic hardship in all IRM sections related to IRS Collection enforcement activities; review polices and procedures related to insolvency and the pursuit of exempt and excluded assets and establish adequate managerial safeguards and controls for situations when enforcement is appropriate; remove any procedural guidance related to the need to secure loan denial letters when a streamlined IA is an acceptable alternative; review and revise all existing policies and procedures related to collection payment alternatives such as OICs and PPIAs to allow for more flexibility and better usage in situations where economic hardship is present; continue to review and revise current case assignment practices to provide earlier intervention and resolution before a taxpayer's financial uncertainty worsens; and proceed in partnership with the National Taxpayer Advocate to develop training for collection employees on taxpayer rights and collection alternatives.

IRS Comments

The IRS understands the sensitive nature of the current economy and the potential effects it is having or will have on taxpayers. The IRS anticipates that taxpayers who previously were able to pay their taxes may be unable to do so as a result of the economic downturn. As reflected in our current case dispositions, we already have procedures in place for taxpayers who are experiencing financial hardships and are unable to pay their tax liability. Collection alternatives such as an installment agreement, an offer in compromise, and currently not collectible status are all used to resolve taxpayer cases. We are closely monitoring our receipt patterns and installment agreement and offer in compromise defaults to be able to effectively manage an increase in taxpayer cases, a subset of which would be those with economic hardship. Additionally, we plan to expand our outreach efforts to ensure taxpayers understand the availability of payment alternatives and where to go for assistance in resolving their tax liability if they are experiencing financial hardship.

We believe our collection policies and procedures maintain the proper balance between service and enforcement. The Fiscal Year 2008 Collection Program Letter outlined collection priorities and our focus on quality and timeliness. As the National Taxpayer Advocate states, a collection priority in FY 2008 was to increase the timely pursuit and appropriate application of enforcement tools. The focus, however, was not to take more enforcement action, but to take timely and appropriate case actions. The Collection Program Letter also included priorities to:

• Ensure that employees consider all available options in resolving taxpayer accounts.

• Improve Field Collection casework quality by ensuring that employees communicate clearly with taxpayers as to what is expected and the possible consequences if expectations are not met, and that there are clear actions dates with timely follow-up.

• Improve service to taxpayers to facilitate their understanding and fulfillment of their tax responsibility.

• Identify and take action to address problems being experienced by taxpayers in the Collection program

The National Taxpayer Advocate notes increases in the number of liens, levies, and seizures from 1999 to 2007 and correlates the increase directly to an increased emphasis on enforcement action. However, the message to collection employees was, and continues to be, "take the right action at the right time" to move the case toward resolution. By taking timely and appropriate case actions, we have increased our case dispositions and are able to work more cases. As a result, there is the potential for an increase in the number of levies, liens, and seizures.

The IRS disagrees with the National Taxpayer Advocate's notion that due to the economic decline and possible decrease in tax revenues that it is natural for the IRS to ramp up efforts to ensure all taxpayers pay their fair share of taxes. We will continue resolving cases with timely and appropriate case actions. Each case resolution is determined based on the individual facts and circumstances of the case, including economic hardship. We believe a balanced measure of an effective Collection program includes overall case quality and appropriate case resolutions, and not the number of enforcement actions taken.

Current guidance provides direction to collection employees on addressing situations and resolving cases when taxpayers experience an economic hardship.⁶⁴ Levies are released and cases reported currently not collectible based on the taxpayer's inability to pay the tax liability while paying necessary living expenses. Enforcement decisions are made based on the individual facts and circumstances of the case available at the time the action is taken. IRS procedures limit situations in which enforcement actions, such as seizure of a taxpayer's principal residence or levy of certain retirement plans, may be taken.⁶⁵ Seizure of a principal residence requires judicial consideration and approval affording the taxpayer the opportunity for a review by an independent third party. Prior to levying on a retirement plan, procedures, which were developed in coordination with the National Taxpayer Advocate, require consideration of the availability of other assets to pay the outstanding liability. Additionally, even if no other assets are available, a determination must be made that the taxpayer's conduct has been flagrant. IRM 5.11.6.2 provides guidance for this type of levy, including examples of flagrant conduct.⁶⁶ The IRS agrees the "fresh start" afforded individual debtors is an important element of bankruptcy policy. The fresh start is just one of the competing policies Congress sought to balance when it created the Bankruptcy Code's comprehensive scheme for treatment of debts. The most recognized example of this balance is found in the numerous exceptions to discharge found in section 523 of the Bankruptcy Code. In balancing the fresh start sought by debtors, creditors' interest in collecting, and the general public's interest in having an orderly process to support the flow of commerce, Congress determined that certain debts would not be discharged, even by a debtor who successfully completed the bankruptcy process.⁶⁷

Similarly, bankruptcy law has long recognized that a bankruptcy discharge does not generally affect lien interests,⁶⁸ and the Supreme Court has affirmed that this rule survives under the current Code.⁶⁹ Collection from such assets is consistent with the policy decisions made by Congress in establishing and defining the scope and limits of the relief afforded to debtors under the Bankruptcy Code. Any collection actions taken to enforce the federal tax lien against assets that were exempt, abandoned, or excluded from the bankruptcy estate must be in accordance with the provisions of the Internal Revenue Code, Treasury Regulations, and IRS policies and procedures. The same IRS requirements applicable to seizures of principal residences or levying on retirement plans,⁷⁰ such as level of approval required, consideration of economic hardship, and use of other collection alternatives, continue to apply when such assets were part of a bankruptcy estate.

The IRS agrees it is important to recognize the effects of the current economic environment and the taxpayer's ability to resolve their tax delinquency. We also believe our current policies and procedures provide sufficient guidance for the "won't pay" determination prior to consideration of seizure action. IRM 5.10.1.4 provides detailed guidance to assist Revenue Officers with this determination.⁷¹ The National Taxpayer Advocate states that enforced collection action should only be taken where unwillingness and a lack of cooperation are present. The actual enforcement decision is often much more complicated. A taxpayer may be willing to make some form of payment and yet still not reach agreement with the IRS on ability to pay or the appropriate resolution of the case. Whether the use of enforced collection action is appropriate must be determined based on all of the facts and circumstances of each individual case.

The IRS agrees installment agreements and offers in compromise are viable collection tools to be used when appropriate to resolve taxpayer liabilities. The IRS uses IAs to collect delinquent taxes and foster compliance. In FY 2007, over 97 percent of the installment agreements granted by the IRS were streamlined agreements which require little or no financial documentation. With respect to documentation requirements, it should be noted that the procedures for streamlined installment agreements have been revised to clarify that loan denial letters are not required as part of the necessary documentation for such agreements

The National Taxpayer Advocate makes the assumption that the reduction in dollars collected via installment agreements is directly related to the number, or reduction in the number, of installment agreements established over a period of time, that being 1999 through 2002, post RRA 98. However, making that assumption may not necessarily be accurate, as the length of the term of a streamlined installment agreement changed from thirty six (36) months to sixty (60) months in April 1999.⁷² Reduction in the tax dollars collected could as well be directly attributable to the change in the length of terms in the installment agreements subsequently granted during the same period of time. The change in length from thirty-six (36) months to sixty (60) would correspond with payment amounts being reduced by almost half.

The Partial Payment Installment Agreement (PPIA) allows a taxpayer to make payments against a tax debt when the payment schedule will not fully pay the liability prior to the expiration of the collection statute. Legislation allowing the use of the PPIA was enacted in 2004; hence, this is a fairly new collection tool for the IRS. In 2006, the first year PPIAs were available, the IRS granted 13,328 agreements. We continue to emphasize the use of PPIAs, when appropriate, to collection employees. We have seen corresponding increases in the number of PPIAs granted in FY 2007 (18,921) and in FY 2008 (22,555).⁷³ Additionally, a recent change in policy requires that a PPIA must be considered in cases where an offer in compromise is being rejected.

The Offer in Compromise program is an important alternative for taxpayers that are unable to pay in full, particularly those taxpayers that are experiencing economic difficulties. Our goal is to evaluate each offer and make a decision based on the facts presented by the taxpayer. As such, the policies and procedures we have established are meant to ensure that taxpayers who qualify have access to the program at any point during the collection process.⁷⁴

While the total number of offer receipts has declined since 2003, the rate of decline has slowed and, over the past three months, total offer receipts as compared to the same time period last year has increased.⁷⁵ There are several factors that have contributed to the decrease in offer receipts, including but not limited to, implementation of the $150 application fee and implementation of the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005 which mandated a payment equal to 20 percent of the OIC amount with all OIC submissions. In an effort to ensure the accessibility of the OIC program the IRS increased its outreach efforts to identify who qualifies for an OIC and provided clearer instructions and worksheets in the Form 656, Offer in Compromise.

The IRS continues to be proactive with internal and external stakeholders by providing outreach and clear guidance on economic hardship, as well as public policy Effective Tax Administration (ETA) offers. Our outreach efforts have been geared toward providing a clear understanding of the regulations governing ETA offers. Publication 594, The IRS Collection Process, also discusses ETA offers as an acceptable resolution. In addition, the Form 656, Offer in Compromise, definition of an ETA offer was revised to help clarify when an ETA offer is appropriate and outline the documentation a taxpayer should include with an ETA offer. Internal guidance, including several sections of the IRM,⁷⁶ specifically discusses ETA offers and alternative resolutions. Effective Tax Administration training was also provided to all field revenue officers during FY 2008.

The National Taxpayer Advocate makes seven specific suggestions to more effectively deal with taxpayers in these difficult economic times. We are taking or have taken the following actions with respect to these issues:

As noted earlier, we believe that current guidance provides sufficient direction to collection employees on addressing situations and resolving cases when taxpayers experience an economic hardship.⁷⁷ However, the IRS is looking to expand outreach efforts to ensure taxpayers understand the availability of payment alternatives and where to go for assistance in resolving their tax liability if they are experiencing financial hardship.

Pre-decisional consideration of economic hardship is present as part of the analysis and determination to pursue certain enforcement actions. In order to ensure our employees have the most up to date guidance, IRM sections, including those related to enforcement actions and economic hardship, are continually reviewed and revised to ensure they are in conformance as policies and procedures are updated. Additionally, we are developing a course for FY 2009 Revenue Officer Continuing Professional Education on responding to economic conditions. The course will focus on current economic conditions and the potential impact to taxpayers in general and collection cases specifically.

Managerial safeguards and controls including managerial approval of enforcement action taken against assets that were exempt, abandoned, or excluded from the bankruptcy estate are incorporated into current IRS policies and procedures. Any collection actions taken to enforce the federal tax lien against these assets must be in accordance with the provisions of the Code, Treasury Regulations, and IRS policies and procedures. The same IRS requirements applicable to seizures of principal residences or levying on retirement plans,⁷⁸ such as level of approval required, and consideration of economic hardship and use of other collection alternatives, continue to apply even when such assets were part of a bankruptcy estate.

The requirements for streamlined installment agreements have been revised to clarify that loan denial letters are not required as part of the necessary documentation for such agreements.⁷⁹ In FY 2007, over 97 percent of the installment agreements granted by the IRS were streamlined installment agreements.

Current policies and procedures allow for flexibility and use of PPIA and OIC in cases where economic hardship is present. A recent revision to the IRM requires that alternative resolutions, including a PPIA, must be discussed with a taxpayer prior to rejecting an OIC.⁸⁰ Additionally, we continue to emphasize the appropriate use of PPIAs to all collection employees.

We agree that reviewing case assignment practices should be an ongoing course of action. The current Consolidated Decision Analytics Project is developing more sophisticated decision analytics to route cases earlier, faster, and more accurately to the correct treatment streams.

The IRS will continue to work with representatives from the National Taxpayer Advocate on established collection improvement teams. These teams are focused on taxpayer rights and issues related to IAs, OICs, notices of federal tax lien, and the Trust Fund Recovery Penalty.

Taxpayer Advocate Service Comments

Troubled economic times require preemptive rather than reactive solutions. Thus, the National Taxpayer Advocate is encouraged that the IRS recognizes that current economic conditions create an environment where many more taxpayers will find it difficult to meet their federal tax obligations in a timely manner, as they struggle financially. We are pleased to note that many of the IRS's comments reflect a proactive approach to dealing with taxpayers who are unable to pay, particularly those affected by the economic uncertainty of the day.

For example, we commend the IRS for its plans to expand outreach efforts so that taxpayers understand the availability of payment alternatives and how to obtain help in resolving their tax liabilities when experiencing financial hardship. Another positive development is the IRS plan to develop a course for revenue officers to provide additional guidance on considering the impact of current economic conditions on taxpayers with IRS tax debts. We expect the IRS will work with TAS in developing this course, particularly since taxpayers with significant hardships frequently end up as TAS cases, and TAS can provide the IRS with valuable information on how the IRS can avoid exacerbating the taxpayers' economic situations. We are very pleased to see that the IRS has clarified its position that loan denial letters are not mandatory prerequisites for streamlined IAs. Moreover, we acknowledge recent communications from the IRS to alert taxpayers to the availability of lien subordinations in situations where such actions will facilitate the ability of some taxpayers to refinance their mortgages, rather than lose their homes to foreclosure actions.⁸¹

The National Taxpayer Advocate also agrees that the IRS actually needs to look no further than its existing collection toolkit to effectively resolve taxpayer cases where economic hardship exists, as it already possesses numerous viable collection alternatives, such as IAs, OICs, and CNC. However, the National Taxpayer Advocate remains concerned that IRS's response to the current economic downturn in regards to collection does not adequately consider the taxpayer's perception of IRS collection practices. Failing to take the appropriate steps to address this economic crisis could result in the perception of the IRS using "harsh" collection tactics in troubled times, thereby, discouraging taxpayers from trying to work things out with the IRS. Conversely, the perception of a more reasonable and flexible IRS is likely to encourage more taxpayers to try.

An Imbalance Between Service and Enforcement Remains.

The National Taxpayer Advocate has repeatedly stated, and the IRS has reiterated "that enforcement and service are not mutually exclusive." The IRS asserts that its collection policies and procedures maintain the proper balance between service and enforcement, but this is not always the case. We acknowledge that the IRS's intent of the FY 2008 Collection Program Letter may have been to focus not on taking more enforcement actions, but rather taking timely and appropriate case actions. In reality, the IRS may have sent mixed signals to its employees by placing a heightened emphasis on maximizing the use of enforcement tools, such as seizure and sale, suits to foreclose on the federal tax lien or reduce the tax liability to judgment, and the pursuit of exempt, abandoned, and excluded assets following a successful Chapter 7 bankruptcy. Considering the training material's lack of direction for employees to consider the potential economic hardship such actions could have on a taxpayer, along with the corresponding lack of procedural guidance in this area, we do not believe that the delivered message adequately reflected a balance of service and enforcement.

Moreover, in FY 2008, the IRS continued to issue the majority of its levies via automation (e.g., ACS and the Federal Payment Levy Program), generally initiating such enforcement action prior to attempting a personal contact with the taxpayer. The IRS's stated goal for collection is "taking the right action at the right time." The National Taxpayer Advocate believes the right time and right action are predicated on two simple factors -- early intervention and personal contact. By personally interacting with a taxpayer when the problem first arises, it is easier to ascertain the appropriate facts and circumstances prior to taking enforcement action and avoid having to deal with negative downstream consequences such as economic hardship and taxpayer burden. The heavy reliance on automated levy and lien filing -- without taxpayer contact -- undermines the IRS's mission of increasing voluntary compliance.

IRS Guidance for Consideration of Economic Hardship Is Lacking.

The National Taxpayer Advocate respectfully disagrees with the IRS's assertions that its current guidance provides sufficient direction to collection employees on how to address economic hardship. As noted in this report, our review of IRS Collection procedures in Part V of the IRM reveals very little specific guidance on what to include in pre-decisional consideration of economic hardship issues prior to initiating enforcement actions. Moreover, the IRM contains very few meaningful examples to illustrate to IRS Collection employees situations where these factors should lead to the use of collection alternatives, such as PPIAs and OICs. In fact, during the past year the National Taxpayer Advocate has seen a number of IRS Collection cases where these considerations were disregarded.

The IRS also states its guidance for levying on a retirement plan properly accounts for and considers whether the action will impose an economic hardship on a taxpayer. However, the National Taxpayer Advocate recently identified serious concerns with the guidance specifically referenced by the IRS and took exception with the IRS's definition of what constitutes "flagrant conduct." IRM 5.11.6.2 cites several examples of flagrant behavior but many of them focus on past actions of the taxpayer rather than his or her current level of compliance. For example, we agree that a taxpayer who is currently raising frivolous arguments or willfully evading the IRS should be classified as flagrant. However, under existing guidelines, a taxpayer who continues to contribute to a retirement plan while taxes are accruing, or who was assessed a Trust Fund Recovery Penalty ten years ago, would also be considered as having exhibited flagrant behavior.⁸² The IRS's rationale is flawed since it fails to consider whether the taxpayer's continued contributions were voluntary or if the IRS ever notified him or her that making future contributions could be construed as flagrant behavior, nor does it account for the current level of compliance by the taxpayer with an old TFRP assessment. The National Taxpayer Advocate has asked the IRS to reconsider this position and to clarify that in general a determination of flagrant behavior should be based on current actions rather than historical.

A Fresh Start in the Eyes of Whom?

The National Taxpayer Advocate appreciates the IRS's acknowledgment of the concept of a "fresh start" for taxpayers whose taxes are discharged through a Chapter 7 bankruptcy. We do not disagree that the IRS retains specific authority to enforce the federal tax lien against assets that were exempt, abandoned, or excluded from the bankruptcy estate. However, we are concerned that current IRS guidance provides far too little direction for local offices to determine which assets they wish to pursue. Moreover, the IRS's lack of any mechanism to track enforcement actions taken against these assets makes the matter even more troubling.

Since many taxpayers survive bankruptcy proceedings with very little to their names other than their exempt or excluded property, the National Taxpayer Advocate respectfully requests the IRS reconsider its pursuit of these assets and develop specific guidance that incorporates consideration of economic hardship into each and every determination. Although the National Taxpayer Advocate agrees there are specific enforcement authorities for the IRS to pursue assets that were exempt, abandoned, or excluded from the bankruptcy estate, it is important to keep in mind the fundamental concept of bankruptcy -- providing taxpayers with a "fresh start."

Limited Use of Available Collection Alternatives

Interestingly, the National Taxpayer Advocate has been engaged in this same dialogue about collection alternatives with IRS Collection management for several years. While we believe that IRS Collection policies and procedures unduly restrict reasonable payment alternatives to many taxpayers who require such flexibility in order to rebuild their lives, the IRS has routinely responded as it has again this year -- "we already have procedures in place for taxpayers who are experiencing financial hardships and are unable to pay their tax liability." However, the IRS fails to fully utilize these collection tools now, and continuing this flawed approach is especially shortsighted in these economic times. For example, in FY 2008, the IRS Collection Field operation collected approximately $6.6 billion dollars on delinquent taxpayer accounts (excluding formal installment agreements).⁸³ Yet, over $11 billion dollars were abated on these accounts, and $12.9 billion were reported as uncollectible.⁸⁴ As a percentage of overall case dispositions, the number of taxpayers granted PPIAs and OICs last fiscal year was negligible.⁸⁵ The IRS only collected a little more than $200 million with OICs in FY 2008, the lowest amount in many years, and approximately 45 percent of those dollars were accepted by Appeals. Tax practitioners increasingly tell us that the OIC has become irrelevant in their considerations of collection solutions for their clients. At the conclusion of FY 2008, the IRS reported over 9.2 million taxpayer delinquent accounts (TDAs) in active inventory.⁸⁶ Of these, approximately 3.3 million -- over a third -- of these accounts were inactive and assigned to the Collection "queue."⁸⁷ Approximately 6.2 million of these accounts involved delinquencies for tax periods from 2004 or older.⁸⁸ The IRS response to this report indicates that the emphasis in the Collection program in FY 2008 was "take the right action at the right time," and "we will continue resolving cases with timely and appropriate actions." Unfortunately, the FY 2008 program data does not reflect the IRS position on this matter.

The National Taxpayer Advocate continues to urge the IRS to reevaluate its Collection strategy, and develop procedures that deliver a true balance of service and enforcement with taxpayers who owe delinquent tax dollars. The conditions discussed in this report are not new. We have identified these concerns for several years. However, the current downturn in the economy has created a situation where many more taxpayers will be suffering through financial difficulties that may lead to tax debts. A continuation of the IRS's current inflexible Collection strategy will likely result in numerous lost opportunities to collect the delinquent revenue while providing service to taxpayers in a manner that fosters voluntary compliance.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

² The number of levies issued by the IRS increased by 1,608 percent (from 220,000 to roughly 3.76 million) from FY 2000 to FY 2007. However, the increase in total collection yield during this period was only slightly less than 45 percent. Moreover, from 1998 to 2000, IRS levies decreased from over 2.5 million to 220,000, yet collection yield during this period actually increased. From FY 2001 to FY 2002, the use of IRS levies almost doubled (increased by 91 percent), yet collection yield increased by only two percent. Our analysis is based on an IRS study: IRS, Small Business/Self-Employed Division (SB/SE) Research, "Liens, Levies, Seizures, and Total Yield: 10 Year Filing Trend," (Aug. 19, 2005) and then supplemented with data from various SB/SE Collection Activity Reports and Statistics of Income (SOI) Data Book information for FY 1999 to FY 2007.

³ SB/SE Collection Activity Report, NO-5000-108 (FY 2001 -- FY 2008). In FY 2001, the IRS accepted 38,643 OICs compared to 10,677 in FY 2008.

⁴See United States Bankruptcy Court, at http://www.uscourts.gov/Press_Releases/2008/bankrupt_newstat_ftable_mar2008.xls (last visited Nov. 14, 2008).

⁵ Alan Zibel, US Foreclosure filings up 71 percent in 3Q, Associated Press, Nov. 6, 2008.

⁶See United States Bureau of Labor Statistics, at http://www.bls.gov (last visited Nov. 14, 2008).

⁷ The Internal Revenue Service Reform and Restructuring Act of 1998 (RRA 98), Pub. L. No. 105-206, 112 Stat. 685 (1998).

⁸ RRA 98 § 3401(a) adding IRC § 6320 which allows a taxpayer the right to a CDP hearing within five days after filing of the first notice of federal tax lien with respect to a tax liability; RRA 98 § 3401(b) adding IRC § 6330 which allows a taxpayer the right to a CDP hearing prior to the first levy (except in special or jeopardy situations).

⁹ RRA 98 § 3445(a) (amending IRC § 6334(a)(13)); RRA 98 § 3445(b) (amending IRC § 6334(e)).

¹⁰ RRA 98 § 3462(c)(1) and (c)(2) (adding IRC §§ 7122(d) and 6159(e), respectively).

¹¹ For a more detailed discussion of IRS measures, see Most Serious Problem, Customer Service Within Compliance, infra.

¹² Internal Revenue Manual (IRM) 1.2.14.1.1 (Aug. 18, 1994).

¹³ IRM 1.2.14.1.8 (2) (May 28, 1999).

¹⁴ IRM 1.2.14.1.2 (Feb. 17, 2000).

¹⁵ IRM 5.10.1.4 (Oct. 1, 2004) provides a detailed description of these three categories.

¹⁶ Heidi Glenn and Warren Rojas, Everson Delays EITC Certification Effort, Backs Other IRSAC Ideas, 105 Tax Notes 905 (2004).

¹⁷ SB/SE Collection Activity Reports and SOI Data Book information for FY 2000 to FY 2007. See National Taxpayer Advocate 2006 Annual Report to Congress 110-29. Note: For the purpose of our analysis, 2008 data was not used due to the impact of the 2008 economic stimulus payment (ESP) on IRS collection activities. The IRS was forced to shift many of its Automated Collection System (ACS) resources away from normal collection work for several months to focus on answering ESP questions.

¹⁸ Various SB/SE Collection Activity Reports and SOI Data Book information for FY 1999 to FY 2007. Note that the FY 2007 figures were 79 percent higher than the FY 1998 figures (382,755).

¹⁹ SB/SE Collection Activity Report, Seizure Disposition Reports, NO-5000-33, and SOI Data Book information for FY 1999 to FY 2007. While the current number of seizures represents only a small fraction of the FY 1998 total (2,259), the significant increase in recent years bears watching.

²⁰ SB/SE, SB/SE Collection Program Letter FY 2008, 6.

²¹ U.S. Bankruptcy Code § 541(a)(1) provides that when a person files a bankruptcy petition, a bankruptcy estate is created consisting of "all legal and equitable interests of the debtor in property as of the commencement of the case," except for the interests identified in subsections (b) and (c)(2). Section 541(b) excludes from the bankruptcy estate certain types of property, including interests in Individual Retirement Accounts and Qualified Tuition Programs, more commonly known as 529 plans. Section 541(c)(2) excludes from the bankruptcy estate, property which is subject to an anti-alienation provision enforceable under applicable non-bankruptcy law. The Supreme Court in Patterson v. Shumate, 504 U.S. 753, 759-760 (1992) held that ERISA qualified pension plans are excluded from the bankruptcy estate under this section. Additionally, the debtor is allowed to exempt certain property from the bankruptcy estate under § 522. Further, property that is considered burdensome or of inconsequential value to the estate can be abandoned as property of the estate by the trustee. As a general rule, exempt or abandoned property cannot be used to satisfy any pre-petition debts during and after the bankruptcy case, unless the liens encumbering such property survive bankruptcy which would occur only if a prepetition notice of tax lien had been filed. U.S. Bankruptcy Code § 522(c)(2)(B). Unlike exempt or abandoned property, which was initially property of the estate, excluded property never becomes part of the bankruptcy estate. As such, excluded property can be used to satisfy prepetition debts in rem without regard to whether a prepetition notice of federal tax lien was filed because unlike with property of the estate, liens against excluded property cannot be avoided.

²² The government uses a suit to foreclose a tax lien where there is a specific, presently available source of collection. In a foreclosure action, the Department of Justice often requests a judgment against the taxpayer.

²³See National Taxpayer Advocate 2007 Annual Report to Congress 324-95, 432-47; National Taxpayer Advocate 2006 Annual Report to Congress 31-171.

²⁴ For a detailed discussion of the five task forces, see National Taxpayer Advocate Fiscal Year 2009 Objectives Report to Congress 39-40.

²⁵ IRC § 7811 authorizes the National Taxpayer Advocate to issue a Taxpayer Assistance Order (TAO) when a taxpayer is suffering or about to suffer a significant hardship as a result of the manner in which the tax laws are being administered if relief is not granted. See also IRM 13.1.20.2 (Dec. 15, 2007). In certain circumstances, the National Taxpayer Advocate or her delegate may issue a TAO to direct the IRS to take a specific action, cease a specific action, or refrain from taking a specific action, or to direct the IRS to review at a higher level, expedite consideration of, or reconsider a taxpayer's case. IRM 13.1.20.3 (Dec. 15, 2007). In FY 2008, TAS issued 28 TAOs on collection-related matters. This accounts for slightly more than 41 percent of all TAOs issued.

²⁶ SB/SE Research, Liens, Levies, Seizures, and Total Yield: 10 Year Filing Trend (Aug. 19, 2005).

²⁷Id.

²⁸See National Taxpayer Advocate 2007 Annual Report to Congress 156-61 (Most Serious Problem, Taxpayer Service and Behavioral Research); National Taxpayer Advocate 2007 Annual Report to Congress vol. 2, 158-67 (Normative and Cognitive Aspects of Tax Compliance: Literature Review and Recommendations for the IRS Regarding Individual Taxpayers).

²⁹ IRM 1.2.14.1.14 (Nov. 19, 1980).

³⁰ For a more detailed discussion of IRS levies, see National Taxpayer Advocate 2006 Annual Report to Congress 110-29.

³¹ IRM 5.19.4.5.2 (Apr. 26, 2006).

³² IRM 5.9.17.4(1) (May 16, 2008).

³³ IRM 5.9.17.4(3) (May 16, 2008). See also, Most Serious Problem, Customer Service Issues in the IRS's Automated Collection System (ACS), infra.

³⁴ 11 USC § 522. Federal bankruptcy law embraces the entire field of debtor-creditor relationships to provide a uniform and equitable method to distribute the debtor's assets to the debtor's creditors. At the same time, it gives the debtor an opportunity to start over with a clean (or at least improved) financial slate.

³⁵ IRC § 6321. A federal tax lien is created by statute and attaches to a taxpayer's property and rights to property for the amount of the liability. This is known as the "statutory" or "secret" federal tax lien.

³⁶ IRM 5.9.17.4.1(9) (May 16, 2008).

³⁷ IRM 5.9.17.4.2(3) (May 16, 2008).

³⁸ SB/SE response to TAS research request (Oct. 27, 2008).

³⁹ IRM 5.10.1.4 (Oct. 1, 2004).

⁴⁰ For more detail, see National Taxpayer Advocate 2006 Annual Report to Congress 62-82 (Most Serious Problem, Early Intervention in IRS Collection Cases).

⁴¹ IRM 1.2.14.1.2 (Feb. 17, 2000).

⁴² IRM 1.2.14.1.8(2) (May 28, 1999).

⁴³Id.

⁴⁴ IRC § 6502(a).

⁴⁵See H.R. Rep. No. 108-755, at 1697 (2004) (Conf. Rep.).

⁴⁶ IRM 5.14.2.2(2) (July 12, 2005).

⁴⁷ IRM 5.14.2.2.2(2)(E) (July 12, 2005). TAS applauds the IRS for including language referencing an economic hardship in this IRM section and encourages the IRS to place similar guidance within all sections related to enforced collection actions.

⁴⁸ National Taxpayer Advocate 2007 Annual Report to Congress 432-47; National Taxpayer Advocate 2006 Annual Report to Congress 86-87.

⁴⁹ SB/SE Collection Activity Report, NO-5000-6, Installment Agreement Cumulative Report (Sept. 29, 2008). A total of 2,624,487 IAs were granted in FY 2008.

⁵⁰ IRM 5.14.5.2 (Sept. 26, 2008).

⁵¹Id.

⁵² IRM 5.19.1.5.4.2(3) (Apr. 28, 2008).

⁵³ SB/SE Collection Activity Report, NO-5000-6, Installment Agreement Cumulative Report, FY 1999 to 2002. For our analysis of dollars collected via installment agreements, we used FY 1999 to FY 2002 data to account for the fact that the revenue for installment agreements is not likely to be fully received within the same year the IA is granted.

⁵⁴See National Taxpayer Advocate 2001 Annual Report to Congress 210-14.

⁵⁵ The conference report for RRA 98 states,

⁵⁶See T.D. 9086, 68 Fed. Reg. 48,785 (Aug. 15, 2003); Treas. Reg. § 300.3 (explaining the IRS's ability to charge a user fee for offer processing and investigation); Pub. L. No. 109-222 § 509, 120 Stat. 362 (2006), effective July 16, 2006, and codified at IRC § 7122(c)(1) (explaining The Tax Increase Prevention & Reconciliation Act of 2005 (TIPRA) and allowing the IRS to require a nonrefundable partial payment of 20 percent at the time of offer submission or monthly installment payments depending on the offer type and terms). For more information regarding IRS's processing of offers, see IRM 5.8.3.4 (Sept. 23, 2008).

⁵⁷ SB/SE Collection Activity Report, NO-5000-108 (FY 2001 -- FY 2008). In FY 2001, the IRS accepted 38,643 OICs compared to 10,677 in FY 2008.

⁵⁸ SB/SE Collection Activity Report, NO-5000-108 (FY 2000 -- FY 2008).

⁵⁹ RRA 98; H.R. Conf. Rep. 599, 105th Cong., 2d Sess., 289 (1998); Treas. Reg. § 301.7122-1(b)(3). "Economic hardship" occurs when an individual taxpayer is unable to pay reasonable basic living expenses. See Treas. Reg. § 301.6343-1.

⁶⁰ IRM 5.8.11.2.1 (Sept. 1, 2005).

⁶¹ For a more detailed discussion of ETA OICs, see National Taxpayer Advocate 2007 Annual Report to Congress 388-94.

⁶² National Taxpayer Advocate 2007 Annual Report to Congress 388-94.

⁶³ TIGTA, Ref. No. 2008-30-126, FY 2008 Review of Compliance with Legal Guidelines When Conducting Seizures of Taxpayers' Property.

⁶⁴ IRM 5.11.2.2.1 (Jan. 1, 2006); IRM 5.16.1.2.9 (Dec. 1, 2006).

⁶⁵ IRM 5.10.2 (Nov. 3, 2006); IRM 5.11.6.2 (Mar. 15, 2005).

⁶⁶ IRM 5.11.6.2 (Mar. 15, 2005).

⁶⁷See Grogan v. Garner, 498 U.S. 279, 287 (1991). "Congress evidently concluded that the creditors' interest in recovering full payment debts in these categories outweighed the debtors' interest in a complete fresh start.")

⁶⁸See Long v. Bullard, 117 U.S. 617 (1886).

⁶⁹See Johnson v. Home State Bank, 501 U.S. 78 (1991); Dewsnup v. Timm, 502 U.S. 410 (1992).

⁷⁰ IRM 5.10.2 (Nov. 3, 2006); IRM 5.11.6.2 (Mar. 15, 2005).

⁷¹ IRM 5.10.1.4 (Oct. 1, 2004).

⁷² IRM 21.9.1 (Apr. 1999).

⁷³ IDRS Extracts, SB/SE Collection Activity Report, NO-5000-6, Installment Agreement Cumulative Report (Sept. 28, 2008).

⁷⁴ IRM 5.8 (Sept. 23, 2008).

⁷⁵ SB/SE Collection Activity Report, NO-5000-108 (FY 2003-FY 2008), Monthly Report of Offer in Compromise Activity (FY 2008 and FY 2009).

⁷⁶ IRM 5.8.11 (Sept. 23, 2008); IRM 5.8.7.8 (Sept. 23, 2008); IRM 5.10.1.3.2 (Dec. 13, 2005); IRM 5.15.1.35 (May 9, 2008).

⁷⁷ IRM 5.16.1.2.9 (Dec. 2006).

⁷⁸ IRM 5.10.2 (Nov. 3, 2006); IRM 5.11.6.2 (Mar. 15, 2005).

⁷⁹ IRM 5.19.1.5.4.2 (Nov. 19, 2008).

⁸⁰ IRM 5.8.7.8 (Sept. 23, 2008).

⁸¹See IRS News Release IR-2008-141, IRS Speeds Lien Relief for Homeowners Trying to Refinance, Sell (Dec. 16, 2008).

⁸² IRM 5.11.6.2(5) (Mar. 15, 2005).

⁸³ SB/SE Collection Activity Report, Taxpayer Delinquent Account Cumulative Report, NO-5000-2 (Sept. 29, 2008)

⁸⁴Id.; SB/SE Collection Activity Report, Recap of Accounts Currently not Collectible Report, NO-5000-149 (Sept. 27, 2008); SB/SE Collection Activity Report, NO-5000-6, Installment Agreement Cumulative Report (Sept. 29, 2008).

⁸⁵ SB/SE Collection Activity Report, Report of Offer in Compromise Activity, NO-5000-108 (Sept. 29, 2008).

⁸⁶ SB/SE Collection Activity Report, Taxpayer Delinquent Account Cumulative Report, NO-5000-2 (Sept. 29, 2008).

⁸⁷Id.

⁸⁸Id.

Richard J. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

The National Taxpayer Advocate, in her 2007 Annual Report to Congress, identified the tax consequences of cancellation of debt income as one of the most serious problems encountered by taxpayers.¹ The rules that determine whether cancellation of debt income is includible in gross income are complex. There are several exceptions to the general rule of includibility, such as the exception for debt canceled when a homeowner becomes unable to make payments on a loan secured by his or her principal residence under the Mortgage Forgiveness Debt Relief Act (MFDRA).² The requirements for reporting excluded amounts are also complex, and taxpayers often do not receive reliable information about their tax reporting and payment obligations concerning cancellation of debt income.

For example, the New York Times described the operation of MFDRA as follows: "Suppose a buyer defaults on a $220,000 mortgage. The bank forecloses and sells the house in today's battered market for $180,000. The $40,000 of remaining debt is discharged. Under previous law, the $40,000 was considered income and was subject to taxation. Under this law, the tax obligation is forgiven."³ According to the Fort Worth Star-Telegram: "In tax law, the amount of forgiven debt is typically treated as income and is taxed. But to help people who are affected by the mortgage crisis, Congress excluded homeowners whose mortgage debt was forgiven in years 2007, 2008 and 2009. Keep good records, and keep track of the amount that the bank wrote off."⁴

These newspaper accounts are not inaccurate, but they fail to mention two important points. First, even though "qualified principal residence indebtedness" under MFDRA includes most home loans whether they resulted from a refinancing transaction, a second mortgage, or a home equity line of credit, the fact that the canceled debt is a home loan does not mean the MFDRA exception applies. The exception does not cover loan proceeds used for any purpose other than to acquire or improve a principal residence.⁵ As described below, many homeowners used a portion of their home loans to pay off medical bills, student loans, or other expenses. These canceled debts are not excludible from income under MFDRA (although they may be excludible under a different exception). Second, neither homeowners nor any other debtors who exclude cancellation of debt from income automatically receive the benefit of the exclusion. To claim the exclusion, taxpayers are required to file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) with their tax returns.⁶ If they fail to file Form 982, the IRS will assume the cancellation of indebtedness income is taxable.⁷

In recognition of the seriousness of the problems taxpayers face in reporting cancellation of debt, the National Taxpayer Advocate makes a Legislative Recommendation in this year's Annual Report to Congress suggesting three options that would make it easier for financially distressed taxpayers to exclude cancellation of debt from gross income.⁸

Analysis of Problem

Background

According to RealtyTrac, "one in every 475 U.S. housing units received a foreclosure filing in September [of 2008]. Foreclosure filings were reported on 765,558 U.S. properties during the third quarter, up more than three percent from the second quarter and up 71 percent from the third quarter of 2007."⁹ In response to this foreclosure crisis, Congress extended MFDRA, which was originally set to terminate on December 31, 2010, through 2012.¹⁰ The rise in foreclosures has taken place against a backdrop of increasingly risky loan practices.

In recent decades, an increasing number of housing loans were made by lenders specializing in subprime lending.¹¹ Subprime loan originations reached $160 billion in 1999, representing 12.5 percent of total originations.¹² According to a Department of Housing and Urban Development and Department of Treasury Task Force on Predatory Lending report, "The primary purpose of over 50 percent of first lien subprime mortgages and up to 75 percent of second lien subprime mortgages is debt consolidation and/or general consumer credit, not home purchase, home improvement or refinancing the rates and terms of a mortgage."¹³ Borrowers 65 years of age or older were three times more likely to hold subprime mortgage loans than borrowers under 35.¹⁴

Of the subprime loans that were second lien mortgages, 45 percent of the loans were used for debt consolidation, 30 percent for medical, education and other expenses, and 25 percent for home improvement.¹⁵

In the majority of loans, a portion of the proceeds was still being used to cover living expenses and pay other non-mortgage debt such as credit cards in 2001 and early 2002, as shown below:¹⁶

 

CHART 1.3.1, Use of Funds from Refinancings, 2001 and 2002

 

 

 

 

Percentages add up to more than 100 because each refinancing loan

 

could have been used for multiple purposes.

 

From 1992 to 2001, the level of credit card debt among seniors between 65 and 69 years old increased by 217 percent.¹⁷ "With virtually all medical expenses now payable by credit card, there is evidence to suggest that deductibles, co-pays, dental and vision care, prescription drugs and other uncovered costs played a significant role in the increased credit card balances of many older Americans."¹⁸

According to the New York Times, after years of "flooding Americans with credit card offers and sky-high credit lines, lenders wrote off an estimated $21 billion in bad credit card loans in the first half of 2008."¹⁹ If unemployment continues to increase, debt cancellation could exceed historic norms.²⁰

Cancellation of this debt does not qualify for exclusion from income under MFDRA, and using home loan proceeds to pay this debt disqualifies canceled loans for exclusion under MFDRA. Taxpayers need to be able to determine whether their canceled debt is excludible from income under a different exception (such as the insolvency exception) and must file Form 982 to claim the benefit of that exception.

Developments Since the 2007 Annual Report to Congress

The 2007 Annual Report recommended changes to various aspects of the reporting process to make it easier for taxpayers to understand their obligations in reporting cancellation of indebtedness income. The report recommended that the IRS:

• Develop a comprehensive publication that would assist taxpayers in preparing returns;

• Provide in-person assistance to taxpayers who seek information or return preparation assistance;

• Improve the form used by lenders to report cancellation of indebtedness income and the form used by taxpayers to report reductions in tax attributes; and

• Improve its communications with taxpayers who it believes misreported cancellation of indebtedness income.

New Publication 4681 Provides Better Information to Taxpayers

The National Taxpayer Advocate strongly recommended "that the IRS develop a publication on the tax treatment and reporting of cancellation of indebtedness income that consolidates all relevant information in one place."²¹ The IRS developed Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, in collaboration with the Taxpayer Advocate Service and released it in May 2008. The publication fills a critical information gap, because it provides an exhaustive explanation of cancellation of indebtedness issues.²²

The Taxpayer Advocate Service (TAS) Raised Awareness about Cancellation of Debt

As part of the 2008 IRS Nationwide Tax Forums, held in six major cities (Atlanta, Chicago, Orlando, Las Vegas, New York, and San Diego), TAS developed and presented a training session entitled Cancellation of Debt -- What You Need to Know. The session was designed to raise awareness of the issue among practitioners and to provide guidance for them. It opened with a video podcast showing the National Taxpayer Advocate describing cancellation of debt income and how this issue affects taxpayers. The session proceeded in a panel format with a TAS executive serving as moderator, a TAS attorney or systemic advocacy analyst sharing the TAS perspective, a representative from the Wage and Investment (W&I) division Automated Underreporter (AUR) unit describing how the IRS handles Forms 1099-C, and a local Low Income Taxpayer Clinic (LITC) staff member discussing the impact of cancellation of debt income on taxpayers and practitioners.

This session proved extremely popular, attracting standing room only crowds at all of the first three Tax Forums. The Atlanta and Chicago presentations drew more than a thousand attendees. In each of the final three locations, the session was presented twice to accommodate everyone who wished to attend, and attendees were given the new Publication 4681 as a reference document.

The IRS Revised Form 982

The National Taxpayer Advocate noted in the 2007 Annual Report that "The IRS could substantially simplify the task of completing the form [Form 982] for non-business taxpayers by clarifying the instructions."²³ In 2008, the IRS, in collaboration with TAS, revised Form 982 and the instructions to incorporate the MFDRA provisions (and other statutory provisions pertaining to Hurricane Katrina) and to provide clarification. The revised instructions include a detailed chart that guides taxpayers to the appropriate lines on the form. The taxpayer sees a column captioned "IF the discharged debt you are excluding is . . . " with a menu of different types of debt (qualified principal residence indebtedness, nonbusiness debt, or any other debt). Each category of debt on the menu corresponds to a column captioned "THEN follow these steps . . . " The steps explain exactly which lines on the form to complete.

The revised Form 982 is a substantial improvement over the previous version, although it does not reference Publication 4681 because the publication was issued later. As described below, further changes in Form 982 are desirable.

The IRS Revised Form 1099-C

Form 1099-C, Cancellation of Debt, is used by lenders to report cancellation of indebtedness.²⁴ Lenders issued Forms 1099-C to over 1.4 million taxpayers in 2006 and to more than 1.6 million taxpayers in 2005.²⁵ In 2006, over 15 percent of the taxpayers issued a 1099-C received more than one, but on only two percent of the Forms 1099-C did the issuer check the box to indicate the debt was discharged in bankruptcy.²⁶

The 2007 Annual Report to Congress noted that although taxable cancellation of indebtedness income does not arise if the underlying debt is nonrecourse, "there is no difference in the way canceled recourse debts and canceled nonrecourse debts are reported on Form 1099-C."²⁷ Form 1099-C also did not instruct the issuer to provide its telephone number, which made it more difficult for a debtor who disagrees with the amount recorded by the issuer as the fair market value of the property (or with any other aspect of the form) to communicate with the issuer to resolve the problem. The IRS revised Form 1099-C in 2008 to include the field "Was borrower personally liable for repayment of the debt?" and to instruct the issuer to provide its telephone number. The reverse side of the 1099-C, which contains "Instructions for Debtor," was changed to incorporate references to Publication 4681. The National Taxpayer Advocate applauds the IRS for making these improvements and looks forward to continued collaboration with the IRS in further refining and developing Form 1099-C and instructions.

The IRS Expanded Assistance to Taxpayers

In her 2007 report, the National Taxpayer Advocate noted that the IRS designated the tax treatment of canceled debt a subject that is "out of scope" for tax return preparation assistance at Volunteer Income Tax Assistance (VITA) sites, Tax Counseling for the Elderly (TCE) sites, and at the IRS's own Taxpayer Assistance Centers (TACs).²⁸ She recommended that the IRS designate the tax treatment of canceled debts as "in scope" for purposes of preparing returns and answering general questions at the TACs. She further recommended that the IRS provide specialized training on cancellation of indebtedness issues to a unit of telephone assistors and then route taxpayer calls on these issues to those assistors.²⁹

The IRS removed the "out of scope" designation at VITA and TCE sites with respect to the MFDRA exception for cancellation of debt income. Volunteers who staff these sites may now assist taxpayers in determining whether the MFDRA exception applies to them. However, training at VITA and TCE sites appears to incorporate Publication 4702, Mortgage Forgiveness Debt Relief Act of 2007, which is inadequate and out of date. We recommend that the IRS develop better training materials for VITA and TCE sites, confirm that VITA and TCE volunteers who staff these sites can spot potential application of other exceptions to cancellation of debt income, and refer taxpayers who visit VITA and TCE sites to TACs or LITCs, as appropriate.

The IRS also removed the "out of scope" designation at the TACs, and is providing more extensive training on cancellation of debt income for some TAC employees. Senior staff began training in November 2008 to be qualified to assist taxpayers with this issue by January 2, 2009, when the new filing season begins. As of December 15, 2008, 277 employees certified that they received such training. The printed training materials cover the insolvency and bankruptcy exceptions for cancellation of debt income, but not the exceptions for qualified farm indebtedness or qualified real property business indebtedness (these exceptions continue -- we believe, appropriately -- to be designated "out of scope").³⁰ The materials explain the meaning of insolvency and state "Note: Advise the taxpayer to attach a statement to their return explaining how they arrived at their insolvency amount. This could be done by listing all their assets in one column and liabilities in another."³¹ The materials include several examples from the new Publication 4681, as well as a glossary of terms and training on how to complete Form 982.³²

The printed training materials will be used in conjunction with an interactive electronic assistance program that was also recently developed and is scheduled to be launched in January 2009. The software, referred to as ITLA (Interactive Tax Law Assistant), is organized as an interview in which the taxpayer (through the IRS employee) answers a series of questions that lead to a conclusion and a recommended course of action.

Although one of the ITLA questions is "Were you insolvent at the time the debt was canceled?" the assistor is cautioned, "Note to Assistor: do not assist taxpayer with the insolvency calculation." Further, ITLA does not appear to distinguish between qualified principal residence indebtedness and home loan proceeds used to pay other types of debt. The relevant question, "Did you incur the debt in acquiring, constructing, or substantially improving your principal residence?" does not permit the taxpayer to respond that only a portion of the debt was so used. Therefore, the assistor may incorrectly conclude that all (or none) of the taxpayer's canceled debt is excludible from income.³³ For this reason, only IRS employees who receive separate training on cancellation of debt income should use ITLA. Taxpayers who call the IRS toll-free number (1-800-829-1040) to inquire about cancellation of indebtedness issues will speak with a Customer Service Representative who has received training and will use the same interactive ITLA software described above. Moreover, the IRS should add a follow-up question to ITLA inquiring whether the taxpayer used the proceeds for another purpose such as debt consolidation.

Continuing Challenges

Since the National Taxpayer Advocate's 2007 Annual Report to Congress, the IRS has dealt with several aspects of cancellation of indebtedness that pose difficulties for taxpayers. Particularly with respect to raising awareness of the issue and providing taxpayers with useful information, the IRS has been proactive. However, the difficulty of accurately describing this area of the law in terms that make sense to many taxpayers makes misreporting more likely. Misreporting will not, in many cases, result in an underpayment of tax, yet it may trigger an enforcement action by the IRS. The IRS needs to communicate with taxpayers who do not perfectly account for their cancellation of debt income before resorting to enforcement measures. As Commissioner Shulman has said, the IRS must show sensitivity in dealing with taxpayers buffeted by difficult economic times.³⁴

As described above, however, many taxpayers cannot use the MFDRA exception to exclude all of the canceled debt because they used some of the debt proceeds for purposes other than the acquisition, construction, or improvement of their principal residences. These taxpayers may avail themselves of the insolvency exception. Form 982, which is used to claim insolvency, contains a definition of insolvency and an example that illustrates the concept, but the form does not include a worksheet for calculating insolvency, nor does it direct the taxpayer to submit any substantiation of insolvency with the completed Form 982. As described below, this lack of guidance may result in later enforcement action by the IRS.

Further, taxpayers who qualify for another exception (such as the insolvency exception) will have to contend with the ordering rules set out in Form 982, which direct them to reduce tax attributes (such as basis, net operating losses, general business credit carryovers, minimum tax credits, and capital losses) in relation to the amount of the canceled debt. Taxpayers who are not farmers or businesses will very likely not have tax attributes other than personal property. Therefore, they will face the requirement of reporting adjustments to personal property such as furniture, jewelry, and clothing.

The reduction in basis in personal property will increase the gain on any subsequent disposition of these items or reduce the (nondeductible) loss. Implicit in the logic of this statutory scheme is the supposition: (1) that the taxpayer can establish that he or she has basis in personal property in an amount greater than zero; (2) that the taxpayer who reduces his or her basis in personal property may later sell such personal property; and (3) in the event of such sale the taxpayer will accurately report the gain or (nondeductible) loss, having kept track of the basis in the sold property in the interim. Also implicit in this framework is the supposition that the IRS likewise keeps track of basis in taxpayers' personal property as reported on Form 982. In a statutory environment such as this, to say nothing of the economic difficulty the taxpayer is likely facing, the importance of engaging in sensitive, proactive, and helpful communications with taxpayers, especially those whom the IRS identifies as having misreported collection of indebtedness income, is evident.

The IRS Is Too Quick to Take Enforcement Measures When Taxpayers Misreport Cancellation of Debt.

Taxpayers may first become aware they may need to report cancellation of indebtedness income when they receive a letter, Notice CP 2000, Notice Proposing Adjustments to Income, Payments, or Credits. The IRS issued 126,906 such notices in 2005.³⁶ The Notice CP 2000 is the first step toward assessment of the tax and in this sense is an enforcement measure.

The IRS may issue Notice CP 2000 after an AUR analyst evaluates a discrepancy between amounts shown on a Form 1099-C and on the taxpayer's return. It may be issued even if the taxpayer files a Form 982 claiming that he or she was insolvent, if the taxpayer does not also include a statement showing the amount of the insolvency. As described above, Form 982 does not direct the taxpayer to include such a statement. The Notice CP 2000 states that a discrepancy exists and instructs the taxpayer: "If you claimed insolvency, please provide us with a breakdown of your total assets and liabilities immediately before the cancellation of debt."

Therefore, taxpayers who successfully navigate Form 982 and attest to their insolvency may nevertheless find themselves facing an IRS enforcement action when they receive a Notice CP 2000 instructing them to provide a breakdown of their assets and liabilities, without any guidance as to what form the report is to take. The IRS should develop tools and schedules, including an insolvency worksheet, to help taxpayers accurately and completely meet their reporting obligations for cancellation of debt income when they file their tax returns.

The IRS Should Create a Single Unit Dedicated to Handling Cancellation of Debt Issues.

The complexity of this area of the law, coupled with the frequency of the issue and the expectation, in view of continued economic difficulties, that the number of taxpayers affected by cancellation of debt will grow, warrants the creation of a specialized IRS unit to handle related questions. This approach is not unusual: the IRS set up a specialized unit in 1998 to handle claims for relief from joint liability under newly enacted IRC § 6015,³⁷ and created procedures for accessing the "U.S. competent authority" in the early 1970s to help taxpayers deal with certain provisions of international tax treaties.³⁸ Providing more in-depth training to fewer employees would lead to better quality control and consequent improvement in service on a more timely basis (or in real time), consistency in service, and greater ease in spotting and accommodating emerging trends. The centralized unit should be given authority to initiate communications with taxpayers who may have misreported their cancellation of debt income by writing to them at their last known addresses and attempting to ascertain their current addresses. The unit should be responsible for initiating communications that focus on helping taxpayers meet their reporting obligations, rather than establishing that they have not.

Conclusion

The rules pertaining to cancellation of indebtedness income are complex and, for most taxpayers, counterintuitive. In 2008, the IRS responded to several concerns raised by the National Taxpayer Advocate in her 2007 Annual Report to Congress, but needs to do more to inform taxpayers of the rules and simplify the reporting procedures. The IRS should update the materials it uses to train volunteers who staff the VITA and TCE sites and revise the new ITLA software to verify that it accurately reflects the statutory framework and complements the written training materials. To the extent the IRS requires taxpayers to furnish a breakdown of assets and liabilities in order to claim the insolvency exception, it should provide appropriate forms and instructions, and revise Form 982 to direct taxpayers to provide this information with their returns. The IRS should create a specialized unit to handle cancellation of debt issues. IRS communications to taxpayers who misreport their cancellation of debt should take into account the economic difficulty that these taxpayers are likely facing. By extending the term of MFDRA through 2012, Congress recognized that the economic distress that leads to debt cancellation is not likely to abate in the next few years. The tax treatment of debt cancellation will therefore require continued attention.

IRS Comments

As a result of the downturn in the economy and the increasing numbers of taxpayers affected by taxable debt forgiveness income, the IRS has taken, and will continue to take actions to help taxpayers better understand and comply with these very complex provisions of the Internal Revenue Code. Many of these actions were taken in close collaboration with the National Taxpayer Advocate, who timely identified this as an emerging issue and provided the IRS with a number of excellent suggestions. As outlined in more detail below, the IRS developed a new Publication 4681, clarified other related forms, instructions, and publications, and expanded the scope of the services offered at TACs and IRS-sponsored volunteer sites to address this issue. In addition, IRS compliance notices are being revised to reference the Mortgage Forgiveness Debt Relief Act of 2007 and to include the new Publication 4681. Finally, as an integral part of the planning for the 2009 filing season, the IRS is developing enhanced communications products, updating and expanding IRS.gov, and increasing outreach to taxpayers, partners, and tax practitioners on this important subject.

The IRS developed Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, in collaboration with TAS, to consolidate all relevant information in one document. The publication, which was released in May 2008, provides a thorough explanation of cancellation of debt (COD) issues. The National Taxpayer Advocate recognized this accomplishment by awarding the National Taxpayer Advocate award to IRS employees who worked on the new publication.

The IRS, in collaboration with TAS, also revised Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and the instructions to incorporate MFDRA provisions and simplify the task of completing the form for non-business taxpayers. A new table was also added to the instructions on How to Complete the Form, to clearly explain which lines on Form 982 must be completed in situations involving qualified principal residence debt, other non-business debt (such as car loan or credit card debt), and other debts.

Although the National Taxpayer Advocate states the revised Form 982 is a substantial improvement over the previous version, she also states taxpayers continue to face challenges in reporting canceled debts on Form 982. Specifically, the National Taxpayer Advocate mentions that Form 982, which is used to claim insolvency, does not include a worksheet for calculating insolvency, nor does it direct taxpayers to submit substantiation of insolvency. The IRS notes that, because of the vast numbers and types of assets and liabilities that can exist for taxpayers, it is impossible to develop a worksheet that would work for all taxpayers. The IRS believes it would be more beneficial to illustrate the calculation through the use of examples, such as those in Publication 4681. To this end, the IRS plans to add a reference in Form 982 that directs taxpayers to the insolvency examples in Publication 4681. Further, the IRS is updating Publication 525, Taxable and Nontaxable Income, to include more specific guidelines on the types of assets and liabilities that must be included in the computation for taxpayers seeking to exclude income based on the insolvency exclusion.

With regard to the National Taxpayer Advocate's recommendation that the IRS direct taxpayers to submit substantiation of insolvency with the completed Form 982, the IRS believes this would pose unnecessary burden on those taxpayers since most will not receive a CP 2000 notice from the IRS. The IRS further notes this information is not required during the processing of Form 982, but is normally requested only in connection with resolution of an information return document matching discrepancy, or when a return is selected for examination.

With respect to the VITA and TCE programs, the IRS expanded the scope at VITA/TCE sites to include COD issues relating to the MFDRA. Volunteers with advanced certification will be trained to assist taxpayers with tax return preparation for income excluded due to "discharge of qualified principal residence indebtedness." A Screening Sheet will be available for volunteers to identify those taxpayers who can be assisted at the volunteer sites and those that need to be referred to TACs or Low Income Taxpayer Clinics. In addition, a training supplement to the 2008 Publication 4491, Volunteer Student Guide, is currently under development. The supplement, Publication 4491-X, will include information about the MFDRA, plus updates on other legislation that have become available since Publication 4491 was published. Two outreach products -- Publication 4702, Mortgage Forgiveness Debt Relief Act of 2007 Overview, and Publication 4705, Tax Relief for Struggling Homeowners and FAQs -- are also being updated to provide partners, volunteers, and employees with current information about the MFDRA.

With respect to TACs, the IRS has also expanded the scope of return preparation assistance to include COD issues related to MFDRA. Further, for tax law assistance, the IRS removed the "out of scope" designation and is providing extensive training on COD income for TAC employees who have received Intermediate Tax Law Training. The Interactive Tax Law Assistant (ITLA), an interactive electronic assistance program, will address insolvency, allowing trained assistors to help with a comparison of assets vs. liabilities.³⁹ Additional probes were added to determine the portion of principal residence indebtedness that was used for a purpose other than acquiring, constructing, or substantially improving the taxpayer's principal residence. The ITLA will also include a resulting response that will address the equity portion of the debt.

The IRS agrees that only IRS employees who receive separate training on COD income should use ITLA. Providing high quality service depends on employees knowing when and where to refer issues that are outside their training, certification and expertise. As such, referral procedures are in place to assist taxpayers when an employee encounters a question beyond their training or expertise. Taxpayer issues beyond these levels will be handled through a clearly defined referral process.⁴⁰

The National Taxpayer Advocate asserts the IRS is too quick to take enforcement action when taxpayers misreport COD. For example, the National Taxpayer Advocate states taxpayers may first become aware that they may need to report COD income when they receive a letter, Notice CP 2000, Notice Proposing Adjustments to Income, Payments, or Credits. The IRS believes taxpayer's first indication that they need to report COD income more often arises when they receive Form 1099-C, Cancellation of Debt, from the lender. Form 1099-C is required to be filed with the IRS and the taxpayer for cancellation of any debts of $600 or more. However, if the taxpayer fails to include this income on their return or to claim one of the applicable exceptions or exclusions on Form 982, they may receive a CP 2000 notice from the IRS. This notice includes a special paragraph that instructs the taxpayer that under certain conditions, cancelled or forgiven debt should be included on returns as income. This paragraph also informs taxpayers that if they claim insolvency, they should provide a breakdown of total assets and liability immediately before the cancellation of debt. Further, TY 2007 and future CP 2000 notices that involve COD income will include reference to the MFDRA and a copy of Publication 4681.

For COD cases selected for review by the Automated Underreporter (document matching) Program, if the taxpayer files Form 982 to claim the insolvency exception, a CP 2000 request for substantiation of insolvency is much like any other issue where the IRS is verifying the taxpayer's claim. The practice of requesting additional information from the taxpayer, even though inclusion of that information is not required at the time of filing, is not unique to situations involving COD insolvency status.

Finally, the National Taxpayer Advocate recommends the IRS create a single unit dedicated to handling COD issues, similar to the current Innocent Spouse program or the U.S. competent authority procedures created in the early 1970s. It is important to understand that unlike Innocent Spouse or the recently centralized Identity Theft unit, where specialized handling is provided to address unique claims or uncommon issues, the requirement to report and pay tax on COD income is an integral part of IRS' information, education, assistance, and compliance operations. In light of current economic conditions, the IRS believes the additional focus and attention to the COD income issue, as outlined above, is fully warranted. However, there are myriad complex provisions in the Code. At this time, the IRS does not believe the COD income issue is so unique as to justify creation of redundant, centralized operations dedicated solely to this particular tax provision.

While the IRS and the National Taxpayer Advocate have worked together very effectively in addressing issues surrounding the problem of understanding and reporting the tax consequences of cancellation of debt income, some challenges remain where the IRS appears not to appreciate the uniqueness and long-term nature of the problem. For example, the IRS believes that a taxpayer first realizes he or she may have cancellation of indebtedness income upon receipt of the Form 1099-C. This assertion simply does not correspond to the realities taxpayers face when their homes are foreclosed, they are evicted, and their former residences sold. Taxpayers in this situation seek alternative living arrangements, such as with friends or family or in shelters, and they may move several times. It should come as no surprise that many taxpayers in this situation do not notify the lender that foreclosed on their home of their current whereabouts in order to ensure that they will receive a form they have never heard of which will permit them to meet a tax reporting obligation that they do not even suspect exists. This is a unique problem, and the IRS should find unique approaches to helping taxpayers understand and report the tax consequences of their debt cancellation. An AUR notice, as the likely first indication taxpayers receive that they may have a tax liability, should be explanatory and helpful, keeping in mind that many taxpayers will not in fact owe additional taxes. The outreach and communications products that the IRS is creating, described in its response, could be included with the initial letter AUR sends.

We are unconvinced that the IRS cannot produce an insolvency worksheet for taxpayers to submit with their tax returns when they claim the insolvency exception. The IRS is developing specific guidelines pertaining to insolvency for inclusion in Publication 525, Taxable and Nontaxable Income, which demonstrates that the capability exists. Designing a form with that information (including a line for "other" assets or liabilities if necessary), providing a general explanation for the form, and referencing Publication 525, would be helpful and appropriate.

As another example of the IRS's underestimate of the significance of this issue, the IRS explains that it solicits substantiation from taxpayers claiming the insolvency exception "much like any other issue where the IRS is verifying the taxpayer's claim." It is true that the rules pertaining to cancellation of debt income have been in place for many years. As our statistics show, however, entire segments of the population, such as the elderly with Most Serious Problems credit card debt used to pay for medical care, are now affected by these rules for the first time. Middle-class taxpayers whose jobs will be impacted by the economic downturn and the subprime lending spree of recent years will join the ranks of those with debt cancellation reporting obligations. These conditions will transform the problem of cancellation of debt reporting into a taxpayer crisis for the next five years at least. The IRS is short-sighted to resist immediate and fundamental accommodation of this reality.

² Pub. L. No. 110-142 (2007).

³ Jan M. Rosen, New Rules Ease the Sting of Mortgages, The New York Times, Feb. 10, 2008.

⁴ Vicki Lee Parker, McClatchy Newspapers, Tax Tips for Dealing with Turbulent Markets, Fort Worth Star-Telegram, Sept. 28, 2008.

⁵ Pub. L. No. 110-142 § 2(b)(2007).

⁶ IRS Pub. 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, 4-7 (2007).

⁷Id. at 3 (2007). The IRS is notified that a debt has been canceled by means of Form 1099-C, Cancellation of Debt, issued by creditors who forgive a debt of $600 or more.

⁸See Legislative Recommendation, Simplifying the Tax Treatment of Cancellation of Debt Income, infra.

⁹ Press Release, RealtyTrac, Foreclosure Activity Decreases 12 Percent in September, at http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=5299&accnt=64847 (Oct. 23, 2008).

¹⁰ Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, § 303.

¹¹ Department of Housing and Urban Development and Department of the Treasury Task Force on Predatory Lending, Curbing Predatory Home Mortgage Lending 28 [hereinafter Treasury-HUD Report], at http://www.hud.gov/library/bookshelf12/pressrel/treasrpt.pdf (2000).

¹²Id. at 29.

¹³Id. at 26.

¹⁴ Neil Walters and Sharon Hermanson, Subprime Mortgage Lending and Older Borrowers, AARP, at http://www.aarp.org/research/credit-debt/mortgages/aresearch-import-182-DD57.html (March 2001).

¹⁵ Treasury-HUD Report at 31.

¹⁶ Javier Silva, A House of Cards: Refinancing the American Dream, at http://archive.demos.org/pubs/house_cards.pdf (2005). Percentages are based on number of loans issued and not on loan amounts.

¹⁷ Heather C. McGhee & Tamara Draut, Retiring in the Red: The Growth of Debt Among Older Americans 3, at http://archive.demos.org/pubs/Retiring_2ed.pdf (2004) (percentage based on 2001 dollars).

¹⁸Id. at 6.

¹⁹ Eric Dash, Consumers Feel the Next Crisis: It's Credit Cards, The New York Times, Oct. 29, 2008.

²⁰Id.

²¹ National Taxpayer Advocate 2007 Annual Report to Congress 31.

²² In July 2008, the National Taxpayer Advocate awarded the National Taxpayer Advocate award to TAS and other IRS and Chief Counsel employees who worked on the new Publication. The National Taxpayer Advocate Award is conferred on IRS employees who make extraordinary contributions in support of the following TAS strategic objectives: advocate changes in tax law or procedures that protect taxpayer rights, reduce taxpayer burden, and improve IRS effectiveness; improve TAS's ability to identify and respond to taxpayer concerns; identify significant sources of TAS casework and work with operating divisions on strategies to reduce inappropriate TAS workload; and ensure the human resources component of TAS is adequate to meet its workload demands.

²³ National Taxpayer Advocate 2007 Annual Report to Congress 23.

²⁴ Treas. Reg. § 1.6050P-1(a)(1).

²⁵ Lenders issued Forms 1099-C to 1,452,393 taxpayers in 2006 and to 1,635,820 taxpayers in 2005. IRS Compliance Data Warehouse, Individual Returns Master File (Tax Years 2005, 2006).

²⁶ IRS Compliance Data Warehouse, Individual Returns Master File (Tax Year 2006).

²⁷ National Taxpayer Advocate 2007 Annual Report to Congress 18.

²⁸Id. at 24.

²⁹Id. at 33.

³⁰Cancellation of Debt for Field Assistance & SPEC Employees (Oct. 2008). Taxpayers who ask questions that are out of scope are referred to the IRS tollfree numbers, the Internet, or a trained phone assistor. If a qualified assistor is not available, the IRS arranges a callback with a response time of up to 15 days. See I.R.M. 21.3.4.3.7.5 (Oct. 1, 2008).

³¹Cancellation of Debt for Field Assistance & SPEC Employees at 5-20 (Oct. 2008).

³² The glossary contains, among other entries, "Insolvency/Solvency" which states, in part: "You were insolvent immediately before the cancellation to the extent that the total of all your liabilities exceeded the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account)."

³³ The IRS has indicated that a revised version of the ITLA software will be available on Dec. 5, 2008, which will address these shortcomings in the current application. IRS response to TAS Nov. 21, 2008.

³⁴ Martin Vaughan, IRS Head: Tough Economic Times Call for Sensitive Approach, Dow Jones Newswires, Oct. 27, 2008. See also Most Serious Problem, Customer Service within Compliance, infra; Most Serious Problem, The IRS Needs to More Fully Consider the Impact of Collection Enforcement Actions on Taxpayers Experience Economic Difficulties, infra.

³⁵ Pub. L. No. 110-142 § 2(b); IRS Pub. 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments 7 (2007).

³⁶ IRS response to TAS research request (Oct. 31, 2007); UR TY 2005 Process Code Results -- Data Extracted 10/27/07, AUR National Rollup for Category 29 (cancellation of debt).

³⁷See IRS Form 8857, Request for Innocent Spouse Relief (1998).

³⁸See Rev. Proc. 70-18, 1970-2 C.B. 493.

³⁹http://serp.enterprise.irs.gov/databases/irm-sup.dr/current/itla/itla-home.htm.

⁴⁰ IRM 21.3.4.3.7, Referral Procedures.

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

With an estimated $58 billion in unpaid employment taxes, it is clear that the IRS faces a significant noncompliance problem.¹ At the same time, approximately 88 percent of all employment tax returns are filed with no balance due.² Thus, recognizing that the majority of taxpayers are compliant, the IRS needs to take a balanced approach to collecting these taxes. While the need to collect unpaid payroll taxes is clear, the IRS should apply different treatments to taxpayers depending on their level of and reasons for noncompliance. The National Taxpayer Advocate has the following concerns about the IRS's current procedures and initiatives to address noncompliance:

• IRS policies may overreach and undermine some of the important protections enacted in the Taxpayer Bill of Rights 2 (TBOR 2) and the IRS Restructuring and Reform Act of 1998 (RRA 98), especially with respect to Trust Fund Recovery Penalties (TFRPs);³

• While it is essential to address the existing significant level of noncompliance, the IRS must also focus on encouraging voluntary compliance by assisting those taxpayers attempting to comply with complex rules and procedures;

• The IRS has not concentrated sufficient resources on early intervention techniques to prevent the accumulation of substantial employment tax liabilities; and

• To avoid costly downstream enforcement actions, the IRS needs to focus on building up a local compliance presence for enforcement purposes and to perform outreach and education initiatives.

High Rate of Employment Tax Compliance

Employment taxes constitute a significant source of revenue for the federal government. In fiscal year (FY) 2007, of the total $2.7 trillion the IRS collected, payroll taxes represented approximately $850 billion.⁴ Despite the burdensome and complex requirements associated with employment taxes, the rate of compliance among employment taxpayers is quite high. For example, IRS data shows that in FY 2007, over 88 percent of all employment tax returns were filed with no balance due.⁵ Thus, IRS data indicates that the overwhelming majority of employers are presumably compliant.

GAO Report on Significant Employment Tax Noncompliance

While employment tax compliance is relatively high, noncompliance is still a significant problem. The Government Accountability Office (GAO) recently conducted an audit to address the problem of unpaid payroll taxes at the request of the Permanent Subcommittee on Investigations of the U.S. Senate Committee on Homeland Security and Governmental Affairs. The results of the study were the focus of a hearing on July 29, 2008, titled "Payroll Tax Abuse: Businesses Owe Billions and What Needs to be Done About it." The audit found that as of September 30, 2007, over 1.6 million businesses owed over $58 billion in unpaid federal payroll taxes (including penalties and interest) that have accumulated over the last 10 years. The IRS has classified over half of the debt as currently uncollectible.⁶

The National Taxpayer Advocate's research similarly indicates that as of September 2007, 1.6 million taxpayers owed approximately $58 billion in employment taxes. Less than half of this amount -- $26.2 billion -- represented actual taxes, as interest ($17.5 billion) and penalties ($14.2 billion) made up the rest.⁷ Approximately 30 percent of the $58 billion consists of interest, demonstrating that the timing of IRS intervention is extremely vital, because the accumulation of interest and penalties significantly exacerbates delinquency issues.

In its report, GAO concluded employment tax noncompliance is increasing. In a 1998 study, GAO found unpaid payroll taxes totaled $49 billion. The recent GAO report found that in the ten years since, the number of businesses with unpaid payroll taxes has decreased from 1.8 million to 1.6 million, but the size of the tax debt increased by approximately 20 percent.⁸

The National Taxpayer Advocate questions whether employment tax noncompliance has in fact increased over the past decade. The 1998 figures cited by GAO were not adjusted for inflation; such adjustment is necessary to reflect the change over ten years. In fact, the amount of the inflation-adjusted employment tax gap appears to have shrunk, because $49 billion in 1998, adjusted for the consumer price index, is equivalent to over $62 billion in 2007. In addition, the GAO data does not indicate whether the number of employers in the United States has increased in the last ten years, or whether the ratio of unpaid payroll taxes to total payroll taxes has increased during this time. Merely providing aggregate data without making these adjustments and comparisons can distort the picture and prevent the IRS from designing appropriate solutions.

Complex Employment Tax Requirements

Employers that pay wages for services of an employee are required to deduct and withhold Social Security, Medicare, and income taxes from the wages.⁹ Employers are also responsible for unemployment tax (FUTA) and their share of the Social Security and Medicare tax for their employees.¹⁰ Employers may receive a credit, subject to limitations, on their unemployment tax up to the amount of state unemployment taxes they pay.¹¹ The determination of whether an employer has employees subject to withholding is based on the facts and relationship surrounding the employment.¹²

Generally, employers are responsible for filing tax returns and making periodic payments, known as deposits, to the IRS for employment taxes. While the rates for Social Security and Medicare taxes are fixed by law, employers may calculate income tax withholding under the percentage method or the wage bracket method.¹³ An employer determines withholding based on the wage bracket method by finding the proper withholding on the tables provided in Publication 15, (Circular E), Employer's Tax Guide, and referencing the bracket for the withholding from the employee's pay period wages, pay period, marital status, and number of allowances for withholding. If the wages exceed the amount for the period and marital status provided, the employer may use the percentage method to determine withholding.¹⁴ The percentage method involves multiplying the employee's pay period wages, reduced by the amount of each withholding allowance for a certain period and marital status, by the percentage for the income level on the table in Publication 15.

An employer determines the amount of allowances for or exemption from withholding from the employee's Form W-4, Employee's Withholding Allowance Exemption Certificate, which is to be completed and submitted at the time the employee begins employment.¹⁵ If the employee fails to provide Form W-4, the employer must withhold taxes as if the employee were single and had no withholding allowances.¹⁶ The IRS requires employers to retain current Forms W-4 for all of their employees and may require the employer to submit copies upon written notice or as directed in published guidance.¹⁷

Employers with total FUTA exceeding $500 in any quarter must deposit the tax with the IRS.¹⁸ Employers are required to deposit Social Security, Medicare, and income tax withholding for employees either annually, semiweekly, or monthly. Those with total Social Security, Medicare, and income tax withholding less than $50,000 during the lookback period (the annual period ending on June 30) generally deposit these taxes by the 15th of the month following the month the taxes were collected.¹⁹ Employers with aggregate employment taxes exceeding $50,000 during the lookback period must deposit the taxes on a semiweekly basis.²⁰ Semiweekly depositors must make their employment tax deposits on or before the following Wednesday if their payroll is paid on Wednesday, Thursday or Friday, or on or before the following Friday if their payroll is paid between Saturday and Tuesday.²¹

Employers may deposit employment taxes through the Electronic Federal Tax Payment System (EFTPS) or by depositing or mailing the funds to an authorized financial institution or IRS lockbox. Employers with deposits exceeding $200,000 in a year are required to use the EFTPS the following year.²² The IRS provides instructions to taxpayers with Form 8109, Federal Tax Deposit Coupon.²³ The IRS may assert a penalty under IRC § 6656 for failure to timely make any required employment tax deposit.²⁴ There are two exceptions to monthly or semiweekly deposits: (1) if in any deposit period an employer has accumulated $100,000 or more of employment taxes, the employer must make a deposit the next banking day;²⁵ and (2) in some cases, a payment with the payroll tax return may be made in lieu of a monthly or semiweekly deposit without penalty.²⁶

Most employment tax returns are due at times other than when the deposits are due. The taxpayer must file Form 941, Employer's Quarterly Federal Tax Return, no later than the last day of the month following the close of the calendar quarter. Some employers may receive written notification from the IRS that they are entitled to file annually on Form 944, Employer's Annual Federal Tax Return, instead of Form 941.²⁷ Employers file Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, to report federal unemployment tax,²⁸ and must file Forms 940 and 941 by the last day of the month following the close of the tax year.²⁹ Employers are required to report to each employee the amounts of wages paid and withholding by January 31 of each year on Form W-2, Wage and Tax Statement.³⁰ Employers must file Form W-3, Transmittal of Wage and Tax Statements, with copy A of all Forms W-2 with the Social Security Administration by the last day of February each year.³¹

IRS Employment Tax Enforcement Procedures

Most IRS collection efforts for employment taxes focus on early intervention and the detection of pyramiding taxpayers.³² In addition to using the specific tools for employment taxes identified below, the IRS collects these taxes through balance due notices, lien and levy determinations, and filing notices of federal tax lien or levy and seizure of the employer's property. The IRS is particularly concerned with collecting employment tax deposits and imposes a trust for these taxes on employers under IRC § 7512(b) by providing notice.³³ The IRS also imposes a special trust under IRC § 7501 on any person required to collect and withhold an employee's taxes, which forms the basis for the TFRP under IRC § 6672.³⁴ In practice, the IRS ensures employment tax compliance by monitoring federal tax deposits (FTDs) and taking action when the employer is delinquent or late on making the deposits.³⁵ However, the IRS appears to focus most of its monitoring efforts on employers making semiweekly deposits.³⁶

Once the IRS is alerted to an employer's noncompliance, it will assign an FTD Alert to a revenue officer.³⁷ During the initial contact with the taxpayer, the revenue officer will explain the noncompliance; provide Publication 1, Your Rights as a Taxpayer, and Notice 931, Deposit Requirements for Employment Taxes; discuss the true cost of failing to deposit taxes, including the FTD penalty, with the employer; ensure that the employer understands the consequences of continued noncompliance; and encourage the employer to remain current with deposits first, while working to resolve past due deposits. After the initial contact, the revenue officer will monitor compliance until the account is resolved.³⁸

A revenue officer who is unsuccessful at collecting employment taxes from the employer or the responsible person after proceeding with any levies and filing any liens will then decide whether a criminal referral is necessary. The revenue officer will determine if the employer's case is egregious; that is, collection procedures have been unproductive or futile in stopping or reducing trust fund pyramiding. The revenue officer will hand-deliver to the employer or, if the employer is unavailable, leave at the place of business a letter explaining the employer has flagrantly failed to pay and collect employment taxes and prosecution under IRC § 7215 may be appropriate.³⁹ The revenue officer may then require monthly filing of Form 941-M and monthly or semimonthly tax deposits.⁴⁰ If the employer fails to comply with the requirements, the revenue officer may seek prompt assessment of unpaid monthly liabilities, prepare substitutes for returns under IRC § 6020(b), or take enforcement action by the end of the quarter. The revenue officer may request a civil injunction to stop further pyramiding or make a criminal referral for failure to adhere to special bank account rules.⁴¹

Assessment and Collection of Trust Fund Recovery Penalties

The IRS has the statutory authority to assess the TFRP against any person responsible for collecting and paying the delinquent employment taxes.⁴² Upon initial contact with the delinquent employer and within 120 days of assignment of the balance due account, the revenue officer will determine whether the IRS will assert the TFRP.⁴³ The period for a TFRP determination may be shortened if necessary to meet the statutory period for assessment.⁴⁴ The amount of the penalty equals 100 percent of the income and FICA taxes withheld from the employees.⁴⁵

The IRS imposes the TFRP on responsible persons that willfully fail to collect or pay over trust fund taxes to the IRS.⁴⁶ The IRS assigns responsibility for this failure as a matter of position, authority, and status that is heavily dependent on the facts and circumstances of each case.⁴⁷ A responsible person may include another business entity or an officer, employee, owner or surety of the employer.⁴⁸ A person is responsible to pay or collect the trust fund taxes if he or she has a duty to perform, a power to direct collection of and payment of the employer's taxes, accountability and authority to pay, and power to control which creditors are paid. The revenue officer will pursue the TFRP against the responsible person(s) unless the employer pays or liquidates specific assets to pay the trust fund taxes within 90 days of the initial contact, the responsible person agrees to pay or liquidate specific assets to pay within 90 days of the initial contact, or the employer enters an In-Business Trust Fund Express installment agreement.⁴⁹

The assessment of TFRPs came under intense congressional scrutiny in the time leading up to and during the RRA 98 hearings. TBOR 2 and RRA 98 included several provisions protecting taxpayer rights during assessment and collection of the TFRP. For example, TBOR 2 required the IRS to provide advance notice of the penalty at least 60 days before assessing it, as well as providing a right to contribution where more than one person is liable for the penalty.⁵⁰ RRA 98 permitted personal service of the preliminary notice informing the "responsible person" of the proposed penalty. The conference report specifically stated that such measure could "afford taxpayers the opportunity to resolve cases involving the 100-percent penalty at an earlier stage."⁵¹ In addition, RRA 98 prevents the IRS from collecting the full amount of any assessed penalty while litigation is pending.⁵²

General Concerns Regarding Development of IRS Employment Tax Strategy

Acknowledgement of IRS Progress

The National Taxpayer Advocate agrees that the IRS should make the collection of unpaid payroll taxes an utmost priority. Employers have already withheld the taxes from their employees' salaries and the IRS pays refunds on these amounts to these employees regardless of whether it collects the withheld funds. In addition, payroll taxes fund the Social Security program, which is projected to experience an excess of program expenses over payroll tax revenue within the next ten years.⁵³ However, considering the high tax dollars at stake and the intense congressional scrutiny, the National Taxpayer Advocate is concerned that the IRS may take a reactive approach to this problem that will not serve the long-term best interests of taxpayers or tax administration.

The IRS has undertaken some efforts to address employment tax noncompliance. For example:

• From FY 2005 to FY 2007, the number of employment tax audits increased by 66.8 percent, while the audit coverage rate rose from 0.11 percent to 0.20 percent.⁵⁴

• The IRS states that it has committed to help employers avoid problems by educating them on their employment tax responsibilities. It says that virtually every IRS function and division participates in employment tax outreach and education.⁵⁵

• The IRS sends fewer notices in employment tax cases so personal contact can occur sooner. The highest priority cases even bypass the telephone operation in favor of making first contact in the field.⁵⁶

• The IRS attempts to identify potential problems as early as possible in the process. For example, the FTD Alert process helps identify at an early stage those semi-weekly depositors that have not made federal tax deposits in the current quarter or have deposited substantially smaller amounts than in prior quarters.⁵⁷

Assessment and Collection of Trust Fund Recovery Penalties

The National Taxpayer Advocate is particularly concerned about the assessment and collection of TFRP under IRC § 6672. It is important that the IRS tread carefully when engaging in enforcement activities or developing new policies regarding this penalty. IRS employment tax examination and collection actions were subject to intense scrutiny during the hearings that led to RRA 98. As the Senate Finance Committee pointed out in a conference report for RRA 98, "[t]he imposition of the 100-percent penalty is a serious matter." In fact, during the hearings, one practicing attorney stated the following:

In addition to the protections afforded taxpayers in TBOR 2,⁶² RRA 98 included several provisions protecting taxpayer rights during assessment and collection of the TFRP. For example, RRA 98 permitted personal service of the preliminary notice informing the "responsible person" of the proposed penalty. Personal service would increase the likelihood that taxpayers would pay attention to and resolve disputes earlier in the process.⁶³ In addition, RRA 98 prevented the IRS from collecting the full amount of any assessed penalty while litigation is pending.⁶⁴ Considering that Congress enacted these protections in response to the hearings, it is important that the IRS strictly monitor compliance with the provisions to verify that taxpayer rights are safeguarded.

In the 2007 Annual Report to Congress, the National Taxpayer Advocate identified the following aspects of the TFRP process as in need of improvement:

• Incomplete TFRP investigations;

• Delays by Collection personnel in sending taxpayer protests to the Appeals function;

• Failure to apply payments and credits accurately and in a timely manner;

• The lack of collectability determinations prior to assessment of the TFRP; and

• Collection policies that compromise the rights of taxpayers before the IRS actually determines a responsible person's liability.⁶⁵

Encouraging Voluntary Compliance

While the GAO study raised concerns about the IRS's focus on voluntary compliance, the National Taxpayer Advocate believes this focus on balance is beneficial. First, the IRS needs to look at the hard facts. In FY 2007, over 88 percent of all employment tax returns were filed with no balance due.⁶⁶ This data indicates the IRS needs to assist the overwhelming majority of employers in maintaining compliance. To do this, the IRS must first understand the causes, barriers, and challenges employers face in complying with employment taxes. Noncompliance may stem from a variety of factors, including but not limited to (1) confusion over complex filing and payment responsibilities, (2) cash flow issues, and (3) intentional tax evasion.⁶⁷ For an effective enforcement strategy, the IRS needs to treat each type of taxpayer according to the particular cause of their noncompliance. The success of this approach would depend upon the IRS's ability to distinguish among taxpayers based on their level of compliance and reason for noncompliance, if applicable. The first step in this approach is for the IRS to continue its field tests of education initiatives.⁶⁸ The IRS should next supplement these tests with combined education and enforcement pilots, which will enable it to determine which techniques encourage compliance for each type of employer and at various stages of the business lifecycle. For example, fully compliant taxpayers might benefit from receiving certain types of outreach and education to ensure future compliance. Businesses struggling to survive but falling behind on payroll tax responsibilities could receive education coupled with early intervention techniques. In addition, where taxpayers might benefit from better business practices, the IRS could work with the Small Business Administration and organizations such as SCORE to pair the taxpayer up with a mentor.⁶⁹ Finally, the IRS should reserve more severe collection techniques for repeat offenders that intentionally fail to comply.⁷⁰ The IRS should also research and analyze the best time to intervene based on the type of taxpayer.

Early Intervention

The recent GAO report noted that early intervention benefits both the government and taxpayers, and encouraged the IRS to concentrate more resources on this process. The National Taxpayer Advocate strongly agrees with GAO in this regard, and has written at length about the benefits of early intervention.⁷¹ Early intervention includes education, outreach, and enforcement initiatives aimed at "touching" the taxpayer as soon as possible after the IRS detects a delinquency. The FTD Alert program is one example of an early intervention technique. While the IRS has an interest in collecting taxes, businesses also benefit if they are prevented from accumulating substantial unpaid payroll taxes, along with the associated penalties and interest. Over time, unpaid balances may compound beyond the business's ability to pay and ultimately cause financial jeopardy.⁷² For example, IRS data shows that for FY 1998, the average amount owed on employment tax returns with a balance due was $8,271 in 1999. However, the average amount of FY 1998 tax module liabilities increased to $19,250 in 2003 and $28,343 in 2008.⁷³

The National Taxpayer Advocate strongly believes early intervention is important to prevent pyramiding of employment tax liabilities. Once a taxpayer demonstrates noncompliance, the IRS should act as quickly as possible to prevent further accumulation of liabilities. While its resources are limited, any additional resources allocated to early intervention will certainly save resources downstream for the IRS. The IRS could use lower grade employees to make personal contacts early in the process, help the taxpayer enter into an installment agreement to satisfy existing liabilities, as well as requiring the taxpayer to pay more frequently in the future.⁷⁴ If the taxpayer continues to fail to make payments, the IRS can initiate enforcement procedures to bring the taxpayer into compliance before the debt grows too large to resolve and the taxpayer acquires a habit of noncompliance. Toward this end, the IRS needs to make many more outbound calls to taxpayers than it does now. Simply sending letters and placing taxpayers into collection queues awaiting assignment is not an effective compliance strategy.

At the end of FY 2008, 30.2 percent of the modules in the collection queue waiting assignment were employment tax liabilities (Forms 941 and 944). Table 1.4.1 illustrates the age of the cases.⁷⁵

              TABLE 1.4.1, Age of Employment Tax Modules

Participants in a Small Business/Self-Employed division (SB/SE) focus group at the IRS's 2007 Nationwide Tax Forums suggested the most important way to educate small business owners about trust fund tax responsibilities is for IRS personnel to conduct field visits. These tax professionals indicated phone calls and letters do not work because many clients just bring unopened IRS letters to their practitioners and ignore the calls. In addition, participants suggested that any marketing materials include stories about the worst penalties.⁷⁶ These focus group findings support the National Taxpayer Advocate's position that a local compliance presence is absolutely critical for an effective collection strategy. The IRS needs to make person-to-person contact with taxpayers as early as possible in the collection process. However, we see no evidence that the IRS plans to increase local compliance initiatives. In fact, the IRS has raised limited resources as an obstacle to pursuing this avenue further.⁷⁷ We agree that local presence would require additional resources. However, making personal contact earlier in the process, especially with respect to employment tax liabilities, could help bring taxpayers into compliance before their liabilities spiral out of control and avoid more costly enforcement actions downstream.

The Need for More Local Outreach and Education Initiatives

The IRS increasingly relies on industry partners to provide outreach and education to taxpayers. While strategic partnerships are vital, the IRS should devote more resources to grassroots initiatives.⁷⁸ A local presence is essential to understand the local economy and culture, and identify issues that may affect compliance.⁷⁹ In fact, as discussed above, focus group participants recommended the IRS educate taxpayers about payroll tax responsibilities through field visits. While any contact is better than no contact, the participants indicated the IRS needs to educate taxpayers through other means besides phone calls and letters.⁸⁰ Thus, the IRS should consider conducting more outreach and education through local initiatives, including field compliance visits.⁸¹ The IRS should also consider developing pilot outreach programs to test the impact of local outreach initiatives on employment tax compliance, and should consider using a cognitive learning lab to design the pilot programs.⁸²

Public Service Campaigns

The IRS should test the impact of a public information campaign that shows the social cost of unpaid employment taxes and warns employers of the risks of noncompliance, with messages such as:

GAO Report and Congressional Hearings

Based on its review of the IRS's collection actions for egregious payroll tax offenders, GAO made the following recommendations:⁸⁴

• Develop a process to monitor collection actions against egregious payroll tax offenders.

• Determine the feasibility of treating businesses with egregious payroll tax debt and the responsible owners/officers with TFRP assessment as a single, unified, coordinated collection effort assigned to a single revenue officer.

• Develop and implement procedures to expeditiously file a notice of federal tax lien as soon as possible once a payroll tax debt is identified -- including cases in the queue awaiting assignment. GAO recommended the IRS file liens on both the businesses with unpaid payroll taxes and the owners or officers assessed a TFRP.⁸⁵

• Develop and implement procedures to monitor compliance with the new TFRP assessment time frames.⁸⁶ In addition, develop performance goals and measures to evaluate the accumulation of unpaid payroll taxes by businesses, the extent and timeliness of TFRP assessments, and the effectiveness of collection actions.

• Work with states that have developed procedures for matching financial accounts to tax debts. The IRS should evaluate the potential to develop and implement similar procedures or collaborate with the states to leverage their efforts.⁸⁷

Streamlining the Procedures to Assess Trust Fund Recovery Penalties

The GAO study found the IRS took an average of 40 weeks to determine whether to assess a TFRP and an additional 40 weeks to actually assess the penalty. In addition, GAO cited an IRS study that found 43 percent of taxpayers assessed the TFRP never made a payment on the penalty.⁸⁸ Based on the findings of the study, both GAO and testimonies submitted for the associated congressional hearing recommended the IRS streamline the assessment of TFRPs. In fact, one proposal provided that the IRS should automatically impose the penalty after a business misses a specified number of quarterly payroll payments, unless a revenue officer provides a written justification why the action should not be taken.⁸⁹

The National Taxpayer Advocate believes the GAO TFRP data does not present the entire picture because it does not reflect the statutory assessment and abatement process. Taxpayers have a right to challenge a proposed TFRP assessment.⁹⁰ It is unclear from GAO's data how much of the 43 percent nonpayment figure is attributable to abatement as a result of an appeal. Further, the TFRP may be assessed on multiple responsible persons for one entity. If the IRS collects fully against the entity or one of the responsible persons, it cannot collect against the others. It is unclear whether the 43 percent figure reflects adjustments for responsible persons who do not pay the liability because one of the parties fully pays that liability.⁹¹

The National Taxpayer Advocate is particularly concerned with the recommendation to automate the assessment of the TFRP, as it appears inconsistent with current law and is likely to result in erroneous assessments that will negatively impact taxpayers. Before the IRS can assess the penalty against an individual, it is statutorily required to conclude the individual was responsible for withholding and paying over the payroll taxes and willfully failed to do so.⁹² Courts have settled on a variety of factors to consider in determining liability for the TFRP. IRM 5.7.3.3 incorporates the judicially determined factors by providing relevant indicators to determine personal responsibility and willfulness.⁹³

Automating these processes would be a step in the wrong direction. Human involvement is absolutely necessary to determine whether the indicia for responsibility and willfulness are present before the IRS assesses this severe penalty on any individual. In addition, assessing the penalty on an individual involves piercing the corporate veil, which raises due process concerns.⁹⁴ Revenue officers need to interview potentially responsible persons, gather and review relevant documents, and look to the role and responsibility the person played in the day-to-day financial affairs of the business entity.⁹⁵ As discussed in the 2007 Annual Report to Congress, the assessment of the TFRP can have disastrous economic results on those deemed responsible. Thus, the IRS needs to confirm that necessary indicia are present, which requires a complete TFRP investigation. Moreover, given that a taxpayer can meet the statutory criteria for a responsible person for one quarter and not for another quarter, an automated or truncated process will not be able to make such determinations and would cause unnecessary downstream work for other IRS functions -- Appeals, TAS, and the Office of Chief Counsel -- and the courts.⁹⁶

In the 2007 Annual Report to Congress, the National Taxpayer Advocate raised concerns about incomplete TFRP investigations and the high abatement rate for the penalty. The failure to follow established procedures for TFRP may lead the IRS to erroneous liability determinations and may even violate taxpayer rights. Table 1.4.2 below sets forth the assessment and abatement data for the TFRP for fiscal years 2000 to 2007:⁹⁷

 TABLE 1.4.2, Trust Fund Recovery Penalties Assessed and Abated⁹⁸

In response to the GAO audit and associated congressional hearings, the IRS committed to conduct an end-to-end review of the TFRP process to identify factors that adversely affect the ability of the IRS to enforce employment tax compliance as well as pursue timely and effective collection. As part of this project, the IRS will review its guidance and employee adherence to the guidance and determine whether to modify existing procedures.⁹⁹ We applaud the IRS for reviewing this topic and encourage the IRS to take a balanced approach with an emphasis on taxpayer rights. We ask that the IRS invite TAS to participate in any such reviews.

Streamlining the Lien Filing Process

GAO recommended that the IRS expedite its procedures to file notices of federal tax lien (NFTL). Specifically, GAO recommended that the IRS file liens as soon as possible once it identifies a payroll tax debt, including in cases awaiting assignment in the queue. It also recommended that the IRS file liens on both the businesses with unpaid payroll taxes and the owners or officers assessed a TFRP.¹⁰⁰ However, based on the abatement data for TFRPs and the intensive, fact-specific nature of TFRP determinations, it appears that such expedited procedures may be inaccurate and impose undue burdens on taxpayers. For example, the IRS abated 47.1 percent of the TFRPs assessed in FY 2006.¹⁰¹ Considering the high dollar amounts of these penalties and the fact that the IRS is piercing the corporate veil by assessing the penalty on individuals, the IRS should proceed cautiously if it plans to implement the recommendation with respect to TFRPs.

The IRS has formed a Lien Policy Analyst Team to review the lien filing process and determine the feasibility of filing the liens as soon as payroll tax liabilities are identified. The National Taxpayer Advocate encourages the IRS to take a balanced approach that increases efficiency with minimal taxpayer burden.¹⁰² The review should also consider whether liens are a productive collection tool for payroll tax liabilities. The IRS should not merely focus of the number of liens filed, because increasing the number of liens may not necessarily bring in more tax dollars. The review should track the dollars collected solely from liens (adjusting for the amount of dollars brought in by refund offsets where individuals are concerned). In addition, the review should include gathering data to determine whether the act of filing the lien impedes the business's ability to continue in business and pay taxes. Further, the IRS needs to review whether employment tax cases were not addressed early before penalties and interest accrue to the business's detriment.

Impact on Worker Misclassification

Before the IRS streamlines the lien process for employment taxes, it needs to consider the impact of such action on the growing worker misclassification problem. There are many reasons for worker misclassification, including situations when, due to the burden and risk associated with having employees, employers inappropriately classify their workers as independent contractors rather than employees. Whether a worker is classified as an employee or independent contractor affects the application of labor laws as well as tax treatment for both the worker and the service recipient. Whether inadvertent or deliberate, the misclassification of employees as independent contractors can have serious consequences for workers and the recipients of the services they provide. In addition, misclassification has a significant revenue impact due to the difference in, and in many cases the absence of, information reporting and tax withholding requirements for independent contractors.¹⁰³ Automatic liens and enforcement initiatives just for the sake of enforcement without the necessary supporting research will only exacerbate the growing trend of worker misclassification.

Conclusion

The National Taxpayer Advocate is concerned that the IRS is taking a reactive rather than proactive approach to employment taxes, which will not serve the best interests of taxpayers and tax administration. Instead of merely focusing on egregious noncompliance, it is essential to acknowledge that the majority of taxpayers are attempting to comply with their employment tax obligations. As such, the IRS needs to research the causes of employment tax noncompliance and treat each type of taxpayer accordingly. For those struggling to understand and meet their complex employment tax obligations, the IRS needs to offer assistance as well as early intervention techniques to bring those taxpayers into compliance. The IRS should reserve its more severe enforcement initiatives for taxpayers who intentionally fail to meet their obligations. Finally, considering that employment taxes, and trust fund recovery penalties in particular, came under intense scrutiny during the landmark 1998 hearings on restructuring the IRS, the IRS needs employment tax procedures that are not only effective but protect taxpayers' due process rights.

The IRS should consider taking the following actions to improve the employment tax program: perform research to determine the reasons for employment tax noncompliance, the types of service or enforcement-related treatments necessary to bring each type of taxpayer into compliance, and the best time for the IRS to intervene with such treatments; partner with the Small Business Administration and organizations such as SCORE to pair up taxpayers with mentors once they have indicated they are confused about tax filing and payment obligations; develop pilot outreach programs through cognitive learning labs to test the impact local outreach initiatives have on employment tax compliance; explore and test a public information campaign to convey to employers the importance of meeting employment tax obligations, and the detrimental impact noncompliance can have on the finances of both the business entity and individuals deemed responsible; as part of the Lien Policy Analyst Team, track the dollars generated by liens to determine whether they are an effective collection tool for payroll tax liabilities; and include the Taxpayer Advocate Service in all studies, reviews, and workgroups associated with the employment tax program.

IRS Comments

Collection of employment taxes is a core mission of the IRS. Historically, we succeed in collecting 99.8 percent of all employment taxes owed.¹⁰⁴ Over the past ten years, the IRS has collected more than $11 trillion in payroll taxes.¹⁰⁵

To achieve this level of success, the IRS uses a balanced approach of service and enforcement to assist businesses in understanding the requirements related to employment taxes and to encourage compliance. The IRS also acknowledges that it can be difficult to start and maintain a business over a number of years given the myriad of laws and regulations with which businesses must comply and the competitive pressures that exist in the market.

To that end, virtually all of the IRS functional and operating divisions participate in employment tax outreach and education. The IRS provides substantial information about employment taxes on IRS.gov, on other websites through partnerships and work with other organizations, including groups that represent small businesses, and through electronic and print media. In FY 2008, IRS partnered with almost 700 tax professional and industry Web sites to include such information.

Quarterly, the IRS sends out approximately seven million Social Security Administration (SSA) IRS Reporter newsletters with Form 941. The newsletter is received by all businesses that receive Form 941 and contains information on subjects such as Social Security Administration laws, the Electronic Federal Tax Payment System, and changes in SSA or IRS electronic filing systems.

The IRS continues to strengthen the Enterprise Wide Employment Tax Program (EWETP). We are developing a EWETP Strategic Plan that outlines objectives to provide affected key stakeholders and the public with the right information pertaining to employment taxes. The identified key stakeholders include practitioner groups, industry and professional organizations, applicable federal, state, and local agencies. The IRS continues to encourage voluntary compliance through outreach and education geared to the small business owner, by providing a host of products and services that assist this customer base with their tax responsibilities, including their employment tax responsibilities, and offers these products and services through a variety of vehicles that meet the needs of the small business audience. For example, the Small Business Tax Workshops (SBTWs) are available in a classroom setting, while the Virtual SBTW is available on a compact disc or on irs.gov. Another example is the "e-News for Small Businesses" which has accumulated over 118,000 subscribers during FY 2008 and includes small business owners as well as other external tax professional and industry stakeholders. We launch regular editions aimed at helping small business owners and self-employed persons voluntarily comply with their tax responsibilities including:

• Important upcoming tax dates;

• What's new for small businesses on the IRS website;

• Reminders and tips to assist small businesses with tax compliance; and

• IRS news releases and special announcements.

We leverage outreach events with external stakeholders such as Small Business Development Centers, SCORE, CPAs, enrolled agents, and chambers of commerce. We provide support to these stakeholders by providing products and approved presentations for key message delivery on various topics concerning the small business owner, including employment taxes. Employment taxes are either a topic of a general small business tax workshop or the only topic presented.

The decision to conduct a workshop is driven by identified demand and determining a leveraged stakeholder to deliver the workshop. During FY 2008 there were Small Business Workshops held in 47 states. We expect to expand these workshops to locations in all 50 states, to include industry specific sessions, and to increase the number offered.

SB/SE did not design its outreach and education function to meet one-on-one with small business owners, as there are more than 45 million small business taxpayers. The outreach mission has always been to strategically leverage stakeholder relationships in such a way to form networks through which we would provide the latest tax law and policy information. With focused research aimed at stakeholder groups, we are able to enhance our network to include channels of communication directly to individual members of these groups.

The vast majority of small business customers rely on practitioners to prepare their tax returns. Our relationship with national practitioner groups and their local affiliates such as the AICPA, National Enrolled Agents, National Public Accountants, American Bar Association, and NATP continues to afford us outreach and educational opportunities while providing a systematic method of capturing issues concerning tax administration. We continue to expand our network each year in order to reach more of the small business community. We believe that this type of educational approach through capable leveraged partners is a successful one.

In addition, the IRS supports the Large and Midsize Business (LMSB) customer base by working with major accounting and law firms to resolve employment tax issues expeditiously. Our LMSB Employment Tax Program and engineers also play an integral role in the valuing of stock options. Our valuations will be utilized as part of a nationwide analysis on the valuation of stock options and will be disseminated at various professional groups of accountants, valuation/appraisal groups and bar associations through out the year.

In situations where our extensive outreach and education efforts do not achieve voluntary compliance to the tax laws, the IRS utilizes the FTD Alert process, which helps to identify, at an early stage, taxpayers classified as semi-weekly depositors who have not made federal tax deposits during the current quarter, or have made deposits in substantially lower amounts from prior quarters.

This program has very positive results, such as increased deposits and a higher percentage of fully paid subsequent tax liabilities. The IRS recognizes that although the program is effective, it must be periodically reviewed and modified to ensure it remains an effective early intervention tool. During FY 2009, the IRS will conduct an end-to-end review of the Most Serious Problems program to include a thorough analysis of available data, current procedures and guidance as well as the program's impact on compliance. An overall assessment of the program will enable the IRS to better leverage this program to assist taxpayers, at a very early stage, if they have fallen behind on FTDs.

The IRS's policies and procedures for assessing and collecting the TFRP follow the requirements of the Taxpayer Bill of Rights¹⁰⁶ and the IRS Restructuring and Reform Act of 1998.¹⁰⁷ We continually monitor and safeguard taxpayer rights throughout the TFRP process through program reviews and case/quality reviews. The IRS is committed to continually safeguard taxpayer rights and approach cases strategically as we consider GAO's recommendations. The proposal to automatically impose the TFRP in certain circumstances was made by Senator Levin during his opening remarks at the Permanent Subcommittee on Investigations (PSI) hearing on Tuesday, July 29, 2008. The IRS is giving thorough consideration to all recommendations resulting from GAO's review of payroll taxes and the subsequent PSI hearing, but has not made final decisions on them at this time.

The IRS has already taken steps to address the National Taxpayer Advocate's concern regarding the timeliness and thoroughness of taxpayers being informed that they are potentially a "responsible person." To ensure potentially responsible individuals are better informed up front of the potential for personal liability and their rights in the TFRP process, we developed guidance that will require revenue officers, during the initial contact, to discuss specifics of the TFRP and its potential impact on the individuals.

The IRS is also developing face-to-face training material entitled "Strategic Approach to Employment Taxes" to reinforce the many tools available to revenue officers to assist taxpayers in achieving and maintaining compliance and actions that can and should be taken when a taxpayer does not cooperate or become current in paying employment tax liabilities. This training will be delivered in 2009 to all revenue officers.

We disagree with the National Taxpayer Advocate's conclusion that the 'high abatement rate is one indicator that the TFRP assessment process is ineffective.' Transaction Code (TC) 241, labeled "abate miscellaneous penalty," is used to adjust the TFRP of responsible individuals when credits are received on either the underlying corporate assessment or on related TFRP accounts. Use of the TC 241 ensures that we collect the unpaid payroll taxes only once; it does not indicate that the original TFRP assessment was erroneous or that the assessment process is ineffective. Financial Management Information System data for FY2006 showed that 82 percent of TFRP transactions coded as "abatements" were actually adjustments to accounts because of payments on related responsible persons' TFRP assessments or on the underlying corporate trust fund liability. Actual abatements may also result from a debtor's successful completion of a Chapter 13 payment plan.

In her report, the National Taxpayer Advocate makes six specific suggestions to improve the employment tax program. We are taking or have taken the following actions with respect to these issues:

We have launched two research projects to gather information that will enable us to more accurately define "egregious," a term often used to describe taxpayers that repeatedly pyramid employment tax liabilities. These projects will not only identify traits and characteristics of taxpayers that pyramid employment tax liabilities but also help us detect ways to improve procedures, guidance and treatment streams that could assist all employers in staying current with payroll tax liabilities.

The IRS routinely leverages partnerships with the Small Business Administration as well as other external stakeholders such as Small Business Development Centers, SCORE, CPAs, enrolled agents, and chambers of commerce to address taxpayer's confusion regarding employment tax reporting and payment compliance. We continually strive to identify issues and concerns that may be impacting taxpayers and work to expand and tailor workshops and outreach efforts to alleviate taxpayer confusion.

The IRS continues to examine products and services that would accurately gauge the impact local outreach initiatives have on employment tax compliance. Currently, we rely on an effective survey and feedback process administered by both the IRS and our external partners as a part of each outreach effort.

The IRS has an effective public information and outreach program that leverages electronic and printed media, as well as personal involvement through directed contact with external stakeholder partners. In addition, IRS policy and requirements ensure taxpayers are provided information throughout the filing and payment process that explains their rights, responsibilities and potential consequences of non-compliance.

The IRS is also engaged in an end-to-end review of the Federal Tax Lien program, in which the overall effectiveness of the program, existing guidance, current policy and the overall cost/benefits of filing liens are being analyzed.

TAS is participating in the current review of the Federal Tax Lien program, and on other teams the IRS has established to analyze various employment tax programs.

Given the high level of employment tax compliance, the EWETP needs to focus heavily on helping taxpayers maintain compliance. The first step in this process is to assist businesses in understanding their employment tax obligations. We are pleased that the IRS engages in extensive outreach and education by leveraging its partnerships with external stakeholder groups. We understand the vital role such partnerships play in the program. However, we continue to believe that local IRS presence is essential for the IRS to understand the local economy and culture, and identify issues that may affect compliance. Thus, the IRS should conduct more outreach and education through local initiatives, including field compliance visits. The IRS should also develop pilot programs to test the impact of local outreach initiatives on employment tax compliance, and should consider using a cognitive learning lab to design the pilot programs.

The IRS needs to focus on early intervention techniques for businesses trying but struggling to meet their employment tax obligations. Both the IRS and taxpayers benefit from early intervention, which prevents taxpayers from accumulating substantial unpaid payroll taxes along with the associated penalties and interest. The FTD Alert process is an important early intervention "touch" and we commend the IRS for planning to assess the program.

We encourage the IRS to safeguard taxpayers' rights as it responds to the recommendations made by GAO and others during the July 2008 hearings by the Permanent Subcommittee on Investigations of the U.S. Senate Committee on Homeland Security and Governmental Affairs. Protecting taxpayers' due process rights is especially important during the assessment and collection of the Trust Fund Recovery Penalty (TFRP), the imposition of which can have a devastating impact on a taxpayer.

As noted in our discussion above and by the IRS in its response, there are several reasons why the IRS may abate TFRPs. Unlike some other penalties, the high abatement rate does not necessarily indicate a high rate of erroneous assessments. While the IRS may abate a TFRP for several reasons, IRS computer systems do not track the particular reasons for the abatement. Thus, the IRS cannot provide data to accurately reflect the performance of the TFRP process.

We are pleased with the IRS's plans to conduct research on issues related to employment tax. The research on common characteristics of taxpayers who pyramid employment tax liabilities is essential to determine how to prevent such behavior. In addition, the IRS's planned research to determine appropriate treatments to encourage compliance is a very important step in a balanced approach. The National Taxpayer Advocate also encourages the IRS to research the effectiveness of local outreach initiatives and looks forward to assisting in this research.

² Compliance Data Warehouse, Business Return Transaction File and Accounts Receivable Dollar Inventory for Tax Periods 200609, 200612, 200703, and 200706 (the data does not account for unfiled return investigations remaining after third quarter 2008).

³ TBOR 2, Pub. L. No. 104-168 § 903, 110 Stat. 1452, 1466 (1996); RRA 98, Pub. L. No. 105-206 § 3307, 112 Stat. 685, 744 (July 22, 1998).

⁴ IRS, FY 2007 Data Book Table 1.

⁵ Compliance Data Warehouse, Business Return Transaction File and Accounts Receivable Dollar Inventory for Tax Periods 200609, 200612, 200703, and 200706 (the data does not account for unfiled return investigations).

⁶ GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes 23 (July 2008). It is unclear why the IRS classified the unpaid taxes as currently uncollectible. GAO noted that the IRS assigned to revenue officers about $7 billion, and about $9 billion remained in the queue awaiting assignment. In addition, GAO's analysis found that the number of businesses with more than 20 quarters of tax debt (five years of unpaid payroll tax debt) more than doubled between 1998 and 2007.

⁷ IRS Compliance Data Warehouse, Accounts Receivable Dollar Inventory, Cycle 200738 (the closest cycle to September 30, 2007) for employment tax (Form 941) delinquencies outstanding.

⁸ GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes 23 (July 2008).

⁹See IRC §§ 3102(a) and 3402(a). The employee's rate of tax is 6.2 percent of wages for Social Security up to the contribution and benefit base and 1.45 percent of wages for Medicare. See IRC § 3121(a). The contribution and benefit base as determined under § 230 of the Social Security Act is $102,000 for 2008 and $106,800 for 2009. See http://www.ssa.gov/pressoffice/factsheets/colafacts2009.htm (last visited Dec. 22, 2008).

¹⁰See IRC §§ 3301, 3111(a) and (b). The employer's tax for Social Security and Medicare is identical to the employee's tax. The employer's unemployment tax under IRC § 3301 is equal to 6.2 percent of each employee's wages up to $7,000. See IRC § 3306(b).

¹¹ IRC § 3302(a). The credit may not exceed 5.4 percent of the wages subject to Federal Unemployment Taxes (FUTA). See IRS Pub. 15, (Circular E), Employer's Tax Guide, 30 (2008).

¹²See Legislative Recommendation, Worker Classification, infra; IRC §§ 3121(b) and 3306(c); IRS Pub. 15-A, Employer's Supplemental Tax Guide, 4-5 (2008).

¹³ IRC § 3402(b) and (c).

¹⁴ IRS Pub. 15, (Circular E), Employer's Tax Guide, 36 (2008).

¹⁵ IRC § 3402(f)(2)(A).

¹⁶ IRS Pub. 15, (Circular E), Employer's Tax Guide, 15 (2008).

¹⁷ Treas. Reg. § 31.3402(f)(2)-(1)(g)(1)(i); IRS Publication 15, (Circular E), Employer's Tax Guide, 16 (2008).

¹⁸ IRS Pub. 15, (Circular E), Employer's Tax Guide, 15 (2008).

¹⁹ Treas. Reg. § 31.6302-1(b)(2).

²⁰ Treas. Reg. § 31.6302-1(b)(3).

²¹ Treas. Reg. § 31.6302-1(c)(2)(i).

²² Internal Revenue Manual (IRM) 5.7.1.7 (July 18, 2008).

²³ IRS Pub. 15, (Circular E), Employer's Tax Guide, 22-23 (2008).

²⁴ For failing to make a timely or proper deposit, the penalties are: two percent for deposits made one to five days late; five percent for deposits made six to 15 days late; ten percent for deposits made more than 15 days late; ten percent for deposits made within ten days from notice and demand for payment; ten percent for deposits made at an unauthorized financial institution, directly to the IRS, or with a payroll tax return (unless excepted); ten percent for amounts subject to electronic deposit requirements but not deposited with EFTPS; 15 percent for deposits not made within the earlier of ten days from notice and demand or on the day that demand for immediate payment is made by the IRS. See IRC § 6656(a).

²⁵ Treas. Reg. § 31.6302-1(c)(3).

²⁶ For example, an employer may be able to submit a monthly deposit with its Form 941, which is due one month after the close of the calendar quarter, if the liability reported on the form is $2,500 or less, or there is a deposit shortfall not greater than the lesser of two percent of the total tax liability or $100 and the payment is made with the return when its due date is the shortfall makeup date. Similarly, an employer who files Form 944 may be able to make its deposit for the fourth quarter with its return if its tax liability does not exceed $2,500 and it has made its deposits for the first, second and third quarters. See IRS Publication 15, (Circular E), Employer's Tax Guide, 19, 22 (2008).

²⁷See IRS Pub. 15, (Circular E), Employer's Tax Guide, 25 (2008).

²⁸See id. at 30.

²⁹See id. at 25, 30.

³⁰See IRC § 6041(d).

³¹See IRS Pub. 15, (Circular E), Employer's Tax Guide, 2 (2008).

³²See IRM 5.7.8.3 (Oct. 6, 2006). A pyramiding taxpayer is an in-business taxpayer, not current with federal tax deposits (FTDs), that has two or more tax modules assigned to the IRS's Collection Field function (CFf). "A taxpayer that is pyramiding taxes is not demonstrating a good faith effort to comply." IRM 5.7.8.3(2) (Oct. 6, 2006).

³³See IRC § 7512(a). The trust is imposed if the person fails to collect, truthfully account for, or pay over such tax, or fails to make deposits, payments, or returns for such tax. The notice required must be delivered in hand to such person for any such failure. For purposes of a corporation, partnership or trust, a notice delivered in hand to an officer, partner or trustee shall be deemed to be delivered in hand to such corporation, partnership or trust and all officers, partners, trustees and employees thereof.

³⁴ IRC § 7501(a) and (b).

³⁵See IRM 5.7.1 (July 18, 2008).

³⁶ IRM 5.7.1.2 (July 18, 2008).

³⁷ IRM 5.7.1.4 (July 18, 2008).

³⁸ IRM 5.7.1.6 and 5.7.1.7 (July 18, 2008).

³⁹ IRM 5.7.2.1 (June 4, 2002).

⁴⁰ IRM 5.7.2.2 (June 4, 2002).

⁴¹ IRM 5.7.2.2(5) (June 4, 2002).

⁴² IRC § 6672.

⁴³ IRM 5.7.4.1 (Sept. 23, 2008).

⁴⁴ IRC § 6501(a) and (b)(2); IRM 5.7.4.1 (Sept. 23, 2008). In addition, the IRS is statutorily authorized to initiate jeopardy assessments for TFRPs. IRC § 6672(c)(5); IRM 5.1.4.2 (Apr. 1, 2005).

⁴⁵ IRC §§ 6671(b), 6672(a); IRM 5.7.3.3.1 (Apr. 13, 2006); IRM 5.7.3.3.2 (Apr. 13, 2006).

⁴⁶ IRC § 6672; IRM 5.7.3.3 (Apr. 13, 2006). Willful means intentional, deliberate, voluntary, reckless, or knowing, as opposed to accidental. No evil intent or bad motive is required. IRM 5.7.3.3.2 (Apr. 13, 2006).

⁴⁷ IRM 5.7.3.3.1(1) (Apr. 13, 2006).

⁴⁸Id.

⁴⁹ IRM 5.7.4.1(3) (Sept. 23, 2008).

⁵⁰ TBOR 2, Pub. L. No. 104-168 §§ 901-903, 110 Stat. 1452, 1466 (1996).

⁵¹ RRA 98, S. Rep. No. 105-174, 105th Cong. § 3307 (Apr. 22, 1998); Pub. L. No. 105-206 § 3307, 112 Stat. 685, 744 (July 22, 1998).

⁵² RRA 98, S. Rep. No. 105-174, 105th Cong. § 3307 (Apr. 22, 1998); Pub. L. No. 105-206 § 3307, 112 Stat. 685, 744 (July 22, 1998).

⁵³ The Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, 2006 Annual Report 2 (May 1, 2006).

⁵⁴Payroll Tax Abuse: Businesses Owe Billions and What Needs to Be Done About It: Hearings Before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Security and Governmental Affairs, 110th Cong. (July 29, 2008) (testimony of Linda Stiff, IRS Deputy Commissioner, Services and Enforcement).

⁵⁵Id.

⁵⁶Id. However, even these high priority cases could wait in a queue before being assigned. As discussed infra, at the end of FY 2007, 30.2 percent of the modules in the collection queue awaiting assignment were employment tax liabilities (Forms 941 and 944). Over 50 percent of the modules were in the collection queue for 16 months or more. IRS, 5000-2 Collection Activity Report (Sept. 2008); IRM 5.1.20.2.3.2 (May 27, 2008).

⁵⁷Payroll Tax Abuse: Businesses Owe Billions and What Needs to Be Done About It: Hearings Before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Security and Governmental Affairs, 110th Cong. (July 29, 2008) (testimony of Linda Stiff, IRS Deputy Commissioner, Services and Enforcement).

⁵⁸ TIGTA, Ref. No. 2007-30-180, The Federal Tax Deposit Alert Program Helps Taxpayers Comply with Paying Taxes, but Alerts Can Be Worked More Effectively (Sept. 17, 2007). In response to the audit, the IRS committed to improve the shortcomings in the program.

⁵⁹See, e.g., National Taxpayer Advocate 2006 Annual Report to Congress 172-96.

⁶⁰IRS Restructuring: Hearing Before the S. Comm. on Finance, 105th Cong. (Feb. 5, 1998) (statement of Robert Schriebman, practicing tax attorney).

⁶¹IRS Restructuring: Hearing Before the S. Comm. on Finance, 105th Cong. (Feb. 5, 1998) (statement of Nina E. Olson).

⁶² TBOR 2 required advance notice of the penalty at least 60 days before assessment and provided a right to contribution where more than one person is assessed the penalty. TBOR 2, Pub. L. No. 104-168 §§ 903, 110 Stat. 1452, 1466 (1996).

⁶³ RRA 98, S. Rep. No. 105-174, § 3307 (Apr. 22, 1998); Pub. L. No. 105-206, § 3307, 112 Stat. 685, 744 (July 22, 1998).

⁶⁴Id.

⁶⁵ For a detailed discussion, see National Taxpayer Advocate 2007 Annual Report to Congress 395-410.

⁶⁶ Compliance Data Warehouse, Business Return Transaction File and Accounts Receivable Dollar Inventory for Tax Periods 200609, 200612, 200703, and 200706 (the data does not account for unfiled return investigations).

⁶⁷ The Small Business/Self-Employed division (SB/SE) conducted focus groups during the 2007 IRS Nationwide Tax Forums on the topic of employment tax compliance. In general, the focus group participants gave the following four main reasons why small business owners do not timely or fully pay their trust fund taxes: (1) cash flow problems, (2) "snowballing" missed payments, (3) lack of enforcement, and (4) poor planning. SB/SE Research, 2007 Nationwide Tax Forums: Employment Tax Compliance -- Are Your Clients at Risk? NCH0088 (May 2008).

⁶⁸See SB/SE Research Report, Project No. 06.08.004.03, Measuring the Effect of TEC Outreach on Construction Industry Employment Taxes 29 (Jul. 2004); SB/SE Research Report, Project No. 06.06.005.04, Measuring the Effect of TEC Outreach on Construction Industry Employment Taxes Phase II 51 (Jan. 2006). Both studies found that general outreach seemed to improve employment tax compliance in the construction industry.

⁶⁹ SCORE is a nonprofit association that works with the Small Business Administration to educate and promote the success of small businesses nationwide. For more information on SCORE, see http://www.score.org (last visited on Nov. 9, 2008).

⁷⁰See IRS Office of Program Evaluation and Risk Analysis (OPERA), Study of TEC, SPEC, and NPL's Prefiling/Outreach Services, Organizational Model Options for Greater Efficiency (Dec. 30, 2004); Memorandum from Mark Gillen, Director of Office of Program Evaluation and Risk Analysis to Deputy Commission for Services and Enforcement, OPERA TEC/SPEC/NPL Study -- Organization Model Options (Dec. 30, 2004).

⁷¹See, e.g., National Taxpayer Advocate 2007 Annual Report to Congress 395-410, 432-47; National Taxpayer Advocate 2006 Annual Report to Congress 62-82.

⁷² GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes (July 2008).

⁷³ IRS Compliance Data Warehouse, IRS Accounts Receivable Inventory File (the data reflects FY 1998 liabilities as of 199934, 200334, and 200834). The data only includes FY 1998 liabilities assessed as of the 199934 cycle and does not reflect the addition of other late filed returns or returns from other tax periods. Our 2006 Annual Report to Congress noted that 71.1 percent of business (BMF) employment tax cases involved delinquencies of less than $3,000. However, due to the small dollar figures, the IRS did not assign high priority to these cases despite the fact that fact that employment tax deficiencies tend to pyramid very quickly. In FY 2005, the IRS briefly worked employment tax deficiencies on a "last due, first worked" basis and saw almost immediate positive results. However, the IRS decided to discontinue this initiative and assign small dollar delinquencies to the Automated Collection System rather than the CFf, because they are not priority assignments. As a result, BMF revenue declined. See National Taxpayer Advocate 2006 Annual Report to Congress 62-82.

⁷⁴See National Taxpayer Advocate 2006 Annual Report to Congress 68-69. As noted in the 2006 report, IRS data provides ample evidence to suggest the IRS may not be working its optimal inventory, and collecting newer, lower dollar inventory is more effective than working older, higher dollar inventory. See IRS CACI Hybrid Test Update (Aug. 13, 2008). Recently, at the urging of the National Taxpayer Advocate, the IRS designed plans for a test that would measure the success of low grade IRS employees in attempting to collect on cases with small dollar amounts, which the IRS is not currently working.

⁷⁵ IRS, 5000-2 Collection Activity Report (Sept. 2008).

⁷⁶ SB/SE Research, 2007 Nationwide Tax Forums: Employment Tax Compliance -- Are Your Clients at Risk? NCH0088 (May 2008).

⁷⁷ For more information, see National Taxpayer Advocate 2004 Annual Report to Congress 226-45.

⁷⁸ Memorandum from Mark Gillen, Director of Office of Program Evaluation and Risk Analysis to Deputy Commission for Services and Enforcement, Opera TEC/SPEC/NPL Study -- Organization Model Options (Dec. 30, 2004).

⁷⁹ For a more detailed discussion of the benefits of local compliance, see Most Serious Problem, Local Compliance Initiatives Have Great Potential but Face Serious Challenges, infra.

⁸⁰ SB/SE Research, 2007 Nationwide Tax Forums: Employment Tax Compliance -- Are Your Clients at Risk? NCH0088 (May 2008).

⁸¹ In 2005, the IRS eliminated the Taxpayer Education and Communications (TEC) organization within SB/SE. The elimination of TEC resulted in the virtual elimination of the local footprint for outreach and education services provided by the IRS to small businesses. See National Taxpayer Advocate 2006 Annual Report to Congress 172-96. In addition, see SB/SE Research Report, Project No. 06.08.004.03, Measuring the Effect of TEC Outreach on Construction Industry Employment Taxes 29 (July 2004); SB/SE Research Report, Project No. 06.06.005.04, Measuring the Effect of TEC Outreach on Construction Industry Employment Taxes Phase II 51 (Jan. 2006). The studies both found that general outreach seemed to improve employment tax compliance in the construction industry.

⁸² For more information about cognitive learning labs, see National Taxpayer Advocate 2007 Annual Report to Congress 156-61.

⁸³ See also our recommendation to the IRS to develop educational materials explaining third party payers and the responsibilities and liabilities each party assumes in such arrangements. Third party arrangements could assist employers in meeting their employment tax obligations. They could also help ensure that the business owners do not spend the funds inappropriately before remitting them to the IRS. National Taxpayer Advocate 2007 Annual Report to Congress 337-54.

⁸⁴ This list is a summary of the GAO report recommendations and is not verbatim. GAO also recommended that the IRS develop performance goals and measures to specifically evaluate the accumulation of unpaid payroll taxes, the extent and timeliness of TFRP assessments, and the effectiveness of actions taken to collect unpaid payroll taxes and TFRP assessments.

⁸⁵ In his opening statement for the hearing, Senator Carl Levin recommended that Congress enact S. 1124, the Levin-Coleman "Tax Lien Simplification Act," which would require Treasury to establish an electronic tax lien registry at the federal level. Payroll Tax Abuse: Businesses Owe Billions and What Needs to Be Done About It: Hearings Before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Security and Governmental Affairs, 110th Cong. (July 29, 2008) (testimony of Sen. Carl Levin, Chairman, Subcomm. on Investigations).

⁸⁶ Revenue officers are required to determine whether to pursue a TFRP within 120 days of the case being assigned and to complete the assessment within 120 days of the determination. IRM 5.7.4.1 (Sept. 23, 2008).

⁸⁷ GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes (July 2008).

⁸⁸ GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes (July 2008).

⁸⁹Payroll Tax Abuse: Businesses Owe Billions and What Needs to Be Done About It: Hearings Before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Security and Governmental Affairs, 110th Cong. (July 29, 2008) (testimony of Sen. Carl Levin, Chairman, Subcomm. on Investigations).

⁹⁰ For more information on the appeal procedures for proposed TFRP assessments, see National Taxpayer Advocate 2007 Annual Report to Congress 395-410.

⁹¹ IRC § 6672(d). TBOR 2, Pub. L. No. 104-168, § 903, 110 Stat. 1452, 1466 (1996), provided a federal statutory right of contribution in favor of responsible persons who actually pay more than their share of trust fund penalties.

⁹² IRC § 6672(a).

⁹³See National Taxpayer Advocate 2007 Annual Report to Congress 396-97 (for a detailed discussion of the judicially determined factors).

⁹⁴ Unlike corporations, sole proprietors and partners are already personally liable for business debts, so this discussion is solely directed at corporations.

⁹⁵ IRM 5.7.4 (Apr. 13, 2006). Revenue Officers use Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes, to interview potentially responsible persons. IRM 5.7.4.2.1 (Apr. 13, 2006).

⁹⁶ The IRS is statutorily authorized to initiate jeopardy assessments for TFRPs. IRC § 6672(c)(5); IRM 5.1.4.2 (Apr. 1, 2005). When the National Taxpayer Advocate was in private practice, she represented many taxpayers against whom the penalty was applied as a result of a "blanket assessment." That is, the IRS merely looked at state corporation records to identify the corporate officers, and without further inquiry assessed the TFRP against anyone listed, regardless of their involvement in or control of the corporation's affairs. In several instances, these "officers" were merely family members who had no involvement with the corporation. In response to concerns such as these, TBOR 2 imposed a requirement of a proposed notice of assessment, providing the taxpayer with the ability to challenge the penalty before it is assessed. TBOR 2, Pub. L. No. 104-168, §§ 901-903, 110 Stat. 1452, 1465 (1996); IRC § 6672.

⁹⁷ IRS Enforcement Revenue Information System (ERIS), Data on IRS Compliance Data Warehouse (as of Mar. 31, 2008).

⁹⁸ It is important to note that that the FY 2007 assessment data reflects newly assessed penalties. The decrease in the abatement rate is not reflective of the IRS's performance. Rather, it merely indicates that these penalties were recently assessed and abatements may not have occurred yet.

⁹⁹ IRS Enterprise Wide Employment Tax Program, Talking Points/Status Update for BOD Commissioners Meeting on June 2, 2008 (May 29, 2008).

¹⁰⁰ GAO, GAO-08-617, Tax Compliance: Businesses Owe Billions in Federal Payroll Taxes (July 2008). In his opening statement Senator Carl Levin recommended that Congress enact S. 1124, the Levin-Coleman "Tax Lien Simplification Act," which would require Treasury to establish an electronic tax lien registry at the federal level. Payroll Tax Abuse: Businesses Owe Billions and What Needs to Be Done About It: Hearings Before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Security and Governmental Affairs, 110th Cong. (July 29, 2008) (testimony of. Sen. Carl Levin, Subcomm. on Investigations).

¹⁰¹ IRS ERIS, as of the end of March 2008.

¹⁰² IRS Lien Policy Analyst Team, Conference Call Agenda (Aug. 20, 2008) (on file with the Office of the Taxpayer Advocate).

¹⁰³ For a detailed discussion of this topic, see Legislative Recommendation, Worker Misclassification, infra.

¹⁰⁴ IRS Masterfile.

¹⁰⁵ GAO Blue Book and IRS Financial Statements.

¹⁰⁶ TBOR 2, Pub. L. No. 104-168, § 903, 110 Stat. 1452, 1466 (1996); RRA 98, Pub. L. No. 105-206 § 3307, 112 Stat. 685, 744 (July 22, 1998).

¹⁰⁷ RRA 98, S. Rep. No. 105-174, § 3433 (Apr. 22, 1998); Pub. L. No. 105-206, § 3433, 112 Stat. 685, 759 (July 22, 1998).

Jim Falcone, Acting Deputy Commissioner for Operations Support

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Deborah G. Wolf, Director, Office of Privacy, Information Protection and Data Security

Julie Rushin, Director, Strategy and Finance, Wage and Investment Division

Definition of Problem

Over the past several years, the National Taxpayer Advocate has cited identity theft as a most serious problem encountered by taxpayers.¹ In her 2007 Annual Report to Congress, the National Taxpayer Advocate included a comprehensive review of IRS identity theft procedures and identified several major concerns.²

Congress also recognizes identity theft as a growing problem. The House Committee on Ways and Means and the Senate Committee on Finance each held hearings about the IRS response to identity theft in early 2008. The National Taxpayer Advocate testified at both hearings.³ In the April 10, 2008 hearing before the Senate Finance Committee, IRS Commissioner Douglas Shulman acknowledged the need for the IRS to improve its procedures for assisting victims of identity theft and promised that the IRS would develop a comprehensive plan to help these taxpayers.⁴

We applaud the IRS for recognizing identity theft as a serious problem and devoting significant resources to resolve many of the issues we have previously identified. Over the past year, the IRS has made a number of improvements to its procedures to assist victims of identity theft. For example, the IRS now tracks victims of identity theft by placing a marker on the victim's account.⁵ The IRS has also established an Identity Protection Specialized Unit and a toll-free hotline for identity theft victims.⁶

However, the National Taxpayer Advocate has concerns with the approach the IRS has taken in implementing the new procedures to assist identity theft victims. First, we are concerned that identity theft victims with tax problems will not receive comprehensive assistance from the Identity Protection Specialized Unit. Second, we have identified gaps in the way the IRS tracks identity theft victims. Third, we would like the IRS to improve its communication with identity theft victims. Fourth, we would like the IRS to allow its employees to exercise greater discretion to deviate from established guidelines when determining the rightful owner of a disputed Social Security number (SSN).

Analysis of Problem

Background

Identity theft occurs when someone unlawfully uses another's personal data to commit fraud or other crimes. Identity theft is most commonly encountered in tax administration when an individual intentionally uses the SSN of another person to file a falsified tax refund claim or fraudulently obtain employment. Identity theft affects almost every aspect of tax administration -- tax return filing, auditing, collection, protection of taxpayer information, etc. -- and harms innocent taxpayers.

According to the Federal Trade Commission (FTC), the lead federal agency charged with combating identity theft, there were 258,427 reported incidents of identity theft in 2007, up from 246,124 in 2006.⁷ As shown in Table 1.5.1 below, TAS stolen identity cases have increased over sixfold from fiscal year (FY) 2005 to FY 2008.⁸

      TABLE 1.5.1, TAS Stolen Identity Cases, FY 2005 TO FY 2008

The second motive is employment-related identity theft, where the perpetrator utilizes the personal information of another to obtain employment. The employer prepares a Form W-2 with the victim's SSN. This can cause problems for the identity theft victim, who may receive bills from the IRS for tax owed on income he or she never earned.

Regardless of the motive, identity theft creates serious consequences for the innocent taxpayer. For a detailed explanation of these problems, please refer to prior Annual Reports to Congress issued by the National Taxpayer Advocate.⁹

Concerns Regarding the IRS's Identity Theft Victim Assistance Strategy

The Identity Protection Specialized Unit Should Monitor All Identity Theft Cases.

Identity theft victims should have a single point of contact within the IRS to assist in resolving all federal identity theft-related tax issues, and should not need to contact the IRS multiple times to resolve their issues. Until recently, the IRS did not have an enterprisewide strategy to deal with identity theft cases. For example, the Automated Underreporter (AUR), Automated Collection System, Accounts Management (AM), Examination functions, and the Criminal Investigation division all assisted victims of identity theft, but no single function had the overall responsibility to resolve all of the victim's tax account issues, which resulted in taxpayers coming to TAS for assistance. Without a coordinated effort, each function worked identity theft cases independently according to its own procedures, requiring some taxpayers to provide the same information to the IRS several times. More importantly, there was a real danger that the IRS was not addressing all related issues or all tax periods of accounts impacted by identity theft.

The National Taxpayer Advocate recommended in her 2007 Annual Report to Congress that the IRS establish a dedicated, centralized unit to handle all identity theft cases.¹⁰ The IRS concurred with this recommendation and created an Identity Protection Specialized Unit to assist victims of identity theft. Effective October 1, 2008, taxpayers can call a toll-free hotline (800-908-4490) to report their identity theft issues, obtain information, and take steps to protect their accounts.¹¹

The Identity Protection Specialized Unit provides two essential services to identity theft victims. First, it conducts a global account review to identify all issues related to the identity theft. Second, the unit provides regular account monitoring to ensure full case resolution. These are two very valuable services the IRS provides to identity theft victims. However, current IRS procedures provide these benefits only to identity theft victims who call the specialized unit with a tax-related problem. The IRS does not provide these benefits to taxpayers who directly call other IRS functions to resolve tax issue(s).

For identity theft victims who have not received any notices from the IRS regarding tax issues, the IRS encourages these individuals to call the toll-free hotline to report their identity theft incident.¹² For individuals who have received notices from the IRS about their identity theft-related tax issues, the IRS directs them to contact the Identity Protection Specialized Unit only "if you have previously been in contact with the IRS and have not achieved a resolution."¹³ A recent Servicewide Electronic Research Program (SERP) Alert advises that "employees in AM, AUR, Collections, Exam, etc., with existing tax-related identity theft cases, or receiving new tax-related identity theft cases, should follow their established procedures to work these cases. . . . Do NOT route these cases to the [Identity Protection Specialized Unit]."¹⁴

To reiterate, the IRS refers identity theft victims without tax account problems to the Identity Protection Specialized Unit, yet directs identity theft victims with tax account problems not to call this unit.¹⁵ It seems counterintuitive for the IRS to devote significant resources to establishing a centralized unit to assist victims of identity theft, only to limit access to this unit to taxpayers who have had their wallets stolen or experienced some other non-tax identity theft issue.

The National Taxpayer Advocate recognizes that there is a benefit in asking taxpayers to respond to the IRS function originating the correspondence -- otherwise, the function may proceed to the taxpayers' detriment. However, if the IRS simply relies on existing procedures, we cannot be confident that the IRS will address all related issues.

The IRS needs to take a much more taxpayer-centric approach to resolving the myriad of account problems created by identity theft. The National Taxpayer Advocate recommends that the IRS operating division or function, as it addresses the tax account issue at hand, refer the case of the identity theft victim back to the centralized unit for a global account review. This account review is necessary to ensure that all of a victim's identity theftrelated account issues are addressed. If the account review uncovers additional issues, then the Identity Protection Specialized Unit should refer the case to the appropriate function(s) and monitor the case until full resolution. If there are no other open issues, the centralized unit would close the case.

The IRS Is Unable to Accurately Quantify Incidents of Identity Theft.

Identity theft is a recurring issue for many taxpayers, who often find themselves battling to resolve account problems with the IRS over multiple years. The IRS recently developed a method to systemically identify taxpayers whose identities were stolen. On January 1, 2008, the IRS implemented a tracking system that places an indicator on an identity theft victim's account once he or she has provided verification of identity theft.¹⁶ This indicator will alert the IRS in subsequent filing years that this taxpayer may need special attention.

The operating divisions will develop "business rules" -- that is, a set of rules intended to filter out fraudulent returns -- that will apply to accounts flagged with the identity theft indicator.¹⁷ Beginning in January 2009, returns that do not meet the business rules will be removed from the posting process.¹⁸ If the return falls outside the established parameters, the IRS will review the return manually before processing any refund claims.

We are pleased with this positive development, as the National Taxpayer Advocate has long advocated such a tracking system.¹⁹ With the ability to track identity theft cases, the IRS will be better able to allocate appropriate resources and identify areas where procedures need to be improved. However, the National Taxpayer Advocate has identified several shortcomings with the way the IRS currently tracks identity theft cases.

The IRS does not place the marker in many situations where the IRS itself identifies identity theft cases. For example, the IRS will not use its identity theft marker in employmentrelated fraud cases involving a "name-SSN mismatch" (i.e., where the taxpayer's name, according to IRS data files, does not match the associated SSN for that name). If an identity thief uses another taxpayer's SSN but the name does not correspond, the AUR function will not attribute the income reported on information returns (e.g., Forms W-2 or Forms 1099) bearing the SSN to the identity theft victim.²⁰ While this result spares the victim significant headaches, it also means that no identity theft marker will be applied, even though it is clear that the SSN has been misused and may be misused for years to come.

In addition, the IRS still does not track cases where taxpayers do not respond to IRS correspondence or where they provide insufficient documentation of identity theft. If a taxpayer does not reply to a request for information or responds after the prescribed time, the IRS simply moves the taxpayer into scrambled SSN procedures and does not count the case as an identity theft case.²¹

For these reasons, it is apparent that even with the identity theft marker, the IRS will not be able to accurately quantify the number of tax-related identity theft cases. Without an accurate estimate, it will be difficult for the IRS to allocate appropriate resources to assist victims of identity theft. More significantly, accounts that are not tracked will not receive the benefit of account monitoring or global account review provided by the Identity Protection Specialized Unit.

The concern over the IRS's ability to accurately estimate the number of tax-related identity theft incidents underscores the need for a centralized unit that monitors all instances of tax-related identity theft. The IRS should apply an indicator on all identity theft cases, whether identified by the IRS or reported by the taxpayer.

Need for Improved Communication with Identity Theft Victims

Current IRS communications with identity theft victims lack clarity. When the IRS receives multiple filings using the same SSN and cannot determine which person rightfully owns the number, it issues a Letter 239C, Scrambled SSN Clarification to Taxpayer, to both taxpayers (the first of two Letters 239C that may be sent). The first letter instructs the taxpayer to provide documents that are not part of the standard identity theft documentation, e.g., a copy of a current utility bill or bank statement. At this point, the only thing the taxpayer knows for sure is that he or she has a tax problem. The requirement to obtain such documents places an unnecessary burden on taxpayers and may delay case resolution.

The Letter 239C does not notify the taxpayer that identity theft is a possible or likely cause of the problem; it merely says that "there may be a problem with the Social Security number you used on your income tax return."²² At no point does the IRS clearly explain that the taxpayer may be a victim of identity theft. More importantly, the letter fails to adequately describe the consequences of an insufficient or untimely response. If taxpayers do not timely respond to this vague notice, the IRS initiates scrambled SSN procedures, which may result in the identity theft victim being unable to claim certain credits and deductions (such as the earned income tax credit (EITC) or the personal exemption) for several years.²³

Even when the IRS has verified the existence of fraud, it still does not notify taxpayers that they may be victims of identity theft. Before June 2008, the IRS was not clear as to whether the disclosure restrictions in Internal Revenue Code (IRC) § 6103 would prevent the IRS from sharing any information about the identity theft with the owner of the compromised SSN. However, in June 2008, the IRS received written guidance from the Office of Chief Counsel stating that the IRS may disclose to the SSN owner that the number has been used on another return and that he or she is an apparent victim of identity theft, without violating IRC § 6103.

The IRS should not only alert taxpayers of potential identity theft when another tax return is filed using their SSN, but also when their number shows up on a document associated with another tax return. For example, the AUR unit does not notify taxpayers about the misuse of their SSNs if the name on the tax return does not match the SSN shown on the associated Form W-2.²⁴

We recommend that the IRS stop using the Letter 239C for identity theft cases and develop a new letter for these cases. This letter should explain why the IRS thinks the taxpayer may be a victim of identity theft, instruct the taxpayer on the next steps to take, provide a form the taxpayer can submit to the IRS, and provide a phone number for the identity theft hotline.

Not only does the IRS use unclear language when communicating with identity theft victims, it also delays processing their tax returns. Some identity theft cases are initially treated as a "duplicate filing," which means that the IRS receives multiple filings of the same tax form using the same name and the same SSN.²⁵ For example, a duplicate filing can occur when an identity thief files a tax return under the name and SSN of the victim.

It is the job of the AM function to sort out whether the duplicate filing is a situation where the taxpayer was attempting to file an amended return or where he or she was the victim of identity theft.²⁶ Given the difficulties in working identity theft cases, this determination ought to be a priority for the IRS. Rather than prioritizing these cases, however, the IRS actually delays the processing of duplicate filings by two to three weeks.²⁷

IRS Employees Should Be Allowed to Exercise More Discretion in Identity Theft Cases.

In 2007, the IRS established standardized documentation requirements for taxpayers to substantiate their claim of identity theft. Identity theft victims are directed to provide either a copy of a police report or an affidavit of identity theft obtained from the FTC.²⁸ There is nothing magical about the FTC affidavit of identity theft. It is a self-reported document that actually contains a statement emblazoned in red ink and capital letters:

When the IRS developed its standardized list of acceptable documents, it did so with the intention of easing taxpayer burden. With this in mind, the IRS should recognize that some identity theft victims are faced with extremely unusual circumstances and may not be able to comply with the requirement to produce one of the two acceptable documents. In order to deal with extraordinary situations, the IRS should allow its managers the discretion to deviate from established guidelines.

For example, a taxpayer came to TAS in 2008 with an unusual situation. He had recently been released from prison after serving several years, and was surprised to receive a letter from the IRS stating that he had failed to report income from a job in another state during one of the years he was incarcerated. The taxpayer provided prison records verifying his whereabouts and a letter from the SSA stating that it had determined that he had no earnings in the year in question. The IRS did not dispute that the earnings were not the taxpayer's, but refused to adjust his account until it received one of the two types of documentation listed in the IRM.

Here, the taxpayer provided two documents that proved he was a victim of identity theft, yet the IRS refused to adjust his account, even when TAS elevated the issue by issuing a Taxpayer Assistance Order (TAO). The issue was finally resolved in the taxpayer's favor after the National Taxpayer Advocate issued a TAO to the Deputy Commissioner of the Wage and Investment division.

Another area where IRS employees should be able to exercise discretion is when deciding whether to implement "scrambled SSN" procedures. When the IRS cannot determine the true owner of an SSN in question, it initiates scrambled SSN procedures and assigns a temporary IRS number (IRSN) to all users of the SSN, including the victim of identity theft.³⁰ All parties are told to use the IRSN on their future tax returns instead of the SSN. This action means these filers will not be eligible for tax benefits that require a valid SSN, such as the EITC and the personal exemption.³¹

For years, the National Taxpayer Advocate has expressed concern that the IRS has been moving identity theft cases into the scrambled SSN process prematurely, rather than using information already available to the IRS to avoid these procedures.³² Not only are scrambled SSN procedures burdensome for innocent taxpayers, but they affect too many taxpayers unnecessarily.

The IRS should give its employees more latitude in determining the rightful owner of the SSN and avoid the scrambled SSN process altogether. For example, if the IRS receives two returns using the same SSN, the IRS employee should be instructed to look at the filing history and utilize all available research tools.³³ If the research shows that taxpayer A has filed returns reporting wages using the associated SSN for ten years, but the SSN belongs to a 16-year-old child (taxpayer B, who has filed a return for the first time this year), the IRS employee should be able to determine who owns the number. In this instance, the IRS should not initiate scrambled SSN procedures, but should place an identity theft indicator on taxpayer B's account and alert taxpayer B that his or her SSN has been compromised so that he or she can take measures to protect his or her identity.

The IRS should allow its employees and managers the latitude to exercise discretion where appropriate. We note that current IRS guidance does instruct AM employees to "make every effort to locate the correct TIN [taxpayer identification number] for each taxpayer before contacting the taxpayer(s)."³⁴ However, our experience is that AM employees have been reluctant to exercise any discretion in making a determination as to which filer is the true owner of the SSN in question. This reluctance may be a result of a slight change in the IRM in 2005. Prior to 2005, the IRM instructed AM employees that "[e]very effort should be made to locate a correct TIN for both taxpayers BEFORE using scramble procedures" (emphasis in original).³⁵ Note that TAS experienced a significant increase in stolen identity cases post-2005.

The IRS can provide adequate guidance to its employees about how to exercise judgment in making these determinations, and can update this guidance with examples derived from actual cases. If warranted, the Identity Protection Specialized Unit should track these "unusual circumstances" and meet with TAS to develop any administrative or legislative changes needed to address these situations systemically.

Conclusion

Commissioner Shulman has expressed a desire to focus on the taxpayer's experience in dealing with the IRS, stating "we must not only meet legal requirements, we must walk a mile in the taxpayers' shoes and help them navigate the system."³⁶ The National Taxpayer Advocate applauds this approach and feels that this should be the IRS's focus in developing procedures for assisting identity theft victims.

We are pleased that the IRS has made positive strides in addressing the concerns we identified in prior years. However, we have identified a number of concerns with the IRS approach. The IRS should consider taking the following actions to improve its assistance to victims of identity theft: provide global account review and account monitoring (if necessary) for all identity theft victims; allow its employees the discretion to deviate from established guidelines in accepting evidence of identity theft; and allow its employees more latitude in determining the rightful owner of a disputed Social Security number.

We urge the IRS to continue working with TAS to improve assistance to victims of identity theft. We will closely monitor the impact of these new procedures and will work collaboratively with the Office of Privacy, Information Protection, and Data Security to address new issues as they arise.

IRS Comments

The IRS appreciates that the National Taxpayer Advocate recognizes the significant progress the IRS is making to address identity theft. We continue to work closely with the National Taxpayer Advocate to identify areas for improvement in meeting the challenges of resolving tax problems related to identity theft. The IRS is committing significant resources to address the challenges posed in protecting taxpayers' identities and identity information. An enterprise-level Identity Protection Strategy serves as the foundation for all of our efforts to provide services to victims of identity theft and to reduce the effects of identity theft on both taxpayers and tax administration. This strategy, which was initiated in 2004 and updated this year, focuses on three priority areas that are fundamental to protecting taxpayers' identities and addressing the impact of identity theft.

Victim Assistance: It is a strategic goal of the IRS to better assist taxpayers by expediting and improving resolution of identity theft-related tax issues. On October 1, 2008, the IRS opened the Identity Protection Specialized Unit (IPSU), a unit dedicated to resolving tax issues incurred by identity theft victims. This unit enables victims to have their questions answered and issues resolved quickly and effectively. In its first two months, the IPSU responded to approximately 7,500 inquiries. We expect this number to rise as awareness of this service increases.

The IRS has also begun sending a series of new letters to taxpayers regarding identity protection. This year, we began by sending letters to individuals identified through our work processes as actual or probable victims of identity theft. Through the pilot program for these notifications, the IRS sent over 2,000 letters. These letters inform taxpayers that their personal information was used by another individual to file a fraudulent refund return or that their information may have been compromised through phishing scams. They provide contact information for the IRS, as well as valuable information on steps victims can take to resolve any tax-related issues and to prevent potential future harm. During the coming year, we will expand our efforts and begin notifying all IRS-discovered victims of refund crimes. Additionally, based on information received by the IRS during return filing, we will begin a new pilot project to notify taxpayers whose information has been improperly used by another person to gain employment.

The IRS is committed to an ongoing review of our communications with identity theft victims to ensure they are clear, meaningful, and necessary. We will continue our practice of vetting communications extensively and requesting feedback from taxpayers to inform these reviews. We look forward to our continued collaboration with the National Taxpayer Advocate on this important area of victim assistance.

Outreach: The IRS is committed to increasing awareness of identity protection through multiple communication channels and education efforts. The IRS has focused heavily this year on raising awareness of identity protection issues through direct contact with the tax practitioner and taxpayer communities. Led by our newly formed Office of Privacy, Information Protection, & Data Security, the IRS has addressed groups at over 40 events throughout the country, including six Nationwide Tax Forums. During the Nationwide Tax Forums, we addressed over 5,700 practitioners on this topic. Additionally, the newly established IRS Online Fraud Detection and Prevention (OFDP) office is a co-sponsor of the Onguardonline.gov website, along with the Federal Trade Commission (FTC), Department of Homeland Security, Naval Criminal Investigative Service, and other federal government agencies. This website is an excellent resource for consumers and contains information from the federal government and technology industry on strategies for protecting personal information. The response to IRS outreach in these settings has been overwhelmingly positive and we have received valuable feedback from taxpayers and the practitioner community.

This year, the IRS engaged key executives and experts in the fields of privacy and identity theft, in the domestic and international arenas, to share and acquire information on best practices for protecting and assisting the public. On July 21-22, 2008, the IRS hosted these individuals in the first IRS Identity Protection Forum. The goal of the forum was to share common experiences and successes in the protection of identity information and gain insights into trends and future developments in this area of growing interest. This forum has proven successful in bringing together its participants to combat identity theft. For example, the IRS has held discussions with one of the forum presenters to discuss vulnerabilities for identity theft in check cashing establishments and is collaborating internally to identify possible opportunities for pursuing proactive identity theft solutions. In addition, the FTC forum participants engaged the IRS to collaborate on developing an identity theft guide for pro bono attorneys. Representatives at the forum from Her Majesty's Revenue & Customs have held several follow-up meetings with the IRS and the Department of Justice (DOJ), resulting in increased collaboration in combating identity theft, generally, and particularly the global problem of phishing.

Prevention: The IRS is building a strong prevention program to reduce incidents of identity theft. This program is based upon three priorities: (1) reducing opportunities for thieves to obtain identity information, (2) reducing the opportunities for thieves to use the data they have stolen, and (3) increasing deterrence efforts to discourage identity theft. The IRS has established the OFDP office to address the increasing and evolving threat of online fraud and reduce opportunities for identity thieves to obtain information. The IRS Criminal Investigation (CI) Division and the OFDP office are working closely with the Treasury Inspector General for Tax Administration (TIGTA), the DOJ, the FBI, and the FTC to pursue criminal investigations and prosecutions of phishing perpetrators, as appropriate.

The IRS has significantly improved the ability to quantify and track incidents of identity theft. In January 2008, the IRS began placing an identity theft marker on the accounts of taxpayers who identify themselves to the IRS as victims of identity theft who have experienced an impact on their tax accounts. This marker is an excellent tool for assisting taxpayers because it indicates to any employee handling the taxpayer's account that they are dealing with a substantiated case of identity theft. We project that more than 24,000 accounts will carry this particular marker by the end of this calendar year.

On October 1, 2008, we rolled out several new markers. One marker is being placed on the accounts of taxpayers who self-identify as potential or actual victims with no apparent impact on tax administration. Another is being used where, through our business processes, we have identified individuals as being impacted by refund fraud or phishing schemes. We project that more than 23,000 accounts will carry this marker by the end of this calendar year.

We also use an account marker to annotate identity theft cases identified through our duplicate returns determination process. When two returns are filed using the same SSN and the IRS is unable to determine the true owner of the SSN through its normal business processes, we have historically used our scrambled SSN procedures to resolve the case. This involves submitting limited information from the returns to the Social Security Administration for verification of the true owner of the SSN. We have been working to improve our procedures to more efficiently resolve duplicate returns cases without using the scrambled SSN process. As we work through the current inventory of scrambled SSN cases and make a determination as to the true owner of the SSN, we are marking the account of the legitimate SSN owner and notifying that individual with a modified, more targeted Letter 239C. This letter contains specific information concerning the impact of identity theft on the taxpayer's account. Within the next few months, we will be working through the existing inventory of cases and notifying the impacted taxpayers.

In 2009, we will test the use of another new account marker with taxpayer notification to annotate the accounts of taxpayers whose SSNs have been inappropriately used by others to gain employment. The IRS receives tax returns each year that are filed using an Individual Tax Identification Number (ITIN) with a Form W-2 attached containing an SSN, and the new marker will specifically address this population of victims.

We are also employing our identity theft markers to reduce the ability of identity thieves to use stolen information. Beginning in January 2009, any tax return filing activity on the accounts of taxpayers who have been flagged in our system as victims of identity theft will be filtered based on a thorough analysis of common indicators of fraud. The use of these filters will enable an automatic, systemic review of a taxpayer's account to determine whether new return filings are legitimate. Suspicious filings will be systemically removed from return processing for manual review. Most legitimate taxpayers will not experience an additional delay in the amount of time it takes to receive a refund in this situation. We will communicate with those taxpayers from whom we may need additional information in order to resolve their cases.

The National Taxpayer Advocate recommends that the Identity Protection Specialized Unit monitor all identity theft cases.

Often, the first IRS point of contact for a taxpayer is the function that initiated a notice to the taxpayer. Our analysis indicates that centralization of all identity theft cases in one unit would increase case resolution time and, thus, taxpayer burden. The function that is the business owner of that taxpayer's specific issue has the case background and specialized knowledge necessary to most effectively and efficiently resolve the problem. To ensure fair and consistent treatment of victims across all functions, the IRS is developing a central reference point in the Internal Revenue Manual that links all identity theft-related procedures outlined in the IRM and cites examples of common issues and proper case resolution. We issued interim guidance in a series of memoranda in September 2008, and intend to release the finalized Servicewide Identity Theft Guidance in early 2009.

The IRS recognizes that tax-related identity theft cases can be very complex and may require specialized support, particularly where a victim has multiple tax-related issues. The IPSU is specifically chartered to assist taxpayers who have experienced tax problems as a result of identity theft and either have been unable to have their issues effectively resolved by the function or have multiple issues that require coordination among various functions. One mission of the IPSU is to reduce the burden of victims by serving as their central contact point within the IRS. IPSU assistors are responsible for working with the various functions to ensure that all known identity theft-related issues are resolved. Taxpayers may contact the IPSU of their own accord or may be referred to the IPSU by the originating function.

We are in the process of establishing mandatory procedures for global account review by all functions that have contact with victims. Our analysis indicates that review by the taxpayer's first point of contact is a more effective and efficient means of reducing taxpayer burden than mandatory referral of the taxpayer to the IPSU for global account review. Where a review uncovers other identity theft-related issues, those specific cases will be routed to the IPSU; which will ensure complete and timely resolution.

The IRS is pleased with the initial success of the IPSU and will continue to raise awareness of this valuable service, both internally and externally. Further, we will review our policies on an ongoing basis to ensure they are consistent with our commitment to provide effective and efficient service in a manner that reduces taxpayer burden.

The National Taxpayer Advocate recommends that employees be allowed the discretion to deviate from established guidelines in accepting evidence of identity theft.

Where taxpayers self-identify as victims of identity theft, in an effort to prevent further fraud, we require proof of identity and substantiation of identity theft with either a police report or the FTC's Affidavit of Identity Theft. We do this to prevent identity thieves from committing further fraud by identifying themselves as the legitimate taxpayer. Because of this risk, we currently limit employee discretion on variations to our standard documentation requirements. The IRS is developing its own identity theft affidavit that will collect from victims the information most pertinent to tax administration, and will require a sworn signature. We expect this form to be available for use in 2009. This new form, which will be both simpler and more specific to IRS use, will make it easier for taxpayers to complete the substantiation process.

For cases with exceptional circumstances, where this documentation cannot be provided, we have established a working group, with representatives from TAS, to address unusual conditions. This working group is also charged with reviewing our business processes in light of such cases and making recommendations for meaningful change where appropriate.

The National Taxpayer Advocate recommends that employees be allowed more latitude in determining the rightful owner of a disputed Social Security number.

The IRS has recently implemented process changes for empowering employees with greater discretion in determining the rightful owner of an SSN in our duplicate returns cases. This year, the IRS chartered a Lean Six Sigma team consisting of process review experts with a mandate to improve the duplicate returns determination process. After a thorough review, the team made specific recommendations for streamlining the resolution process and preventing future duplicate returns cases from being submitted to the SSA through our scrambled SSN process. The team developed a criteria-based checklist that enabled employees to use their knowledge and judgment to make a determination as to the rightful owner of the SSN in approximately 63 percent of the cases that would have been referred for scrambled procedures. This means that 63 percent of legitimate taxpayers whose returns would otherwise have been held up in the scrambled SSN process had their account issues resolved efficiently and received their refunds quickly.

As of October 1, 2008, a group of employees with specialized training are applying the new process modifications, as detailed in interim procedural guidance, to the entire existing open inventory of scrambled SSN cases. Based on feedback from their experience in working through the cases, we will further modify the redesigned processes as appropriate. We are confident that, with additional experience, training, and, if necessary, process modifications, our employees will be able to use their knowledge and judgment to prevent a greater percentage of duplicate returns cases from being placed in the scrambled SSN process.

Conclusion

The IRS has made significant progress in the area of identity protection this year. We are committed to the ongoing implementation and improvement of our Identity Protection Strategy. We will continue to engage taxpayers, the practitioner community, and industry experts in educational and collaborative outreach initiatives such as the Identity Protection Forum. We look forward to continuing our collaboration with the National Taxpayer Advocate in identifying, developing, and implementing additional improvements in this important area of tax administration.

Taxpayer Advocate Service Comments

We are pleased that the IRS recognizes identity theft as a serious problem and has made it a priority to address many of the concerns identified in this report. In the past year, the IRS has improved a number of processes relative to identity theft-related tax issues.

We advocated for a global account review for all identity theft victims who come to the IRS. The IRS notes in its response that it is establishing mandatory procedures for global account review. The IRS prefers that this review be conducted by the function having the first contact with the victim. From a taxpayer perspective, it does not matter which function performs this global account review, as long as it is conducted timely and thoroughly. The National Taxpayer Advocate does not have any concerns with the IRS's proposed approach, and looks forward to seeing these procedures implemented.

We also recommended that the IRS allow its employees the discretion to deviate from established guidelines when accepting documentation as evidence of the identity theft. The IRS feels that the burden of providing documentation will be lessened with the development of a new IRS identity theft affidavit. The IRS notes that a working group will review cases with exceptional circumstances. The National Taxpayer Advocate remains concerned that there will always be taxpayers with circumstances that the IRM does not contemplate. We feel that a better approach is to provide managers the authority to exercise discretion in these unique circumstances.

The National Taxpayer Advocate also recommended that the IRS empower its employees with greater discretion in determining the rightful owner of an SSN in duplicate returns cases. We are pleased to learn that the Lean Six Sigma team has reached a similar conclusion. We hope that the IRS will adopt this proposal to streamline the resolution process and prevent future duplicate returns cases from being submitted to the SSA through the Scrambled SSN process, and we applaud the IRS for applying these procedures to the current backlog of Scrambled SSN cases.

The IRS has made significant improvements to its procedures for assisting identity theft victims. The National Taxpayer Advocate looks forward to continued collaboration with the IRS in this area. She expects, as a result of these improvements, that TAS identity theft cases will be few and far between in the years to come.

Recommendations

In light of the IRS's agreement with our suggestions, the National Taxpayer Advocate has no specific recommendations at this time. However, she will continue to monitor that the IRS implements the following actions it has agreed to take to improve its assistance to victims of identity theft:

²See National Taxpayer Advocate 2007 Annual Report to Congress 96-115.

³Identity Theft in Tax Administration: Hearing Before the Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Nina E. Olson, National Taxpayer Advocate); The Tax Return Filing Season, Internal Revenue Service Operations, Fiscal Year 2009 Budget Proposals, and the IRS National Taxpayer Advocate's Annual Report: Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and Means, 110th Cong. (Mar. 13, 2008) (statement of Nina E. Olson, National Taxpayer Advocate).

⁴See Identity Theft in Tax Administration: Hearing Before the United States Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Douglas Shulman, IRS Commissioner); see also Tax Notes Today, IRS Officials Pledge Improved Communications with Taxpayers, 2008 TNT 91-5 (May 9, 2008); Tax Notes Today, Shulman Promises Improvement in IRS Response to Identity Theft, 2008 TNT 71-2 (Apr. 11, 2008).

⁵See Memorandum for Division Commissioners, Chiefs, National Taxpayer Advocate, Directors, from Director, Privacy, Information Protection and Data Security, Identity Theft Tracking Implementation (Jan. 4, 2008).

⁶ Servicewide Electronic Research Program (SERP) Alert, Identity Theft Hotline (Sept. 24, 2008).

⁷ Federal Trade Commission, Consumer Fraud and Identity Theft Complaint Data, January -- December 2007 5, at http://www.ftc.gov/opa/2008/02/fraud.pdf (last visited Dec. 16, 2008).

⁸ Taxpayer Advocate Management Information System, FY 2005, FY 2006, FY 2007, and FY 2008.

⁹See National Taxpayer Advocate 2007 Annual Report to Congress 96-115 (comprehensively addressing the problems with IRS identity theft procedures); National Taxpayer Advocate 2005 Annual Report to Congress 180-91 (addressing the excessive delays in resolving taxpayer problems and deficiencies in IRS procedures); National Taxpayer Advocate 2004 Annual Report to Congress 133-36 (addressing the inconsistent treatment of identity theft cases across the IRS); National Taxpayer Advocate Fiscal Year 2009 Objectives Report to Congress viii-xx; National Taxpayer Advocate Fiscal Year 2008 Objectives Report to Congress 15-16, 36-40; National Taxpayer Advocate Fiscal Year 2007 Objectives Report to Congress 24.

¹⁰See National Taxpayer Advocate 2007 Annual Report to Congress 115.

¹¹See SERP Alert, Identity Theft Hotline, at http://www.irs.gov/individuals/article/0,,id=136324,00.html (Sept. 24, 2008).

¹²See http://www.irs.gov/individuals/article/0,,id=136324,00.html (last visited Oct. 3, 2008).

¹³See id.

¹⁴See SERP Alert 080389, Functions Are Referring Their Tax-Related Identity Theft Cases to the AM Identity Theft Units in Error (Oct. 6, 2008).

¹⁵See http://www.irs.gov/individuals/article/0,,id=136324,00.html (last visited Oct. 3, 2008).

¹⁶See Memorandum for Division Commissioners, Chiefs, National Taxpayer Advocate, Directors, from Director, Privacy, Information Protection and Data Security, Identity Theft Tracking Implementation (Jan. 4, 2008). See also IRM 4.19.13.25 (Jan. 4, 2008) (implementing identity theft tracking procedures in the Automated Underreporter units).

¹⁷See PIPDS, Substantiated Identity Theft Tracking and Implementation (Jan. 4, 2008).

¹⁸See id.

¹⁹See National Taxpayer Advocate 2005 Annual Report to Congress 191.

²⁰See Internal Revenue Manual (IRM) 4.19.3.4.1 (Nov. 8, 2005).

²¹See IRM 21.6.2.4.3.9.1 (June 4, 2008).

²² IRM 21.6.2.4.4 (Oct. 1, 2007).

²³See National Taxpayer Advocate 2007 Annual Report to Congress 545-46.

²⁴See IRM 4.19.3.4.1 (Nov. 8, 2005).

²⁵See IRM 21.6.7.4.4 (Oct. 1, 2008).

²⁶See id.

²⁷See Most Serious Problem, Incorrect Examination Referrals and Prioritization Decisions Cause Substantial Delays in Amended Return Refunds for Individuals, infra.

²⁸See Memorandum for Commissioner, Small Business/Self-Employed Division, Commissioner, Wage and Investment Division, and Chief, Appeals, from Deputy Commissioner for Services and Enforcement and Deputy Commissioner for Operations Support, Standard Identity Theft Documentation (June 11, 2007).

²⁹ The Identity Theft Affidavit may be obtained from the FTC website at http://www.ftc.gov/bcp/edu/resources/forms/affidavit.pdf (last visited Dec. 16, 2008).

³⁰ The IRS follows scrambled SSN procedures when two or more taxpayers file returns using the same SSN and there is no clear indication as to which taxpayer owns the SSN. See IRM 21.6.2.4.2(4) (Jan. 22, 2008).

³¹See IRM 21.6.2.4.4 (Oct. 1, 2007).

³²Identity Theft in Tax Administration: Hearing Before the United States Senate Committee on Finance, 110th Cong. (Apr. 10, 2008) (statement of Nina E. Olson, National Taxpayer Advocate); National Taxpayer Advocate 2007 Annual Report to Congress 101-03; National Taxpayer Advocate 2005 Annual Report to Congress 184; National Taxpayer Advocate 2004 Annual Report to Congress 134-36.

³³ While current IRS guidance does instruct AM staff to "make every effort to locate the correct TIN [taxpayer identification number] for each taxpayer before contacting the taxpayer(s)," TAS's experience is that these employees are reluctant to exercise any discretion in determining the true owner of the SSN. See IRM 21.6.2.4.2.3 (May 23, 2008).

³⁴ IRM 21.6.2.4.2.3 (May 23, 2008).

³⁵ IRM 21.6.2.4.2.2 (Oct. 27, 2004). The IRM further instructs employees to research CC IMFOL, RTVUE, INOLE, NAMES, DUPOL, FFINQ, and REINF, request MFTRA, obtain NUMIDENT, and request all returns for the years involved.

³⁶ IRS Commissioner Douglas Shulman made these remarks during a discussion of the ten-Year Anniversary of the IRS Restructuring and Reform Act of 1998 at a conference organized by Tax Analysts. See IR-2008-90 (July 18, 2008).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Stephen T. Miller, Commissioner, Tax Exempt & Government Entities Division

Definition of Problem

The IRS has the responsibility to help taxpayers understand and meet their tax obligations. Taxpayer service is not a "one size fits all" endeavor, but one that requires continuous innovation and testing of new solutions. Fundamental to this concept is a proactive service strategy by which the IRS reaches out to the taxpayer with education and help in solving problems.

Although the IRS is improving its face-to-face service and outreach, it should explore additional taxpayer-centric services. As part of this effort, the IRS should return to its original "one-stop shopping" concept on which Taxpayer Assistance Centers (TACs) were founded (i.e., a centralized location where taxpayers can resolve all issues related to their accounts, have questions answered, and receive tax preparation services) and extend this concept to other environments such as phone and Internet service.¹ The IRS should also offer taxpayers service through the channels they need and prefer; provide face-to-face assistance with tax law questions based on the needs of different geographic areas; offer taxpayers a more efficient method of submitting cash payments; explore new alternatives and best practices for future taxpayer service; and consolidate its outreach, marketing, and education initiatives.

Analysis of Problem

The Evolution of Taxpayer Assistance Centers

In response to concerns raised by the IRS Restructuring Commission,² Congress held hearings in 1997 and 1998 focusing on taxpayer problems and restructuring the IRS.³ The hearings revealed, among other things, that the IRS failed to provide quality service to taxpayers.⁴ Shortly thereafter, the IRS established Problem Solving Days,⁵ which proved to be a great success and led the IRS to reevaluate services offered in its walk-in offices. The IRS modified services to make every day a problem-solving day.⁶

The hearings led to the IRS Restructuring and Reform Act of 1998 (RRA 98).⁷ As part of RRA 98, Congress allocated funds to enable the IRS to extend more pre-filing and other assistance to taxpayers.⁸ In 2001, the IRS created a business unit named Field Assistance (FA) to plan for 676 TAC sites⁹ tasked with providing a wide variety of services.¹⁰ Presently, however, the IRS has only 401 TACs, and those sites are within 30 minutes drive time of just 60 percent of the United States population.¹¹ As discussed in the 2007 Annual Report, the National Taxpayer Advocate considers this level of coverage insufficient.¹² The National Taxpayer Advocate hopes the IRS uses the lessons from its Geographic Coverage Initiative, an evaluation of TAC locations and services, to expand TAC services to a larger percentage of taxpayers.¹³

Improved Aspects of Face-to-Face Service

Commissioner Douglas Shulman stated the IRS should focus on transparency, seamlessness, and building an environment of trust in the agency.¹⁴ He has also declared that the IRS must approach taxpayer service from a taxpayer's viewpoint to develop trust, providing the taxpayer with a seamless experience that produces the correct answer during the first Most Serious Problems contact.¹⁵ The National Taxpayer Advocate commends the IRS on its most recent taxpayer service initiatives, which help increase trust and taxpayer understanding of the IRS through face-to-face contacts.¹⁶

Taxpayer Assistance Blueprint

Congress mandated that the IRS, in consultation with the National Taxpayer Advocate and the IRS Oversight Board, develop a five-year plan for taxpayer service by April 2006.¹⁷ The IRS subsequently developed the Taxpayer Assistance Blueprint (TAB).¹⁸ However, studies conducted for the TAB, the 2006 Oversight Board study, and the National Taxpayer Advocate's 2006 Annual Report to Congress demonstrate that taxpayers need different services provided through different channels.¹⁹ The TAB addressed taxpayer service only for individual taxpayers. The National Taxpayer Advocate believes that the Small Business/Self-Employed division (SB/SE) would benefit from a similar initiative to understand the characteristics and needs of small business taxpayers.²⁰

Geographic Coverage Initiative

In 2008, the IRS established the Geographic Coverage Initiative to evaluate TAC locations and determine the best locations and services based on IRS and taxpayer needs.²¹ In the 2007 Annual Report to Congress, the National Taxpayer Advocate found the level of TAC coverage insufficient, in that 40 percent of the population is more than 30 minutes drive time from a TAC location.²² The National Taxpayer Advocate recommends the IRS use the lessons from the Geographic Coverage Initiative to expand face-to-face service through the TACs to a larger percentage of taxpayers and urges the IRS to share the final report from this initiative with TAS.²³

Facilitated Self-Assistance Research Project

The Facilitated Self-Assistance Research Project (FSRP) is located at 15 TACs where the IRS provides help with self-assistance (on computer workstations) or telephone self-assistance via the IRS toll-free system.²⁴ FSRP provides the IRS the opportunity to educate taxpayers on different services channels, freeing the TAC employees to help taxpayers with issues that are more complex. While the potential exists for the FSRP to be successful, current operating procedures hinder that success. To accomplish the goals of the FSRP, the IRS needs to use screeners effectively to determine which taxpayers can use self-assistance stations. TIGTA is concerned that screeners are not available or used effectively and efficiently at all FSRP sites.²⁵ The program needs the full support of the IRS in both staffing and effective evaluation to succeed.²⁶

Account Transcripts

TACs provided account transcripts until October 1, 2003,²⁷ when the IRS changed its policy and made transcripts available only by methods not conducive to the time-sensitive needs of taxpayers. In response, TAS cases increased. The IRS finally recognized that taxpayers need to receive transcripts face-to-face and changed its policy again in 2007, which the National Taxpayer Advocate recommended in several Annual Reports to Congress and in testimony before the Senate and House.²⁸ The original decision to cease providing transcripts at TACs flew in the face of taxpayer needs and preferences, and if the IRS had researched the decision effectively, it would have avoided imposing substantial taxpayer burden. The account transcript history should serve as a cautionary tale to the IRS regarding the hazards of making decisions without fully researching the consequences to taxpayers. The IRS now provides account transcripts to all taxpayers on an immediate basis at walk-in offices. This service reduces both taxpayer burden and the need for taxpayers to seek account transcript assistance from TAS.²⁹

Bringing the IRS to the Taxpayer

Service Delivery

The IRS is making strides in improving taxpayer outreach through face-to-face services, but needs to do more to meet taxpayer needs. The expansion of the IRS's Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs increased VITA Most Serious Problems tax preparation to more than 3.5 million returns through June 2008, a gain of more than 33 percent compared to June 2007.³⁰ The National Taxpayer Advocate believes VITA and the TACs should complement and coordinate with each other. This approach should include the use of mobile vans to provide taxpayer service to remote locations during the filing season, offering tax preparation and including issues that are normally "out of scope", but needed in different geographic areas.³¹ However, TACs and VITA sites should only be part of the IRS strategy to deliver service to the taxpayer. Previously, the IRS committed to providing alternate service methods³² The IRS should coordinate with other federal and state agencies, such as the Social Security Administration or state tax authorities, to provide one-stop shopping for taxpayers. The IRS could target specific groups of taxpayers by collaborating with agencies the groups use frequently; for example, by working with state motor vehicle departments, the IRS could offer excise fuel tax assistance to truck drivers.

Outreach Examples

On February 13, 2008, the President signed the Economic Stimulus Act (ESP) of 2008, providing stimulus payments to approximately 124 million households.³³ To help deal with the task of delivering these payments IRS employees contributed ideas for outreach, education, and services to taxpayers, with outstanding results.³⁴ The ESP effort was a one-time, unanticipated, consolidated outreach initiative, and the National Taxpayer Advocate commends the IRS for the efficiency of its work. The IRS opened 700 IRS and partner sites in 50 states on Saturday, March 29, 2008, and another 200 sites in April to reach out to taxpayers to file ESP returns. These efforts resulted in approximately 155,700 ESP returns prepared in the TACs through July 31, 2008,³⁵ and approximately 11 million ESP telephone services provided between October 1, 2007 and August 30, 2008.³⁶ The IRS also found that taxpayers demanded direct personal contact about the ESP program, despite receiving mailings and having information available online.³⁷

Another example of outstanding service is the IRS's Office of Indian Tribal Governments outreach to Indian Nations. During 2008, the office conducted 85 events with a total attendance of more than 3,600 customers.³⁸ The office also offered large-scale workshops for 227 Alaskan tribal villages and 112 Navajo villages.³⁹ Services include educational workshops on Title 31, employment tax forms, tip reporting, employment taxes, the Earned Income Tax Credit (EITC), information reporting, and gaming issues.⁴⁰ VITA also held sessions at seven events.⁴¹ The IRS should follow the Office of Indian Tribal Governments' model in targeting and bringing programs to other taxpayer populations.

Face-to-Face Service: One Step Forward, Two Steps Back.

After RRA 98, the IRS embarked on a campaign to improve face-to-face taxpayer service. However, before achieving its initial goals, the IRS began paring back face-to-face service and offering more Internet services, without adequately studying the impact of such reductions on taxpayer needs or their ability to comply with their tax obligations.⁴²

Reduced Services for Small Business and Self-Employed Taxpayers

The SB/SE division, created after RRA 98, included the Taxpayer Education and Communications (TEC) organization, whose purpose was to deliver face-to-face education and outreach programs to small business taxpayers to help them comply with their tax obligations.⁴³ The IRS planned to provide TEC with over 1,200 staff in 15 major field locations by FY 2002.⁴⁴ Instead, in October 2005, the IRS merged TEC with other outreach and communications organizations under the Communication, Liaison and Disclosure (CLD) function in SB/SE and reduced it from 536 to 183 employees.⁴⁵ CLD provides information electronically or through partners and stakeholders in the field, and has eliminated specialized face-to-face services for small businesses.⁴⁶ To adequately assist this taxpayer base in complying with tax obligations, the IRS should revive the original concept of TEC, and develop a five-year strategic plan based on the services and delivery channels that small business taxpayers need and prefer.

Reduced Services for Tax-Exempt Organizations

The TE/GE division conducted workshops through its Exempt Organizations (EO) unit on various topics, including Form 990, Return of Organization Exemption from Income Tax, between October 2007 and May 2008.⁴⁷ These workshops include face-to-face interactive forums on the Form 990, Return of Organization Exemption from Income Tax.⁴⁸ However, EO delivers most of its education and outreach through the Internet, and responds to Most Serious Problems invitations received rather than initiating speaking opportunities.⁴⁹ Because TE/GE received fewer of these requests, the number of customers reached dropped 35 percent compared to the first quarter of FY 2006.⁵⁰ Specifically, two 2006 events not repeated in 2007 accounted for 2,300 fewer customers reached.⁵¹ Electronic taxpayer service should not supplant face-to-face outreach unless EO has data that supports organizations preference for these services.⁵²

The IRS Should Consider Reviving Telefile.

The National Taxpayer Advocate commends the IRS for studying the revitalization of aspects of TeleFile, after previously failing to consider the consequences of eliminating the program, which enabled taxpayers to file returns at no charge by using their telephone keypads.⁵³ Approximately 4.4 million taxpayers used the program annually.⁵⁴ However, the IRS discontinued TeleFile in August 2005, over the objections of the National Taxpayer Advocate, because of increasing costs and declining use. The IRS ended TeleFile to save an estimated $17 million to $23 million,⁵⁵ but a subsequent TIGTA report found the move increased burden for a significant number of taxpayers.⁵⁶ Approximately two million taxpayers who used TeleFile in 2005 would have been eligible to do so again in 2006. Instead, more than one quarter of these taxpayers paid a total of $23.6 million to file their 2006 returns, and nearly half of the former Telefile taxpayers reverted to filing paper returns.⁵⁷ In the end, the elimination of TeleFile cost taxpayers more than the program would have cost the IRS.⁵⁸

The IRS Needs to Provide More Face-to-Face Service.

Taxpayer service from the perspective of a taxpayer needs to be more taxpayer-centric, transparent, and seamless. The IRS needs to examine which services it can deliver to various demographic groups, and the channel, or means of delivery, that each group needs and prefers.⁵⁹

TAC Services Remain Out of Reach for Many Taxpayers.

Many opportunities exist for the IRS to improve face-to-face services. Taxpayers in remote areas may have difficulty obtaining services from a TAC since most TACs are in more populous areas.⁶⁰ Further, only 55 percent of TACs are open 36 to 40 hours per week.⁶¹ Even though the IRS has hired seasonal workers to provide a higher level of staffing, more resources are necessary to meet taxpayer needs.⁶² For example, many people can only visit TACs during their lunch hours, when many TACs are closed.⁶³ Thus, the IRS should vary the service times at different locations to allow more taxpayers to use the TACs. TACs could rotate tax preparation to Saturdays and certain evenings during the week, marketing these services to taxpayers in advance. By using alternatives to brick-and-mortar TACs, such as mobile vans, the IRS could deliver specialized services to communities that need them. In collaboration with state tax agencies, and other service-oriented agencies, such as the Social Security Administration, the IRS should target specific taxpaying populations and services.⁶⁴

TACs Should Be Able to Answer More Tax Law Questions.

TACs are required to answer tax law questions for taxpayers.⁶⁵ Because the IRS considers many such issues out of scope at the TACs, their employees cannot provide seamless taxpayer service.⁶⁶ Not all geographic areas require identical tax law issues to be in scope, however, and the IRS could perform a comprehensive study to determine the need for issues to be back in scope in various areas. At present, the preparation of Schedule F, Profit or Loss from Farming, is out of scope in all areas.⁶⁷ A study might find it makes no sense to offer Schedule F preparation at all TACs, such as those in New York City, but it could benefit taxpayers to bring it into scope in areas where farming is a major industry, such as Iowa. The IRS does a disservice to taxpayers by universally declaring face-to-face assistance on certain issues out of scope without determining the geographically based demand for those services.

Taxpayers Continue to Face Problems in Submitting Cash Payments to the IRS.

Taxpayers who do not have checking or savings accounts (i.e., the unbanked) encounter difficulties when trying to make payments at TACs. The IRS is offering a courier service that allows taxpayers to make cash directly payments directly into an IRS account so the taxpayer will receive immediate account credit.⁶⁸ While the National Taxpayer Advocate commends this initiative, the IRS is piloting the service in only ten TACs due to funding issues.⁶⁹ The IRS needs to study the possibility of offering cash payment centers at local banks, grocery, or retail stores, many of which already have bank branches. The IRS needs numerous payment locations that are not just conventional brick and mortar sites, and should never turn away any taxpayer who is ready to make a payment, regardless of how he or she wants to make the payment.⁷⁰

A Vision of Taxpayer Service

The National Taxpayer Advocate previously addressed the need to determine taxpayer preferences and needs for service, including preferred channels such as face-to-face, telephone, and the Internet.⁷¹ Tax agencies and other organizations recognize the need for such information and focus on the needs of the taxpayer as crucial to the success of taxation systems. For example, the Organisation for Economic Co-Operation and Development (OECD) Taxpayer Services Sub-group identified putting the customer in the center as one of its guiding principles, and supports marketing and information based on individual customers according to socio-demographic criteria.⁷²

The Australian Tax Office (ATO) strives to be an open and transparent organization where interaction with taxpayers allows for service channel choice.⁷³ Australia designs its taxpayer systems from the "outside in," that is, building customer interaction points from the perspective of the customer, taking into account the needs and preferences of the taxpayer.⁷⁴ In 2003 the ATO developed a channel strategy with the aim of creating a tax program that is "easier, cheaper, and more personalized" to the taxpayer.⁷⁵ Using research, studies of taxpayer needs and preferences, tax administration concerns, and channel restrictions, the ATO created a channel preference system for various types of taxpayer interactions.⁷⁶ Australia provides transaction assistance through the Internet, the phone, by paper, and face-to-face; customer interactions may be held over the phone, on the Internet, through e-mail, over paper, and face-to-face; and customers can receive information through the Internet, via paper, on the phone, by e-mail, or in person.⁷⁷ Through research, the ATO seeks to define the best channels to provide service to the taxpayers, balancing taxpayer needs and preferences with the achievement of the ATO mission.⁷⁸

New Zealand's Inland Revenue Service developed a new business plan, Our Way Forward, in 2006.⁷⁹ The plan encompasses four goals, of which the first is to "target and tailor our activities through understanding our customers."⁸⁰ New Zealand presents its tax collection and administration activities as a collaborative agreement between the taxpayer and the government, emphasizing the role that each must play for the tax system to function effectively.⁸¹ The goal is to form a "customer-led" revenue system where taxpayer involvement will encourage voluntarily compliance with tax obligations.⁸² Based on this goal, New Zealand developed a Families Customer Perspective, which uses child support issues in New Zealand and Working for Families Tax Credits as well as paid parental leave to identify opportunities to improve and tailor the way the New Zealand tax administration communicates with its family customers.⁸³ New Zealand intends to complete a series of longitudinal studies to evaluate the effectiveness of the Working for Families program, encompassing elements such as awareness of the program, household economic surveys, and demographic information.⁸⁴

OCED members report they intend to use interactive digital television or telepresence.⁸⁵ Several tax authorities are testing this channel, which will integrate video, text, and data, and be interactive. In the United States, medical professionals have used videoconferencing for some time but are also using a variety of tools, including one called "telemedicine."⁸⁶ Physicians can provide services through a robot with an attached computer beaming to a patient's bedside from anywhere in the world as long as the physician has a high-speed Internet connection. Using a joystick and laptop, the physician can navigate the robot down hospital corridors, rotate it 360 degrees, zoom in on a patient's eyes, X-rays, or vital signs monitor, and can hear and speak as if he were in the room with the patient.⁸⁷ The IRS could use similar technology to reach taxpayers in remote geographic locations with pre-fling and post-filing services, thereby using its staffing more efficiently and effectively. Since telepresence is interactive, the TACs could provide all services, including return preparation, tax law, and account services through this communication mode.

Conclusion

July 22, 2008, marked the tenth anniversary of the IRS Restructuring and Reform Act of 1998. In this time, the IRS has substantially improved its customer service to taxpayers. The development of the Taxpayer Assistance Blueprint (TAB) helped the IRS learn more about taxpayers than it ever knew in the past. It also provided a strategic roadmap for future services and research. However, the IRS, the world's largest tax administrator, must do better. To bring world-class customer-centric service to the taxpayer, the IRS should continue the TAB with a comprehensive study of taxpayer service needs and preferences, expand the TAB to address other taxpayer segments, and implement the findings in a taxpayer service strategy tailored to the needs of the population it serves. The IRS should conduct a survey of tax law needs by geographic location and bring tax law areas into scope at the TACs based on taxpayer demand. To make taxes easier, the IRS needs to expand its cash payment acceptance program to all TACs and consider offering payment stations in alternative locations such as banks. The IRS must put the needs and preferences of the taxpayer first to provide timely and effective service that encourages voluntary compliance.

IRS Comments

The IRS agrees that it must help taxpayers understand and meet their tax obligations. We are committed to offering top quality service and, in doing so, continuously evaluate and improve our large and diverse portfolio of customer services. We remain aware of changing taxpayers' preferences in how they access the IRS and receive the information they need and believe that we must innovate and evolve to provide customer service successfully.

2008 Filing Season and Economic Stimulus Payments

The 2008 filing season was very successful, both in terms of serving taxpayers through multiple channels and in meeting challenges the IRS faced. Through November 7, 2008, the IRS processed over 155 million individual income tax returns and issued over 107 million refunds, totaling nearly $259 billion. The IRS also processed an additional 8.5 million returns filed solely for purposes of claiming an economic stimulus payment. Electronic filing grew again this year with 89.9 million, or 58 percent, of individual taxpayers filing electronically. This represents a 12.4 percent increase over the prior year.

The ESP legislation had a dramatic impact on our telephone program, resulting in over twice the number of toll-free calls in the January-June period of 2008 than in 2007 (118 million versus 57 million). Automated Calls and Web Services more than doubled from last year's volumes while Assistor Calls Answered increased by 26 percent. The IRS.gov website also proved to be a valuable resource to taxpayers, with a 24 percent increase in "Where's my Refund" inquiries, while our new "Where's my Rebate" tool experienced 37 million completed inquiries. In addition, as of November 8, 2008, the website has been visited more than 332 million times, a 65.9 percent increase over 2007. These visits resulted in more than two billion page views, an almost 67.3 percent increase over 2007.

During the 2008 filing season, the IRS continued to provide services at all 401 TACs. Assistance with ESP contributed to an increase in the volume of contacts at the TACs from February 15, 2008, through May 31, 2008, compared to the same period in 2007. The IRS also continued to provide services to low income, the elderly, the disabled, and those with limited-English proficiency through the VITA and TCE programs. The VITA/TCE volunteers prepared over 3.5 million returns, an increase of 33.2 percent over last year. Due to our outreach efforts, this increase includes many taxpayers that filed for ESP that normally do not have a filing requirement.

Face-to-Face Services

The IRS has improved its delivery of face-to-face services and will continue to do so. The National Taxpayer Advocate commends the IRS on its most recent taxpayer services initiatives and suggests the IRS do more to meet taxpayer needs. We have plans in place in several areas that will help improve our services.

Taxpayer Assistance Blueprint

With regard to continuing the TAB, we developed a multi-year research strategic plan to ensure that we expand and refine our understanding of taxpayer and partner needs, preferences, and behavior. This plan addresses a wide array of service-related research that will build upon the benchmark survey undertaken during the TAB, including recurring surveys of needs and preferences of taxpayers who have contacted the IRS, as well as those who have not.

In addition, we established a multi-divisional research council to ensure that the research plan addresses a broad spectrum of taxpayer segments. By helping the IRS increase its understanding of taxpayer needs and behaviors, efforts of the council and analysis of research findings will help to refine and improve future service delivery strategies.

The IRS agrees the SB/SE division would benefit from a similar TAB initiative. The SB/SE division's Research office is already working with the W&I division on a TAB Research Plan to address similar issues with small business taxpayers and practitioners and has taken on several TAB projects and other related research on the characteristics and needs of small business taxpayers.

The SB/SE division CLD function is also partnering with SB/SE Research to obtain data to assist in determining and planning outreach activities. For example, SB/SE Research provided a comprehensive library of existing research targeted toward the non-filer Most Serious Problems community. This research will be used to develop an outreach strategy aimed at small business taxpayers who are not complying with their filing requirements. SB/SE is also working on a project to determine whether significant portions of the tax gap can be isolated by industry and geography to best focus outreach. In the last two years, SB/SE Research has completed approximately 60 projects with many current projects underway.

Geographic Coverage Initiative

The IRS established the Geographic Coverage Initiative (GCI) in 2008 to evaluate TAC locations and services based on the IRS and taxpayer needs. Through the GCI, the IRS is exploring options for increasing the geographic coverage rate by using alternative locations and increasing partnership services. For example, the TAC program is partnering with the Volunteer program in FY 2009 to provide account resolution services in addition to the normal return preparation services offered at select VITA/TCE locations. After evaluating this pilot program, the IRS may offer these services at additional locations. In addition, the IRS is collaborating with Federal, State, and City agencies to establish alternative locations similar to disaster assistance sites where customers can receive one-stop assistance. There is already one multi-agency site in Salt Lake City, Utah, where IRS employees are co-located with the Utah State Tax Department. We expect to expand the number of locations offering multi-agency services during 2009.

Facilitated Self-Assistance Research Project

As the National Taxpayer Advocate mentions, the IRS implemented the FSRP to provide taxpayers options for self-assistance through computer workstations and access to the IRS toll-free system. The National Taxpayer Advocate believes that for the FSRP to be successful, the IRS needs to use screeners effectively to determine which taxpayers can use self-assistance stations. The IRS agrees and, based on analyses it performed on the current operating procedures, we are already implementing changes to improve the screening process. In this regard, we have allocated additional resources to ensure screeners are available and used effectively in each site and expanded training to ensure support for FSRP is readily available. For the 2009 filing season, FSRP has expanded to 35 additional TACs, bringing the total number of sites to 50.

Service Delivery to Taxpayers

The IRS is committed to providing service to taxpayers in the range of ways that they want. This includes face-to-face interaction at TACs, as well as by electronic means. How IRS provides services, both in terms of methods and through its organizational structure, needs to change and evolve with taxpayer preferences. The IRS continuously evaluates and studies its service delivery to maximize its assistance to taxpayers.

Face-to-Face Contact at Taxpayer Assistance Centers

The National Taxpayer Advocate mentions many taxpayers can only visit TACs during their lunch hours, when many TACs are closed and that the IRS should vary service times at different locations to allow more taxpayers to use the TACs. As noted in the IRS response to a similar point raised in the National Taxpayer Advocate's 2007 Annual Report for Congress, TAC standard operating hours are 8:30 a.m. to 4:30 p.m., which allows employees to have lunch as required by negotiated labor management agreements. However, to ensure we make face-to-face services available to those taxpayers unable to visit a TAC during normal operating hours, the IRS is adding a Super Saturday during the FY 2009 filing season to allow taxpayers to receive return preparation on Saturday. Further, with a goal of assisting over 530,000 EITC-eligible taxpayers with return preparation during the 2009 filing season, special EITC events will be held on January 31, February 7, and February 21, 2009, to help customers outside of normal business hours.

Scope of Questions Answered at TACs

The National Taxpayer Advocate also argues that TACs should be able to answer more tax law questions based on the needs of different geographic areas and asserts that, because the IRS considers many issues out of scope at the TACs, employees cannot provide "seamless" taxpayer service. As noted in the IRS response to the same point raised in the National Taxpayer Advocate's 2007 Annual Report for Congress, and again in its response to this year's Most Serious Problem on Centralization, just a few years ago the IRS was criticized for the relatively low level of tax law accuracy provided by its TACs. To address this concern, the IRS took aggressive action to increase employee training, implement enhanced quality measures and employee accountability, and control the scope of the issues addressed. The latter is intended to concentrate our employee training on the kind of issues most often encountered in the TAC environment, as well as to ensure consistency with TAC employees' grade levels and expertise.

The National Taxpayer Advocate is correct that TAC employees may not address Schedule F farm income issues currently. This complex area of tax law includes such issues as accrual accounting, leases and rents, inventory valuation, employee expenses, pensions and profit sharing, depreciation, cooperative distributions, agricultural program payments, crop insurance payments, and other sophisticated and specialized issues. However, the GCI is exploring the possibility of adding into scope geographic-based tax law topics, such as farming. The IRS expects to accomplish this by training selected subject matter experts and employing a referral system, while carefully evaluating the accuracy of these services. For FY 2009, two topics have already been added into scope at the TACs -- Non-Resident Alien issues and Cancellation of Debt (Mortgage Forgiveness). Cancellation of Debt income has also been added into scope at the VITA/TCE sites.

Cash Payments at TACs

The IRS accepts all approved forms of payment at its TACs, including cash when nearby conversion options are unavailable. To address employee safety concerns and potential integrity issues involved in dealing with cash, the IRS is refining its payment processes and seeking other options for handling cash payments. In FY 2008, the IRS successfully implemented a pilot program that offered courier services at ten TAC locations. Using the courier service, taxpayers can make cash payments that are deposited directly into a Treasury account. These payments are secure and taxpayers receive immediate account credit. In FY 2009, the IRS will expand courier services to the 177 TACs that are not co-located with a financial institution or U.S. Post Office where taxpayers can otherwise readily convert cash into other forms of payment.

Taxpayer Education and Communication Division

The National Taxpayer Advocate offers the merging of TEC with other outreach and communications organizations under the CLD function in SB/SE as an example of reduced services for small businesses and self-employed taxpayers. The IRS disagrees with the National Taxpayer Advocate's assessment.

Since SB/SE's inception, it has been committed to balancing service and enforcement by educating its taxpayers on tax law and IRS policy using a leveraged outreach approach. Although SB/SE has adjusted its organizational structure since RRA 98, it has always contained an education and outreach function and staffing dedicated to pure outreach and education has not diminished.

The IRS used a strategic approach when it merged TEC with other outreach and communications organizations under the CLD function. Research data showed locations with the highest concentration of small business and self-employed taxpayers, which drove the decision on employee placement. External stakeholders in all 50 states and Washington, D.C., have a liaison contact in the Stakeholder Liaison function. With advancements in technology and strengthened stakeholder relationships, liaison activities are not diminished from changes to the numbers or physical locations of the IRS employees involved. Although the original TEC design included approximately 1,200 staff, the organization never reached that level. Further, the number of TEC staff that were to be fully dedicated to outreach activities is approximately the same as the number of staff in the redesigned Stakeholder Liaison function.

Service to the Tax-Exempt Community

The IRS agrees that service to the tax-exempt community is essential and is committed to educating this sector through the EOs division within the Tax TE/GE division. The EO division has expanded and diversified its efforts to communicate, update and share information for tax-exempt organizations by balancing "in-person" employee presentations for their administrators with "round the clock" availability through the IRS.gov.⁸⁸ For example, the "Charities and Non-profits" section of IRS.gov has approximately 1,600 articles on 70 pages devoted specifically to tax-exempt organizations. Public reliance on the internet to receive timely and relevant information has grown exponentially. Use of the "Charities and Non-Profits" pages of IRS.gov has increased 81 percent since FY 2005.

This increased presence on the Internet was complemented by increased in-person presentations. Due in large part to the release of the redesigned Form 990 and the new Form 990-N (e-Postcard), requests for speakers during FY 2008 increased nearly 50 percent over the previous year.⁸⁹ To reach a broader audience, EO also offered 19 two-hour workshops on the new Form 990 at the six 2008 nationwide Tax Forums and introduced the form changes during its 17 Small and Mid-size Workshops in six cities across the country. In all, 41,752 people attended the speeches, Tax Forums, and Workshops, an increase over the FY 2006 figure of 32,368 and FY 2007 figure of 39,338.⁹⁰

Reviving Telefile

With regard to reviving Telefile, the IRS launched a comprehensive study, the Advancing e-file Study, to review the characteristics of taxpayers who do not file electronically and analyze a number of options that could help drive up the rate of electronic filing, including Telefile. The IRS engaged an independent firm, the MITRE Corporation, to conduct the study and produce the report. The IRS will look at the experience of the States and other countries, consider costs, benefits and security issues, and discuss potential implementation issues. The Advancing e-file Study will be done in two phases. Phase I was completed and released to the public on November 6, 2008, and provides 13 options for expansion. Phase II will address initial costing, cost-benefit and return on investment analyses and predictions of growth and is expected to be delivered in August 2009.

Conclusion

In summary, the IRS currently offers a large and diverse portfolio of customer services targeted to meet the needs and preferences of specific taxpayer populations. The IRS strives continually to improve these services within appropriated funding levels in order to help taxpayers understand and meet their tax obligations.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is encouraged by the actions the IRS is taking and intends to take in regard to customer service. We understand the evolving nature of taxpayer needs and preferences and support the effort of the IRS to expand upon the TAB Benchmark Survey with continuing studies of taxpayer needs and preferences. The National Taxpayer Advocate commends the IRS efforts to study the SB/SE taxpayer population, to bring tax law issues back into scope at the TACs, and expand the FSRP and the courier cash payment acceptance program.

The Voice of the Taxpayer

The Taxpayer Advocate Service is the voice of the taxpayer within the IRS. When the IRS creates projects and working groups on issues affecting taxpayer service, it is essential that TAS be represented and able to voice concerns from the perspective of the taxpayer. TAS provided three team members for the IRS's Geographic Coverage Initiative, but after several months of work, the IRS stopped including our team members in the Initiative. The National Taxpayer Advocate is surprised to learn that these activities have continued while TAS has been excluded. It is also a matter of concern that TAS has not been included in plans for a TAB for small business and self-employed taxpayers, like the one already in place for individual taxpayers. While the National Taxpayer Advocate commends the IRS for beginning work on this strategy, it is necessary that TAS be a part of such projects if the IRS truly intends to think about service from the perspective of the taxpayer. The National Taxpayer Advocate has recommended in several Annual Reports that the IRS conduct a small business/self-employed TAB.⁹¹ The Taxpayer Advocate Service was a significant author of the original TAB. It is in the interest of taxpayers and tax administration that the IRS reach out to the Office of the Taxpayer Advocate and invite participation on matters that have significant impact on taxpayers.

Scope of Tax Law Assistance

The National Taxpayer Advocate is encouraged by the effort to bring tax law issues into scope at TACs based on geographic need. However, we are concerned that the IRS reiterates the same response provided in last year's Report to Congress about not providing assistance on issues such as farming income because the issues are too complicated.⁹² A tax law issue that is complex for IRS employees is just as complex for taxpayers, if not more so. Previous criticism of the IRS's accuracy rate in answering tax law questions does not justify the decision to simply declare those issues out of scope instead of training employees in complicated areas of the law where taxpayers need the most assistance. While we understand that the IRS may have needed to limit its scope of questions several years ago in order to get its quality under control, as the IRS itself notes, it is now doing well with the limited scope of questions it is answering. The techniques that enabled it to achieve higher quality with easier tax law questions can and should be applied to more complex questions, where there is a demonstrated need. Complexity of the tax code is not an excuse for taxpayers' noncompliance; nor should it be an excuse for the IRS to fail to assist taxpayers in their need.

TAC Hours of Operation and Service Locations

While the National Taxpayer Advocate commends the IRS plan to hold a Super Saturday and three EITC Saturday events, this response does not address the concern that on a regular basis, taxpayers can only receive face-to-face assistance at TACs from 8:30 a.m. until 4:30 p.m. One Super Saturday is not enough, because it will only reach taxpayers available that one day. Holding more than one event would ease the burden on taxpayers who need IRS help. Varying the hours at TACs, staggering employees' lunch hours, and rotating tax preparation to evenings, combined with well-targeted outreach regarding the hours, would reach more taxpayers and permit flexibility in scheduling for taxpayers.⁹³

Partnering with VITA and TCE sites is a good first step. However, the IRS needs more avenues for reaching taxpayers in remote areas where brick and mortar TACs do not exist. The IRS should consider using mobile vans, telepresence, and other creative solutions to meet the needs of these taxpayers. While co-locating a TAC with the Utah State Tax Department site in Salt Lake City, Utah, is a good example of working with other agencies, Salt Lake City is a relatively populated area that already has a TAC and at least five VITA sites.⁹⁴ Co-locating should be used especially as a tool where the IRS currently has little or no presence.

The Way Forward

The National Taxpayer Advocate is encouraged by the steps the IRS is taking and has committed to take to address customer service issues. We remind the IRS that including the perspective of the taxpayer is crucial when evaluating changes to taxpayer service and we encourage the IRS to include TAS in all taxpayer services initiatives. The National Taxpayer Advocate emphasizes the need for a comprehensive study of taxpayer needs and preferences. We are hopeful that as the IRS moves forward it will continue to study these evolving needs and preferences and look for innovative ways to provide service.

Recommendations

The National Taxpayer Advocate recognizes the efforts the IRS has made thus far to improve service and recommends the IRS make the following changes to bring more services to taxpayers:

² Bob Kerrey, Co-Chair and Rob Portman, Co-Chair, Report of the National Commission on Restructuring the Internal Revenue Service, A Vision for a New IRS (June 25, 1997).

³See Practices and Procedures of the Internal Revenue Service: Hearing of the S. Comm. on Finance, 105th Cong. (Sept. 23-25, 1997); Recommendations of the National Commission on Restructuring the IRS on Taxpayer Protections and Rights: Hearing of the Comm. on Ways and Means Subcomm. on Oversight, 105th Cong. (Sept. 26, 1997).

⁴Practices and Procedures of the Internal Revenue Service: Hearing of the S. Comm. on Finance, 105th Cong. (Sept. 23-25, 1997). United States Senate, Committee on Finance, 105th Congress 2nd Sess. on H.R.2676 (Jan. 28-29; Feb.5, 11, 25, 1998).

⁵Many Unhappy Returns, Charles O. Rossotti, 136-137, Harvard Business School Publishing (2005).

⁶The 2002 Tax Return Filing Season and the IRS Budget for Fiscal Year 2003: Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and Means, 107th Cong. (Apr. 9, 2002) (testimony of Charles O. Rossotti, Commissioner of Internal Revenue).

⁷ RRA 98, Pub. L. No. 105-206 § 1002.

⁸Id.

⁹ Charles O. Rossotti, Commissioner, Internal Revenue Service, Approval of the Wage and Investment (W&I) Organization 21 (Oct. 1, 2001); TIGTA, Ref. No. 2005-40-110, The Effectiveness of the Taxpayer Assistance Center Program Cannot Be Measured 1 (July 2005).

¹⁰ Services included: accepting cash and checks for taxes due; setting up installment agreements and payment plans; answering taxpayer questions and assisting in resolving issues detailed in various IRS letters and notices; active involvement in the IRS's enforcement efforts by focusing on face-to-face compliance activities and working delinquent taxpayer cases; and making appointments, including multilingual assistance. TIGTA, Ref. No. 2005-40-110, The Effectiveness of the Taxpayer Assistance Center Program Cannot Be Measured 7(July 2005).

¹¹ IRS, Taxpayer Assistance Blueprint: Phase 2, 116 & 194 (Apr. 17, 2007).

¹² National Taxpayer Advocate 2007 Annual Report to Congress 162-82 (Most Serious Problem, Service at Taxpayer Assistance Centers).

¹³ Although TAS provided three team members to assist on the Geographic Coverage Initiative, the team did not share its findings with the National Taxpayer Advocate. It is the understanding of the National Taxpayer Advocate that the IRS Commissioner was briefed on the Geographic Coverage Initiative. In May 2005, the IRS announced plans to close 68 of the 401 established TAC offices. In response to the IRS proposal, Congress directed that the IRS not close any TACs, and mandated that the IRS address taxpayer needs, and IRS service delivery. This directive prohibited reducing any level of taxpayer service until the completion of a TIGTA study detailing the results of any proposals. Congress also mandated that the IRS consult with the National Taxpayer Advocate and the IRS Oversight Board. TIGTA determined that inaccuracies in the TAC model's workload and the absence of customer information diminished the effectiveness of the closure model, but neither the IRS nor TIGTA were able to ascertain the effect TAC closures might have on compliance. TIGTA, Ref. No. 2005-40-061, The Taxpayer Assistance Center Closure Plan Was Based on Inaccurate Data 3 (Mar. 2006).

¹⁴ IRS, Remarks of Douglas Shulman Before the Federation of Tax Administrators on June 9, 2008, at http://www.irs.gov/irs/article/0,,id=183721,00.html (last visited July 14, 2008).

¹⁵ "First, in every interaction, every transaction we conduct with a taxpayer, we should think about it from the outside-in -- from the taxpayer's point of view, even though we may not ultimately agree with the taxpayer. Taxpayers will be judging their interactions with the IRS and the government based on their most recent experiences with other world-class service organizations. This should be our standard. Second, if a taxpayer deals with more than one business group within the IRS, we should coordinate with each other so the hand-off is quick and trouble-free." IRS Commissioner Douglas Shulman, e-mail to all IRS employees (July 9, 2008).

¹⁶ IRS, Report to Congress: Progress on the Implementation of the Taxpayer Assistance Blueprint, April 2007 to February 2008 (Apr. 2007).

¹⁷Processing Assistance, and Management (Including Rescission of Funds), Joint Explanatory Statement of the Committee of Conference, Conference Report 109-307, 2-6, at http://www.rules.house.gov/109/text/hr3058cr/109hr3058jes.pdf (last visited Dec. 10, 2008).

¹⁸ IRS, Taxpayer Assistance Blueprint: Phase 2 (Apr. 17, 2007).

¹⁹See IRS Oversight Board, Taxpayer Customer Service and Channel Preference Survey Special Report (Nov. 2006); National Taxpayer Advocate 2006 Annual Report to Congress vol. 2, 1-15, Study of Taxpayers Needs, Preferences, and Willingness to Use IRS Services.

²⁰ National Taxpayer Advocate 2006 Annual Report to Congress 183.

²¹ In May 2005, the IRS announced plans to close 68 of the 401 established TAC offices. In response to the IRS proposal, Congress directed that the IRS not close any TACs, and mandated that the IRS address taxpayer needs, and IRS service delivery. This directive prohibited reducing any level of taxpayer service until the completion of a TIGTA study detailing the results of any proposals. Congress also mandated the IRS consult with the National Taxpayer Advocate and the Oversight Board. As a result, TIGTA determined that inaccuracies in the TAC model's workload and the absence of customer information diminished the effectiveness of the closure model, but neither the IRS nor TIGTA were able to determine the effect TAC closures might have on compliance. TIGTA, Ref. No. 2005-40-061, The Taxpayer Assistance Center Closure Plan Was Based on Inaccurate Data 3 (Mar. 2006).

²² IRS, Taxpayer Assistance Blueprint: Phase 2, 116 & 194 (Apr. 17, 2007).

²³ Although TAS contributed three members to the team, the IRS did not share the final report with them or the National Taxpayer Advocate before briefing the IRS Commissioner. The IRS also denied repeated requests from the National Taxpayer Advocate for a copy of the report to be used in developing this Most Serious Problem.

²⁴ IRS, Report to Congress: Progress on the Implementation of the Taxpayer Assistance Blueprint, April 2007 to February 2008 31 (Apr. 2007).

²⁵ Information provided by TIGTA (Oct. 15, 2008).

²⁶Id.

²⁷ IRS Field Assistance Newsletter, Congressional Update, Get Copies of Tax Return Information in Two Easy Ways (2002).

²⁸See National Taxpayer Advocate 2007 Annual Report to Congress 162-82; National Taxpayer Advocate 2005 Annual Report to Congress 254; National Taxpayer Advocate 2004 Annual Report to Congress 8-25; United States Senate Appropriations Subcommittee on Transportation, Treasury, the Judiciary, Housing and Urban Development, and Related Agencies, 109th Cong. (Apr. 7, 2005) (statement of Nina E. Olson, National Taxpayer Advocate); Joint Review of the Strategic Plans and Budget of the Internal Revenue Service: Hearing Convened by the Chairman of the Joint Committee on Taxation, 109th Cong. (May 19, 2005) (statement of Nina E. Olson, National Taxpayer Advocate).

²⁹ IRM 21.3.4.14.4 (Dec. 19, 2007).

³⁰ IRS, Customer Assistance, Relationships and Education (CARE) Weekly Report (Sept. 28, 2008). Tax returns prepared increased by 872,733, or 33.2 percent (this includes Economic Stimulus Package Returns).

³¹ "Out of scope" refers to issues in the areas of tax law questions, account questions and tax return preparation that TAC employees cannot address. IRM 21.3.4.3.7.5 (Dec. 31, 2007); IRM 21.3.4-1 (Apr. 7, 2008); IRM 21.3.4.3.7.5 (Dec. 31, 2007).

³² National Taxpayer Advocate 2003 Annual Report to Congress 149.

³³ IRS, Basic Information on the Stimulus Payments, at http://www.irs.gov/newsroom/article/0,,id=179211,00.html (last visited on Sept.15, 2008).

³⁴ IRS, Wage and Investment Division (W&I), Economic Stimulus Payments, IRS Employees Reach Out, at: http://win.web.irs.gov/Econ_Stim_Paymnts/ESP_employee_stories_home.htm (last visited Sept. 15, 2008).

³⁵ W&I, Field Assistance response to TAS information request Sept. 15, 2008.

³⁶ W&I, Customer Account Services response to TAS information request Nov. 13, 2008.

³⁷Financial Services and General Government Appropriations Bill 2009 Report, 110th Congress, 2d session 24 (June 2008).

³⁸ Tax Exempt and Government Entities (TE/GE), Office of Indian Tribal Governments response to TAS information request (Aug. 7, 2008).

³⁹Id.

⁴⁰ TE/GE, Office of Indian Tribal Governments response to TAS information request (Aug. 7, 2008).

⁴¹Id.

⁴² "We will continue to launch new and enhanced filing and payment programs to create an environment where electronic interaction is the preferred option for our customers." IRS, Strategic Plan 2005-2009 13.

⁴³ National Commission on Restructuring the Internal Revenue Service, A Vision for a New IRS 8 (June 25, 1997).

⁴⁴ General Accounting Office, GAO-03-711, Workforce Planning Needs Further Development for IRS's Taxpayer Education and Communication Unit 2 (May 7, 2003).

⁴⁵ National Taxpayer Advocate 2006 Annual Report to Congress 177.

⁴⁶ IRS, My SB/SE, at http://mysbse.web.irs.gov/CLD/SL/AboutSL/default.aspx (last visited Dec. 10, 2008).

⁴⁷ TE/GE response to TAS information request (Sept. 24, 2008).

⁴⁸ TE/GE response to TAS information request (June 30, 2008).

⁴⁹ TE/GE, Business Performance Review 23, at http://tege.web.irs.gov/content/PLANMainWindow/LinkedHtmlDocuments/TEGE_BPR_Feb_07.doc (Feb. 23, 2007).

⁵⁰Id.

⁵¹Id.

⁵²Internal Revenue Service FY 2009 Budget Request: Hearing Before the Subcomm. on Financial Services and General Government, S. Comm. on Appropriations, 110th Cong. (Apr. 16, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate).

⁵³ Information provided by IRS Customer Assistance, Relationships and Education (CARE) representative (Sept. 15, 2008).

⁵⁴ TIGTA, Ref. No. 2007-40-116, Eliminating TeleFile Increased the Cost and Burden of Filing a Tax Return for Many Taxpayers 2 (July 2007).

⁵⁵Id.

⁵⁶Id.

⁵⁷Id.

⁵⁸Id. at 3.

⁵⁹See, e.g., National Taxpayer Advocate 2005 Annual Report to Congress 7; National Taxpayer Advocate 2006 Annual Report to Congress vol. 2, Study of Taxpayers Needs, Preferences, and Willingness to Use IRS Services 14.

⁶⁰See http://www.irs.gov/localcontacts/index.html (last visited Dec. 22, 2008).

⁶¹ National Taxpayer Advocate 2007 Annual Report to Congress 166.

⁶²Internal Revenue Service FY 2009 Budget Request: Hearing Before the Subcomm. on Financial Services and General Government, S. Comm. on Appropriations, 110th Cong. (Apr. 16, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate).

⁶³ Internal Revenue Service, Contact My Local Office, at http://www.irs.gov/localcontacts/index.html (last visited Nov. 12, 2008).

⁶⁴Internal Revenue Service FY 2009 Budget Request: Hearing Before the Subcomm. on Financial Services and General Government, S. Comm. on Appropriations, 110th Cong. (Apr. 16, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate).

⁶⁵ IRM 21.3.4.3.6.(5) (June 2, 2008).

⁶⁶ IRM 21.3.4-1 (Apr. 7, 2008). Taxpayers needing assistance with certain types of return preparation or tax law questions involving rental property, cancellation of debt, rental income, depreciation, Schedule F, Profit or Loss from Farming, or most self-employment income need to hire a preparer or call the toll-free line because these tax law areas are out of scope (assistors cannot answer) in the TACs.

⁶⁷ IRM 21.3.4-1 (Apr. 7, 2008).

⁶⁸ W&I response to TAS information request (Sept. 15, 2008).

⁶⁹Id. Also, TACs do not accept payments at 22 percent of the locations. National Taxpayer Advocate 2007 Annual Report to Congress 172.

⁷⁰ National Taxpayer Advocate 2007 Annual Report to Congress 172.

⁷¹ National Taxpayer Advocate 2006 Annual Report to Congress vol. 2, 14, Study of Taxpayers Needs, Preferences, and Willingness to Use IRS Services.

⁷² OECD is a global organization that produces global sources of comparable statistics, and economic and social data. In addition to collecting data, OECD monitors trends, analyzes and forecasts economic developments, and researches social changes or evolving patterns in trade, environment, agriculture, technology, and taxation in democratic countries. See The Organisation for Economic Co-Operation and Development, Improving Taxpayer Service Delivery: Channel Strategy Development, prepared by the Forum on Tax Administration Taxpayer Services Sub-group 9, 38 (May 2007) 73 ATO, Towards the New Millennium, A Benchmark for Tax Administration, at http://www.ato.gov.au/corporate/content.asp?doc=/content/22866.htm (Sept. 11, 2000).

⁷⁴Id.

⁷⁵ OECD, Improving Taxpayer Service Delivery: Channel Strategy Development, prepared by the Forum on Tax Administration Taxpayer Services Sub-group 42, 58 (May 2007).

⁷⁶Id. at 16.

⁷⁷ OECD, Improving Taxpayer Service Delivery: Channel Strategy Development, prepared by the Forum on Tax Administration Taxpayer Services Sub-group 42, 58 (May 2007). Id. at 17.

⁷⁸Id. at 58.

⁷⁹ Inland Revenue, Our Way Forward, David Butler, Commissioner of Inland Review, at https://www.ird.govt.nz/resources/file/eb3c8201af5d6c8/way-forward-2006.pdf (last visited Aug. 22, 2008).

⁸⁰Id.

⁸¹ Meeting with representatives of New Zealand's Inland Revenue Customer Insight Group (June 3, 2008).

⁸²Id.

⁸³ Inland Revenue, Families Customer Perspective, Families Child Support, Working for Families Tax Credits, Paid Parental Leave (Aug. 2007).

⁸⁴ Presentation of Valmai Copeland, You Earn How Much! An Investigation of Self-Reported Income Versus Administrative Income Data, New Zealand Inland Revenue, at the 2008 IRS Research Conference (June 11, 2008)

⁸⁵ Cindy Waxer, Telepresence; Current and Future, VOIP-News, Making VoIP Connections, at http://www.voip-news.com/feature/telepresence-current-futureapps-051507/ (May 15, 2007).

⁸⁶ Linda Lou, Dr. Robot is On Call, Interactive tool can make rounds, The San Diego Union Tribune, at http://www.signonsandiego.com/news/northcounty/20080815-9999-1m15robodoc.html (Aug. 15, 2008).

⁸⁷Id.

⁸⁸ TE/GE, EO Annual Report and FY 2009 Work Plan 7-8, at http://www.irs.gov/pub/irs-tege/finalannualrptworkplan11_25_08.pdf.

⁸⁹ TE/GE, 4th Quarter Business Performance Review 13, at http://tege.web.irs.gov/content/PLANMainWindow/LinkedHtmlDocuments/TEGE_BPR_4th_Quarter_FY08_Executive_Summary.doc.

⁹⁰Id.

⁹¹See, e.g., National Taxpayer Advocate 2006 Annual Report to Congress 172-96, National Taxpayer Advocate 2007 Annual Report to Congress 35-65.

⁹² National Taxpayer Advocate 2007 Annual Report to Congress 174.

⁹³ National Taxpayer Advocate 2007 Annual Report to Congress 179.

⁹⁴See http://www.irs.gov/localcontacts/article/0,,id=98338,00.html; http://utahtaxhelp.org/findSite.aspx (all sites last visited Dec. 18, 2008).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Steven T. Miller, Commissioner, Tax-Exempt and Government Entities Division

Frank Y. Ng, Commissioner, Large and Mid-Size Business Division

Sarah Hall Ingram, Chief, Appeals

Eileen C. Mayer, Chief, Criminal Investigation

Art Gonzalez, Deputy Chief Information Officer for Modernization and Information Technology Services

Frank Keith, Chief, Communications and Liaison

Definition of Problem

The IRS Restructuring and Reform Act of 1998 (RRA 98) required the IRS to reorganize and improve customer service.¹ Congress directed the IRS to create separate units responsible for providing "end to end" service to groups of taxpayers with similar needs.² Ten years after RRA 98, employees, taxpayers, and practitioners still have difficulty locating the appropriate IRS office or employee to assist them in resolving tax problems.

In contrast, many state government agencies and tax agencies in other countries provide easy access and a wealth of information for their customers, suggesting the IRS can do much more to help taxpayers and practitioners navigate the IRS. Citizens compare the service they receive from the IRS with the service they receive from other organizations, where accessing account information, resolving problems, and sending and receiving information 24 hours a day with minimal inconvenience and cost, have become the norm. The IRS would do well to consider what it is like for taxpayers to accomplish these tasks when they encounter difficulties in simply determining where and to whom, in a 100,000-person agency, they should direct their inquiries.³

Analysis of Problem

Background

In years past, the IRS was the subject of a great deal of study and criticism. According to one IRS publication, studies identified a wide range of problems, including a lack of resources for employees and poor service for taxpayers.⁴

In the mid 1990s, Congress created the National Commission on Restructuring the IRS to review IRS practices and make recommendations for modernizing and improving efficiency and taxpayer services.⁵ The House Committee on Ways and Means conducted hearings regarding the recommendations of the commission.⁶ In 1997, the Senate Finance Committee held hearings to examine IRS practices and procedures,⁷ restructuring,⁸ and oversight.⁹ The enactment of RRA 98 followed. First, RRA 98 required the IRS to reorganize its structure and restate its mission.¹⁰ Specifically, RRA 98 called for the IRS to eliminate or modify its structure, at that time based on national, regional, and district subdivisions,¹¹ and to restate its mission to place greater emphasis on serving the public and serving taxpayers' needs.¹²

RRA 98 also required the IRS to be more accountable to taxpayers and practitioners. Section 3705 of the law requires IRS employees to provide taxpayers with their names and a unique identifying number, and to the extent practical and if advantageous to the taxpayer, assign one employee to handle a taxpayer's matter until it is resolved.¹³

The IRS Faces Challenges in Helping Taxpayers Locate Assistance and Resolve Problems.

Taxpayer Characteristics Influence Communication with the IRS

Although the IRS encourages taxpayers to choose the Internet as their preferred method of communication,¹⁴ Internet services "cannot be the only game in town."¹⁵ Some taxpayers cannot use the Internet as their primary source of communication, due to technical problems,¹⁶ language barriers,¹⁷ literacy skills,¹⁸ or problems associated with aging.¹⁹ Even taxpayers who could use the Internet as their primary communication channel do not necessarily prefer it. As Table 1.7.1 (below) indicates, many would rather use the telephone when seeking help from the IRS.

The Type of Service Needed Influences Communication.

Table 1.7.1 shows the results of a study of taxpayer preferences for communicating with the IRS. The study illustrates that the method of communication taxpayers choose depends on the type of assistance they need.²⁰

 Table 1.7.1, Survey Respondents' First Choice of Method of

The Structure and Size of the IRS Contribute to Navigational Problems.

The IRS deals directly with more Americans than any other institution, public or private.²² In fiscal year (FY) 2007, the IRS processed more than 138 million income tax returns.²³ The IRS employs more than 100,000 employees in 12 major business units with over 800 offices inside and outside the United States.²⁴ A taxpayer trying to find an employee with the knowledge and authority to help with a particular tax question or problem is facing a difficult task. The IRS does not have a topical directory or a personnel directory available to help the taxpayer determine the department or business function that he or she must contact. Instead, the IRS offers toll-free numbers that direct the taxpayer to one of almost 14,000 Customer Service Representatives (CSRs).²⁵ The CSR will research publications and Internal Revenue Manuals (IRM) to try to answer the taxpayer's question or help resolve a particular tax problem. If the question or problem is "out of scope," the CSR will use a list of over 1,000 topics, organized by issue, to determine the correct number to which to transfer the call.²⁶

When the taxpayer ultimately reaches the "correct department," the results may be less than satisfying. Since the reorganization, and in spite of RRA 98's mandates, the IRS has moved away from providing end-to-end service to taxpayers. Because a taxpayer's problem may involve more than one program or function, he or she may need to make additional calls to separate functions -- and as each function works independently, the problem may become worse before being resolved. For example, a taxpayer who needs to have an audit reconsidered, but in the meantime has received a notice of intent to levy, may have to work with the Examination, Collection, and Appeals units.

In addition to the list that CSRs research when transferring calls, the IRS maintains a topical list of publically marketed numbers.²⁷ However, neither list is available to the public.

How Successful is the IRS in Helping Taxpayers and Practitioners Navigate?

In accordance with § 3705 of RRA 98, the IRS assigns all employees unique identification numbers and requires them to give their names and identifying numbers during telephone, face-to-face and written contact with taxpayers.²⁸ However, IRM directives virtually ensure that the taxpayer's subsequent efforts to speak to the same employee will be futile. The manual instructs employees not to research internal phone directories in response to taxpayer requests to speak to a specific employee, even if the taxpayer knows the name and identifying number of that employee. Only if a taxpayer insists will the IRS try to locate a specific employee and ask that person to return the call.²⁹ It is unclear whether the IRS monitors the effectiveness of this procedure.

Apart from the obstacles the IRM provisions pose, knowing an IRS employee's identification number will not help the taxpayer find a specific employee because the IRS has no searchable database of these numbers. As a practical matter, it is virtually impossible for a CSR to identify the employee with whom the taxpayer previously spoke by name alone.³⁰ TAS has asked the IRS to create a searchable database of identification numbers as it converts to a new employee identification system.³¹

Even Internet-savvy taxpayers have difficulty in navigating the IRS. The Internet provides a wealth of information, including a topical tax index.³² However, this directory does not have an associated telephone number the taxpayer can call for further help with a particular problem or question.

International taxpayers face very special problems in navigating the IRS. Taxpayers located outside the United States cannot access the toll-free number to call the IRS for help with account problems, notices, and bills, or to request a publication.³³ In addition, the international taxpayer has very limited opportunities for face-to-face interaction as the IRS has offices in only four foreign cities.³⁴

The problem of navigating the IRS is especially acute for practitioners who interact with the IRS frequently and need to give and receive information to resolve their clients' tax matters. Preparers who participated in TAS focus groups repeatedly stated that communicating with the IRS is a problem. The problems practitioners identified include the amount of time required to resolve issues; the inability to reach someone who can resolve the issue; the difficulty in finding a person familiar with the case; and the inability to talk with the same person more than once.³⁵

Taxpayers Turn to the Taxpayer Advocate Service to Help Navigate the IRS.

The Systemic Advocacy Management System (SAMS) allows IRS employees, taxpayers, practitioners, and other interested parties to report systemic issues and problems directly to TAS. A systemic issue affects a segment of taxpayers locally, regionally, or nationally and involves systems, processes, policies, procedures, or legislation. Problems involving "Access to IRS" rated sixth among issues submitted on SAMS from October 1, 2007, to September 30, 2008.³⁶ Taxpayers who cannot resolve their cases with the IRS because they are continually referred to various divisions may turn to TAS. TAS handled approximately 274,000 cases in FY 2008, of which more than 180,000 related to systemic problems and failures.³⁷

IRS Employees Have Trouble Navigating Their Own Agency.

The centralization of programs within the IRS has caused significant confusion about workload realignment and responsibility. If the IRS does not timely update the Campus Locater Guide used by TAS employees or inform TAS that a program has moved to a different campus, TAS employees have trouble determining where to send Operations Assistance Requests (OARs).³⁸ OARs returned to TAS employees after being sent to an incorrect address create unnecessary delays in resolving taxpayers' issues. Other IRS employees experience similar problems and must diligently review daily updates to the Servicewide Electronic Research Program (SERP), multiple IRMs, and the Campus Locator Guide to determine the correct number to call or address to use when forwarding taxpayer correspondence. Informational tools, when updated in a timely manner, will remove obstacles for all IRS employees.

The IRS should pattern its internal navigation tools after those developed by TAS. The TAS intranet (internal) website includes a comprehensive directory of field and headquarters offices and staff.³⁹ It lists employees by position and location (state or TAS area, i.e., region), which allows users to find specific TAS employees and determine the duties they perform.

How Does the IRS Compare to Other Agencies?

The IRS customer service line for individuals, 1-800-829-1040, requires taxpayers to navigate through a number of prompts before reaching a CSR, who will try to transfer the call to the correct department if he or she cannot help the taxpayer.⁴⁰ In contrast, many state tax agency websites display telephone directories with numbers for various departments.⁴¹ For example, the Indiana Department of Revenue site has an option to "find a person" or "find an agency." This feature searches for personnel by name, phone number, or department. If the employee's name is unknown, the search will display all employees of the agency in alphabetical order when the user selects the Department of Revenue.⁴² The United Kingdom's revenue agency website also has a search feature that allows the user to select from contacts for individuals, employers, small businesses, and corporations.⁴³ Under each of these selections, the taxpayer will find tax information regarding the topic and contact information, including the phone number, e-mail address, and hours when the contact is available. The agency also has a text-phone option for customers who are deaf, hearing impaired, or speech impaired.

Centralized customer call numbers help connect people to government and community services with greater accuracy and less wasted time. The Federal Communications Commission (FCC) approved a 311 telephone service for nationwide use in 1997.⁴⁴ More than 30 city governments use the three-digit dedicated phone number to allow residents and visitors to reach important government services from any location at any time.⁴⁵ When dialing 311, a customer service representative will answer the call, ask for detailed information about the request, and immediately transfer the call to the appropriate city department. New York City`s three-digit number is the largest such system and perhaps the largest public call center in the country. The system is available 24 hours a day, in more than 150 languages.⁴⁶

The 311 service is also accessible on nyc.gov. There, a customer can access a directory of community based organizations providing health and human services in New York City. The directory provides descriptions, addresses, and phone numbers of the various organizations and programs, and is searchable by category, location, zip code, or name. The 311 service also includes a look-up that allows customers to check the status of existing service requests created through the 311 call center.⁴⁷

Conclusion

Taxpayers need to be able to navigate the IRS to determine correct tax liabilities, file returns, remit payments, and resolve any account problems. The IRS has the responsibility to provide the navigational tools that will enable taxpayers to accomplish these tasks.

The IRS should consider taking the following actions to enable navigation: for internal use, create a researchable directory of IRS personnel using a unique identifying number and a topical index organized by business function of IRS personnel; for Internet savvy taxpayers and practitioners, create a topical index on IRS.gov that outlines the related tax law and IRS procedures and gives a contact number for the department with the expertise to answer any questions that the site fails to resolve; and for taxpayers who need personal interaction, create a phone number (similar to the 311 system) staffed by operators who will obtain details about the taxpayer's question or problem, and direct the taxpayer to the department(s) that can help.

IRS Comments

We agree that navigating the IRS, both internally and externally, is essential to providing world class customer service and we are dedicated to providing the navigation tools necessary to serve taxpayers and IRS employees. The National Taxpayer Advocate's report implies that the IRS is not in conformance with requirement of the IRS Restructuring and Reform Act of 1998 (RRA 98). The IRS disagrees and has taken every step necessary to implement both the requirements and spirit of this law. Although we were pleased to learn that for an agency as large as the IRS serving millions of taxpayers every year only four percent reported access to the IRS as a problem, we will continue to work to improve those results.⁴⁸

Internally, IRS employees have access to extensive information regarding "who does what in the IRS" on internal websites and employee contact data on the Discovery Directory. The latter is an employee database researchable by name, Standard Employee Identification Number (or SEID), and job series. We believe current business unit directories available to IRS employees through the Intranet and the Discovery Directory meet the employee-locator needs of the vast majority of internal IRS customers without the addition of employee badge numbers.

Externally, the IRS provides taxpayers with multiple customer contact toll-free numbers, understanding that this is the preferred method to contact the IRS for the majority of customer service needs. These services are divided into three main categories:

• Taxpayer-initiated calls, such as Form 1040 individual tax law help, business and specialty tax help, and tax help for exempt organizations, retirement plan administrators, and government entities: These are publicly marketed numbers located in publications and forms instructions, media campaigns, on the IRS website, as well as telephone directory assistance.

• Calls in response to an IRS notice, letter or bill: These numbers are not published for general use. When the IRS initiates a contact with a taxpayer, (as opposed to taxpayer initiated contacts) a unique number is provided on the notice for the taxpayer to call. The telephone scripts and services reached through these numbers are targeted to notice recipients. For example, for Individual Master File (IMF) notices we provide a unique telephone number that provides only IMF options to the caller. The Customer Service Representatives that answer these calls are specifically trained to meet these taxpayers' needs. The comparable Business Master File (BMF) notice response number offers choices tailored to that customer segment. This reduces taxpayer burden by providing only a customized set of options and is more expeditious in getting the caller to the information they need or to an IRS employee trained and able to respond to their question.

• Calls from tax practitioners: Contact numbers are also provided to practitioners through the Practitioner Priority Service (PPS). The menu choices and associated employee skills are adapted to meet the unique needs of these customers. For example, PPS offers the support needed to resolve multiple cases with one call. By limiting the customer base to practitioners only, we can plan service delivery more accurately based on the number of calls received on this line, as well as ensure the line is adequately staffed with employees specifically trained to address practitioner issues.

In addition, IRS stakeholder liaisons in every state maintain an IRS Telephone Directory for Practitioners to assist members of the local practitioner community as they attempt to resolve tax issues through normal channels. These directories provide the name and telephone contact information of each IRS employee having supervisory responsibility for IRS programs in the practitioner's state. In addition to the practitioner directory, the IRS.gov website lists stakeholder liaison contact information, by state, for use by practitioners and industry partners to discuss IRS policies and practices.⁴⁹ The IRS continues to make improvements to IRS.gov, including website navigation. Currently, taxpayers can research specific topics by using the "Search" function. We also encourage taxpayers to use IRS.gov as a resource for the most updated tax and filing season information, answers to Frequently Asked Questions, and quick and easy access to IRS forms and publications. For FY 2009, we will be including an enhanced Frequently Asked Questions offering on IRS.gov, featuring "natural language" searchability that allows customers to enter a search question or topic in the same manner as everyday conversation. The system uses programmed syntax and content links to point users to the correct source information.

While the IRS endeavors to provide taxpayers with the best customer experience possible, these services must be provided in a way that ensures their accuracy and timeliness while maximizing the use of limited IRS resources. Developing and maintaining an immense public directory for a subject as complex as the Internal Revenue Code and an organization as large and physically dispersed as the over 100,000 employees of the IRS is in no way comparable to the State or Taxpayer Advocate Service examples offered by the National Taxpayer Advocate. Such a public directory for use by as many as 200 million taxpayers would likely prove unwieldy for taxpayers and a very costly administrative challenge for the IRS to maintain. Further, current telephone systems cannot support large-scale public access to employees' personal administrative telephone lines, nor are most non-customer service occupations trained or able to effectively handle any volume of taxpayer calls. Instead, the IRS has taken well-considered and industry-proven steps to service large volume and wide-ranging subject matter inquiries from taxpayers through our web, toll-free telephone, and Taxpayer Assistance Center services.

Taxpayer Advocate Service Comments

Taxpayers are responsible for complying with the Internal Revenue Code in determining their correct tax liability, filing their returns, and paying their taxes. To meet this responsibility, the taxpayer must communicate with the IRS, an agency with over 100,000 employees and a multitude of offices, divisions, and functions. RRA 98 was enacted to ease this process by creating separate units responsible for providing "end to end" service to groups of taxpayers with similar needs and by directing that to the extent practicable and where advantageous to the taxpayer, one IRS employee "shall be assigned to handle a taxpayer's matter until it is resolved."

Assigning employees a badge number that has no directory associated with it does not guarantee that the same employee will handle the taxpayer's matter until it is resolved. The Discovery Directory is searchable by name (which, as noted, may be similar to another employee's name) and SEID, which is not the same as the badge number the employee is required to furnish to the taxpayer. Further, even if the IRS had a database searchable by the badge number actually provided to the taxpayer, IRM directions hinder the congressional mandate to allow the taxpayer access to the employee with whom the taxpayer previously spoke. The IRM directs its employees to encourage the taxpayer to allow the employee who responds to a call to research the account instead. Eventually (only at the taxpayer's insistence), the IRS may arrange for a callback by the employee the taxpayer previously dealt with (under a procedure whose effectiveness may not be measured).

We agree with the IRS that it would be wonderful if only four percent of taxpayers reported access to the IRS as a problem. However, when interpreting data on the issue from TAS's Systemic Advocacy Management System (SAMS), the IRS evidently assumed each SAMS submission represents a single taxpayer. In fact, each SAMS submission relates to multiple taxpayers, often entire segments of the population (hence the "systemic" nature of the problem).

We agree that the IRS provides publicly marketed telephone numbers, but they are scattered as indicated by the IRS in its response. Our recommendation is to consolidate these numbers for reference in one publicly available location. The phone numbers furnished in IRS communications to taxpayers are generally for departments, and not for the employees who may have actually worked on the taxpayers' issues. Practitioners also identified difficulties in using the PPS, such as finding the same IRS employees they spoke with previously.

We applaud the IRS for continuing to improve IRS.gov. Web-based navigation by taxpayers may increase over time, but some taxpayers prefer personal contact by phone or in person and are unlikely to change their preference. Therefore, the IRS also should continue to enhance phone operations.

The IRS's mission is not to "endeavor to provide taxpayers with the best customer experience possible." It is "providing America's taxpayers top quality service." The fact that tax agencies in states or in other countries provide better service means that IRS service is not "top." By describing other states' and countries' experience with helping their constituents navigate bureaucracies, we are not suggesting the IRS blindly adopt those methods. Rather, we are challenging the IRS to think about new ways of helping taxpayers reach the person or program area they need, instead of merely maintaining what it is willing to do. The IRS could learn a great deal about the difficulty taxpayers experience in navigating its system by setting up a learning lab and observing actual taxpayers trying to find their way, unassisted, around our phone system and the Internet. As the tax administrator -- the face of government to so many people -- the IRS cannot afford to be simply as good as a credit card company or health insurance company -- we must be better.

Recommendations

In summary, the National Taxpayer Advocate recommends that the IRS:

² Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1998, 1 (1998).

³ Commissioner Douglas Shulman recently stated, "In order to make voluntary compliance easier, we must walk a mile in the taxpayers' shoes and help them navigate the system. Taxpayers will be judging their interactions with the IRS and the government based on their most recent experiences with other worldclass service organizations. This should be our standard." E-mail from Commissioner Shulman to all employees (July 9, 2008).

⁴See IRS Pub. 3349, Modernizing America's Tax Agency 1 (Jan. 2000).

⁵ Pub. L. No. 104-52, 109 Stat. 509 (1995), amended by Pub. L. No. 104-134, 110 Stat. 1321, § 2904 (1996) and Pub. L. 104-208, 110 Stat. 3009, § 643 (1996).

⁶Report of the National Commission on Restructuring the Internal Revenue Service: Hearing Before the House Ways and Means Committee, 105th Cong. (June 25, 1997).

⁷Practices and Procedures of the Internal Revenue Service: Hearings Before the S. Comm. on Finance, 105th Cong. (Sept. 23-25, 1997).

⁸IRS Restructuring: Hearings Before the S. Comm. on Finance, 105th Cong. (Jan. 28, 1998).

⁹IRS Oversight: Hearings Before the S. Comm. on Finance, 105th Cong. (April 28-30 and May 1, 1998).

¹⁰ Before enactment of RRA 98, the mission of the IRS read: "The purpose of the Internal Revenue Service is to collect the proper amount of tax at the least cost; serve the public by continually improving the quality of our products and services; and perform in a manner warranting the highest degree of public confidence in our integrity, efficiency and fairness." IRS, Full Text: Revised IRS Policy Statement on Privacy, Tax Notes Today, Mar. 18, 1994, LEXIS 94 TNT 53-47 . After enactment of RRA 98, the IRS changed the mission statement to read: "Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all." IRM 1.1.1 .1 (1) (Mar. 1, 2006).

¹¹ Pub. L. No. 105-206, § 1001, 112 Stat. 685, 689 (1998).

¹² Pub. L. No. 105-206, § 1002, 112 Stat. 685, 690 (1988).

¹³ Pub. L. No. 105-206, § 3705, 112 Stat. 685, 777 (1988).

¹⁴ The IRS strategic plan states: "We will continue to launch new and enhanced filing and payment programs to create an environment where electronic interaction is the preferred option for our customers." See IRS Strategic Plan 2005-2009 13.

¹⁵Internal Revenue Service FY 2009 Budget Request: Hearing Before the Subcommittee on Financial Services and General Government, S. Comm. on Appropriations, 110th Cong. 9 (Apr. 16, 2008) (statement of Nina E. Olson, National Taxpayer Advocate).

¹⁶ Nearly two-thirds of Americans (64 percent) have broadband access at home or at work and the remaining 36 percent have dial-up access (13 percent) or no access at all (23 percent). Pew Internet and American Life Project, How People Use the Internet, Libraries, and Government Agencies When They Need Help 3 (Dec. 30, 2007).

¹⁷ Only one in ten recent immigrants is proficient in reading English. Among immigrants who have lived in the United States for 26 years or more, only 37 percent say they can read a book or newspaper in English very well. Pew Hispanic Center, English Usage Among Hispanics in the United States, Shirin Hakimzadeh and D'Vera Cohn 8 (Nov. 29, 2007).

¹⁸ The literacy skills of approximately 14 percent or 30 million American adults are below basic levels (no more than the most simple literacy skills). U.S. Department of Education, National Assessment of Adult Literacy, at http://nces.ed.gov/naal/kf_demographics.asp (last visited Sept. 9, 2008).

¹⁹ Physical and mental limitations attributable to age, including visual impairment, coordination problems, and ability to process information, contribute to decreased use of the internet. Only 22 percent of Americans age 65 and older use the internet. Pew Internet and American Life Project, Older Americans and the Internet 12-13 (Mar. 25, 2004).

²⁰ IRS Oversight Board, Taxpayer Customer Service and Channel Preference (Nov. 2006).

²¹ Wage and Investment, Strategy and Finance, Understanding Customer's Communications Channel Use 6, 22 (Aug. 2003).

²² IRS, IRS Organization Blueprint (Apr. 2000).

²³ The IRS processed 138,893,908 individual income tax returns in FY 2007. See IRS 2007 Data Book.

²⁴ The actual number of employees as of Sept. 27, 2008, was 101,759. IRS, Human Resources Reporting Center, IRS Staffing by Business Unit, at http://152.217.41.30/ (last visited Oct. 15, 2008).

²⁵ The actual number of CSRs as of Sept. 27, 2008 was 13,956. IRS, Human Resources Reporting Center, IRS Staffing by Occupational Series and Grade, at http://152.217.41.30/ (last visited Oct. 15, 2008).

²⁶ Toll-free tax law assistance "Out of Scope" policy delineates the services the Customer Account Services: Accounts Management function (CAS: AM) will and will not provide in tax form/schedule preparation, tax planning, legal advice, and answering complex tax questions. "Out of scope topics" appear in the following categories: International, Partnership, Corporation, Exempt Organization, Trusts, Rentals, Sale of Business, Depreciation, Capital Gains and Losses, and more than a dozen miscellaneous topics. See Probe and Response Guide, at http://serp.enterprise.irs.gov/databases/irm-sup.dr/current/pr.dr/pr_home (last visited Dec. 15, 2008). Taxpayer calls are transferred to one of 40 English lines or one of 17 Spanish lines. See Telephone Transfer Guide, at http://serp.tcc.irs.gov/TTGuide/TTGuide.jsp (last visited Dec. 15, 2008).

²⁷ A "publicly marketed" telephone number is available on IRS.gov or published in specific IRS forms, instructions or publications. This list is not available to the public in any one location. See "The Source," at http://gatekeeper.web.irs.gov/plList.asp (last visited Oct. 15, 2008).

²⁸ IRM 3.21.259.1 (Jan. 1, 2008).

²⁹ IRM 21.1.3.15 (Oct. 1, 2007), provides:

³¹ This initiative is in response to Homeland Security Presidential Directive 12 dated August 27, 2004. This initiative requires that all applicable IRS employees receive a new "Smart ID" badge with a personal identification number (PID) to meet the RRA 98 requirement for a unique identifier. The PID is a 10 digit number that will be static for the life of each employee's account. TAS has elevated the need for a researchable PID database in compliance with RRA 98 to the HSPD Project Management Office (PMO).

³² For more information, see IRS Tax Topics Index, at http://www.irs.gov/taxtopics/index.html (last visited Oct. 28, 2008).

³³ IRC § 7701(a)(9) defines the term "United States" to include the 50 states and the District of Columbia.

³⁴ IRS offices are located in Frankfurt, Germany; London, United Kingdom; Paris, France; and Beijing, China. See IRM 4.30.3 (Sept. 12, 2006). For additional information on communication problems specific to international taxpayers, see Most Serious Problem, Access to the IRS by Taxpayers Located Outside of the U.S., infra.

³⁵ Preparers stated that employees in one location answering questions about letters sent from another IRS location contribute to the problem of finding someone knowledgeable about a case; the inability to contact the same person about an issue leads to several iterations of assistors asking the same questions and preparers restating the same issue before finding someone with the authority and knowledge to address the situation; relatively simple problems could be resolved quickly if they could just talk to one person; and when calling the telephone number given to them by CSRs, they were referred back to the CSRs. TAS, 2006 IRS Tax Forum Focus Group, Most Serious Problems Facing Taxpayers 6-7 (Feb. 2007).

³⁶ SAMS database. In FY 2008, SAMS received 964 submissions covering 91 different issues. There were 37 submissions relating to problems involving Access to the IRS.

³⁷ Taxpayer Advocate Management Information System (TAMIS) data obtained from Business Performance Review System (BPMS) (Sept. 30, 2008).

³⁸ TAS uses OARs to request assistance from an IRS operating division or functional unit to complete an action on a TAS case when TAS does not have the authority to take the required action(s).

³⁹ TAS, TAS Directory, at http://tasnew.web.irs.gov/TASdirectory/ (last visited Oct. 27, 2008).

⁴⁰ The IRS offers other specialized help lines for businesses, exempt organizations, refund inquiry, TAS, hearing impaired, and IRS.gov website help.

⁴¹ Several state tax agencies have departmental phone numbers that taxpayers can use to direct dial the department that can help them with their particular tax problem. See California, at http://www.ftb.ca.gov/forms/misc/1240.pdf; Indiana, at http://www.in.gov/rde/xfw/in_core/phonebook.htm; Maine, at http://www.state.me.us/revenue/homepage_files/telephon.html; Minnesota, at http://www.taxes.state.mn.us/taxes/home_con/contact_page.shtml; New Hampshire, at http://www.nh.gov/revenue/contact/index.htm; New Mexico, at http://www.tax.state.nm.us/trd_fone.htm; Oklahoma, at http://www.tax.ok.gov/phone.html; Ohio, at http://tax.ohio.gov/channels/global/globalcall_us.stm; North Carolina, at http://www.dornc.com/aboutus/department.html; South Carolina, at http://www.sctax.org/shell/phone.pl?searchkey=B (all sites last visited Oct. 15, 2008).

⁴²See Indiana Government website, at http://www.in.gov/rde/xfw/in_core/phonebook.htm (last visited Oct. 15, 2008).

⁴³ See Her Majesty's Revenue & Customs, at http://www.hmrc.gov.uk/index.htm (last visited Oct. 27, 2008).

⁴⁴ Federal Communications Commission, Report CC97-7, FCC Creates New 311 Code for Non-Emergency Police Calls and 711 Code for Access to Telecommunications Replay Services (Feb. 1997).

⁴⁵See Cities with 311 Non-Emergency Telephone Service, at http://www.911 dispatch.com/info/311map.html (last visited Oct. 15, 2008).

⁴⁶See 311 Service Non-Emergency Government 311 Services, at http://www.311service.org/ (last visited Oct. 15, 2008).

⁴⁷See NYC 311, at http://www.nyc.gov/html/misc/html/311atnycgov.html (last visited Oct. 15, 2008).

⁴⁸See footnote 36, supra.

⁴⁹See IRS, Stakeholder Liaison (SL) Local Contacts, at http://www.irs.gov/businesses/small/article/0,,id=153991,00.html (last visited Dec. 15, 2008).

Richard E. Byrd, Jr., 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 In recent years, the National Taxpayer Advocate has raised concerns over ITIN processing.²

IRS problems often cause lengthy delays in assigning ITINs and impose other burdens on taxpayers, including:

• Delayed processing of ITIN applications and associated returns;

• Loss of original taxpayer identification documents;

• Denial of ITINs to decedents; and

• Inadequate tax assistance and information to applicants.

ANALYSIS OF PROBLEM

Background

The IRS established the ITIN program in 1996 to facilitate tax return filing by aliens who have U.S. tax filing obligations and are ineligible for SSNs.⁴ An ITIN does not establish an identity for the applicant and is to be used only for tax administration purposes.⁵ The IRS has assigned over 14 million ITINs since the inception of the program.⁶

The IRS continues to process a very large number of ITIN applications.⁷ For the 2008 processing year, the Austin Submission Processing Center (AUSPC) received 1.7 million applications.⁸ The ITIN database reflects that the IRS has approved 90 percent of applications over the course of the program.⁹ Table 1.8.1 below shows receipts, assignments, and rejects for 2005 through 2008.

     TABLE 1.8.1, ITIN Applications Processed 2005 -- 2008

Delays in Processing ITIN Applications Cause Taxpayer Burden.

The IRS Does Not Measure the Time for Processing ITIN Applications.

The IRS does not monitor the time it takes to process ITIN applications, which leaves it unable to accurately measure the timeliness of service provided to these individual taxpayers. The IRS's goal for processing applications submitted with tax returns is 11 business days; the goal for processing applications without returns is 16 business days.¹⁵ The IRS calculates this time not from the date it receives the applications, but from the batch creation date.¹⁶ Since the batch creation date may be substantially later than the date the application was originally submitted to or received by the IRS, the IRS does not measure the actual length of time that taxpayers must wait for an ITIN.¹⁷ The IRS also does not measure the time required to resolve the hundreds of thousands of applications it suspends for lack of sufficient documentation or information, nor does the IRS measure the delays encountered by those who must resubmit applications.¹⁸

Absent valid and accurate measurement, IRS inventory control systems cannot monitor applications experiencing delays in processing. The IRS should follow the IRM to measure the time for processing from the original receipt of each and every ITIN application, including those it suspends. The IRS should also measure the rework generated by rejected or suspended applications to assess its own effectiveness in communicating application requirements and processing applications.

The IRS Should Modify Its Requirement to Attach a Valid Tax Return with the ITIN Application.

On December 17, 2003, the IRS announced a significant change to the ITIN application process.¹⁹ From that date on, the IRS required applicants to attach an original valid federal tax return with their Form W-7, Application for IRS Individual Taxpayer Identification Number, unless they meet one of the delineated exceptions.²⁰ Previously, a taxpayer could apply for an ITIN in advance to ensure that he or she received a number from the IRS before filing a return.²¹

By requiring ITIN applicants to attach tax returns to their Forms W-7, the IRS policy causes a wave of ITIN applications at the beginning of each filing season. This policy creates a bottleneck of ITIN applications at the peak of the tax return processing season, placing a seasonal strain on IRS resources. Delays in ITIN processing cause downstream consequences to taxpayers, acceptance agents, and tax preparers.²² The IRS decision to postpone ITIN applications also impacts state taxing authorities, since the applicants must wait to receive ITINs before filing state tax returns.²³

The National Taxpayer Advocate recommends that the IRS process ITIN applications throughout the year but retain the requirement that taxpayers demonstrate a tax administration purpose for the number. For example, a primary taxpayer could include a copy of a current pay stub showing withholding of tax.²⁴

IRS Rationale for Not Allowing ITIN Applications Before Filing Is Based on Flawed Assumptions.

The IRS stands behind its decision to require taxpayers to attach a valid tax return to the ITIN application. The IRS explains its rationale for the requirement as follows:

The National Taxpayer Advocate's 2003 Annual Report to Congress included a table showing ITIN use on tax returns. Of approximately 6.9 million ITINs assigned from the inception of the program in 1996 through October 1, 2003, nearly three quarters showed up on returns.²⁶ The Wage and Investment division (W&I) conducted a subsequent study in 2005, with similar results.²⁷

It is disingenuous for the IRS to imply that less than 100 percent usage of ITINs on tax returns is symptomatic of ITIN misuse. In fact, there are many valid reasons why an ITIN may not be used in conjunction with a tax return. Many aliens who obtained ITINs later adjusted their immigration status to permanent resident status, thus becoming eligible for SSNs. Others leave the United States for their home countries when their temporary work or student visas expire. Some foreign investors need an ITIN for a one-time transaction. Some may obtain ITINs for return filing purposes but do not file because their incomes were below the filing threshold. In each of these situations, the ITIN is eventually no longer needed by its owner, but the IRS has no procedures to automatically "retire" or set an expiration date for the numbers.²⁸ If the IRS prefers to retire unused ITINs, it should do so as a function of post-assignment ITIN administration and not as a pretext for restricting new ITIN assignment.

ITIN Delays Hold Up Tax Return Processing and Refunds.

In 2008, over 95 percent of Forms W-7 were submitted with tax returns.²⁹ Moreover, according to an IRS study, 83 percent of ITIN tax returns are due refunds, all of which are delayed by ITIN application and paper return processing times.³⁰ Filing tax returns concurrently with ITIN applications delays processing of the returns and associated refunds because:

• Regardless of whether the ITIN applications are complete or incomplete, the IRS does not forward the attached returns for processing until it either assigns an ITIN or rejects the application;³¹

• The IRS requires the accompanying tax return to be filed only on paper, so the return cannot receive the expeditious processing afforded to e-filed returns;³² and

• The IRS processes tax refunds due to taxpayers with ITINs only after accepting their ITIN applications and associated paper returns, thus significantly extending processing times.³³

If applicants could apply for and receive ITINs before filing their initial tax returns, the ITIN processing time would not postpone the processing of the returns, and the applicants could file their tax returns electronically. E-filing initial ITIN returns will also help the IRS achieve its goal of having 80 percent of all returns e-filed and reduce its paper return processing costs. Additionally, an ITIN applicant who is compelled to file a paper return cannot benefit from the Free File initiative or the free e-file services of the Volunteer Income Tax Assistance (VITA) program.

IRS Procedures Lead to the Loss of Taxpayer Documents.

The IRS requires ITIN applicants to substantiate their personal identities and foreign status by submitting original documents (or certified or notarized copies) with their applications.³⁸ Acceptable documentation includes passports, driver's licenses, and civil birth certificates.³⁹ Because of the difficulty of acquiring certified or notarized copies, applicants frequently submit originals.

Because of this policy, applicants do not have access to their original documents, sometimes for extended periods, while the IRS processes their applications. The subsequent lack of access to these documents can create burden for the applicants, who are advised in the application instructions that if the IRS does not return the original documents after 60 days, the taxpayers can only call the IRS's general help telephone number.⁴⁰ An IRS telephone assistor who takes a call from a taxpayer asking for the return of original documents prepares a paper form reporting the loss of documents and routes it to the AUSPC.⁴¹ If the original documents are permanently lost, the burden on the applicant can be profound, including the inability to establish personal identity until he or she can obtain replacements from the issuing country or office.⁴² The loss of documents may also affect individuals' abilities to earn a livelihood or travel within and outside the United States.

Many times, the IRS attempts to send documents back to the applicant, but they are returned to the IRS because the applicant has moved and not provided a forwarding address. The IRS maintains a local database of original documents, including passports, which the Postal Service has returned to the IRS as undeliverable.⁴³ If an applicant subsequently contacts the IRS to recover the document and the IRS has established a database record for it, the IRS will search for and return the document to the applicant. However, the IRS does not inform applicants when it cannot find their documents. In these cases, applicants do not know that the IRS ever received or acted on their requests to locate a missing document.⁴⁴ The IRS should promptly acknowledge all applicant requests for the return of original documents and notify the applicants if it cannot locate them.

Denying ITINs to Decedents Creates Burden.

The IRS policy of not assigning ITINs to decedents⁴⁵ causes unwarranted negative tax consequences to their estates or, in the case of a decedent dependent, to the primary taxpayer.⁴⁶ The denial of an ITIN to a decedent dependent denies a personal exemption deduction and a possible child tax credit to the taxpayer filing the tax return.⁴⁷ The IRS should assign ITINs to decedent aliens who are otherwise entitled to a tax number.

The IRS Provides Inadequate Tax Assistance and Information to Applicants.

More than one million taxpayers submit new ITIN applications each year, challenging the IRS to provide adequate informational assistance to applicants and practitioners in English and foreign languages through publications, forms, IRS.gov postings, live help by telephone, and letter notices. Many applicants rely on the Taxpayer Assistance Centers (TACs) for face-to-face help in completing or submitting applications, requiring more IRS resources.

The National Taxpayer Advocate previously recommended that Publication 1915, Understanding Your IRS Individual Taxpayer Identification Number (ITIN), should provide accurate instructions that conform to the actual handling of ITIN applications.⁴⁸ The IRS significantly changed Publication 1915 (and the Spanish version) for 2008. Still, during the 2008 processing year, the IRS suspended over 260,000 applications for lack of adequate documentation or information.⁴⁹ Moreover, the IRS ultimately rejected over 186,000 of those suspended applications because applicants did not respond timely or provide adequate information.⁵⁰

The National Taxpayer Advocate remains concerned about the availability and adequacy of assistance and information in Publication 1915, including telephone assistance, toll-free and international access, and help from TACs, embassies, consulates, notaries, and acceptance agents.⁵¹ The National Taxpayer Advocate previously recommended that the IRS revise the ITIN application rejection notice to refer to Publication 4134, Low Income Taxpayer Clinic List, to make applicants aware of a resource that could help them.⁵² However, the CP567 reject notice, the CP566 suspense notice, and the CP569 hard reject notice do not cite Publication 4134.⁵³

The IRS should provide the information in Publication 4134 to recipients of the rejection notices. Low Income Taxpayer Clinics (LITCs) are statutorily charged with providing education and outreach to taxpayers who speak English as a second language (ESL),⁵⁴ and are excellent resources on the barriers ESL taxpayers face in complying with tax obligations. Therefore, the IRS should not only inform taxpayers about the clinics, so they can obtain assistance when their ITIN applications are denied, but it should also use the LITCs to review related draft documents and publications.

The National Taxpayer Advocate also previously asked the IRS to revise the ITIN database to generate a copy of the notice issued to an applicant to the Acceptance Agent or power of attorney who submitted the application.⁵⁵ We applaud the IRS for implementing this suggestion in January 2007.

The IRS Has Missed Opportunities to Expand Acceptance Agent Services.

The IRS authorizes Acceptance Agents to provide specialized assistance to taxpayers filing ITIN applications. Certified Acceptance Agents are designated to inspect original documents of applicants and certify that the documentation meets IRS standards. This certification eliminates the need for the applicant to forward original documents or notarized copies to the ITIN processing unit. IRS employees at TACs may perform the same document inspection and certification service.

The only form of personal identification for ITIN application purposes that the IRS accepts without supplemental documentation is the passport. However, only 9.9 percent of applicants submitted passports or certified copies (compared to 42.3 percent who provided birth certificates).⁵⁶ This figure suggests the preferred method of documentation is unavailable to most applicants because they lack passports or have no means of submitting acceptable certified copies. Because many U.S. jurisdictions (including California, Texas, Illinois, and Florida) prohibit the copying and the subsequent certification of public records by a notary public, taxpayers need a universally workable method for applicants and Acceptance Agents to meet the requirements for submitting copies of documents.⁵⁷

Certified Acceptance Agents can reduce burden on taxpayers by reviewing original documents in the presence of the applicant and immediately returning the documents to their owners. The agent submits a copy of the document with the application to the IRS and attests to its validity. The controlling revenue procedure provides that other federal agencies, banks, colleges, and universities can certify copies of documents, which independent notary publics cannot do.⁵⁸ The IRS should promote the Certified Acceptance Agent program and use other federal agencies to perform acceptance agent duties as contemplated in the Treasury Regulation (e.g., the Postal Service performs a similar service in processing passport applications).⁵⁹

Conclusion

IRS policy restrictions and flaws with the ITIN application process significantly delay returns and refunds, and disadvantage affected taxpayers compared to taxpayers with SSNs. Taxpayers who must use ITINs to comply with their tax obligations face significant difficulties with receiving timely assignment of ITINs, expeditious processing of associated returns and refunds, and timely return of original taxpayer identification documents.

The IRS should consider taking the following actions to streamline the ITIN application process: permit applicants to file an ITIN application without a return prior to the filing season if applicants can document that they are required to file returns; implement adequate timeliness measurements for processing all ITIN applications, including applications suspended by the IRS as incomplete; allow new ITIN applicants to file returns electronically; promptly acknowledge all applicant requests for the return of original documents; permit the assignment of ITINs to decedents; provide all applicants a toll-free number that is answered by employees of the ITIN operation; share draft ITIN forms and publications with LITCs on a regular basis; revise ITIN rejection notice with a reference to the LITC publication and webpage; and promote and expand the Certified Acceptance Agent program.

IRS Comments

We appreciate the National Taxpayer Advocate's review of the ITIN program. Since the inception of the ITIN program in 1996, the IRS has assigned over 13.9 million ITINs. During FY 2008 alone, the IRS successfully processed 2.5 million Form W-7 applications, assigned 1.6 million new ITINs, and processed over 1.5 million returns related to these applications.

In 1996, the U.S. Department of the Treasury issued regulations that introduced the ITIN and required foreign persons to use an ITIN as their unique identification number on federal tax returns.⁶⁰ These regulations were intended to address the concern by the IRS and Treasury Department that without a unique number taxpayers could not effectively be identified and their tax returns could not be efficiently processed. As a result, ITINs are issued by the IRS to non-resident and resident alien individuals that do not have, and do not qualify for, an SSN. ITINs enable these aliens to comply with U.S. tax laws and provide the IRS a means to effectively process and account for their returns and payments. An ITIN does not authorize work in the U.S., establish immigration status, or provide a valid form of identification outside of the federal tax system. For this reason, the IRS does not apply the same strict standards as agencies that provide genuine identity certification, such as a requirement to apply in person or third-party verification of identity documentation.

In December 2003, in addition to other changes, the IRS adopted a requirement for most ITIN applicants to attach a valid tax return to their Form W-7 application. This procedure 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 the only reliable method for IRS to verify the number is being requested for 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 continually strives to provide the best possible customer service and agrees with several of the National Taxpayer Advocate's recommendations, as outlined below.

With regard to timeliness measures, our goal for processing applications submitted with tax returns is 11 business days. This timeframe ensures the tax return is processed and refunds are issued timely. Form W-7 applications without tax returns have an established processing period of 16 business days. In order to more accurately reflect the received date, in March 2008, we implemented procedures that set the batch (grouping of applications) date as the actual received date plus two days.⁶¹ This procedure was adopted to identify the date an application was received in the processing center from the applicant and/or their representative. The additional two days account for the time needed for mail to be processed by the Receipt and Control function and batching to be completed by the ITIN clerical function. This more accurately reflects the date applications are input into the ITIN Real Time System (RTS). The IRM allows 45 days for applications that are suspended to be resolved.⁶² This timeframe was adopted for notices and is consistent with the timeframes used for processing returns within the interest free period. However, we agree that management information on suspended applications is currently limited on RTS. Contingent on funding availability, we plan to expand and improve the management reports available from RTS to enable the IRS to better monitor the status of suspended applications.

The National Taxpayer Advocate recommends that IRS permit applicants to file an ITIN application without a return prior to the filing season upon establishing a federal tax administration need, such as including a current pay stub. The IRS acknowledges that the majority of ITINs are used on tax returns. However, there are still significant issues that must be addressed to ensure that ITINs are issued and used for their intended purpose. The same ITIN usage statistics cited by the National Taxpayer Advocate in her report reflect that fully a quarter or more of all ITINs issued by IRS have not been used on tax returns.

The IRS motives for requiring the filing of a tax return with the ITIN application are hardly disingenuous, as suggested by the National Taxpayer Advocate. Rather, the IRS had, and continues to have, significant and valid concerns that ITINs were being requested for nontax purposes, such as for obtaining a driver's license. Because a growing number of states were beginning to accept ITINs for driver's license purposes, in August 2003, the IRS took the unprecedented step of sending letters to all the state departments of motor vehicles to alert them to the risks of accepting ITINs as a form of non-tax identification. In March, 2004, this and related concerns about potential misuse of ITINs were also the subject of a joint hearing before the House Ways and Means Subcommittees on Oversight and Social Security.⁶³ Indeed, during this hearing the General Accounting Office (GAO, now the Government Accountability Office) testified that it was able to obtain a bogus ITIN and use it for a variety of non-tax purposes that could allow someone to blend into society under a false identity. In light of these concerns, the IRS believes the requirement to attach a return to the Form W-7 ITIN application strikes a reasonable balance between the competing objectives of facilitating compliance with U.S. tax laws and ensuring, to the extent possible, that ITINs are not issued for purposes other than federal tax administration. The National Taxpayer Advocate's suggested acceptance of a pay stub in lieu of the requirement to file a tax return with the ITIN application will not achieve the same degree of assurance.

With regard to the National Taxpayer Advocate's additional concerns that taxpayers who are filing an ITIN application with a tax form are not able to file electronically and may not receive their refunds as quickly as other taxpayers, it is important to note that a taxpayer must apply for and obtain an ITIN only once. As a result, the taxpayer's inability to file electronically and any potential delay in receiving a refund will only occur in the year the ITIN is issued; subsequent years are not affected.

We agree with the National Taxpayer Advocate's recommendation that all applicants' requests for the return of original documents should be promptly acknowledged. We previously identified this as an area for improvement and are actively exploring options for an appropriate format that will acknowledge the applicant's inquiry and advise the taxpayer of the IRS's attempts to locate missing original documents. We expect to have the new procedures in place by 2010.

With regard to issuing decedents an ITIN, these types of situations are infrequent and unusual. The affected applicants represent less than one percent of the total volume of Form W-7 applications with returns that have been processed this year⁶⁴ and even less in prior years. We previously evaluated this issue and concluded that it was not prudent to allow ITINs for decedent applicants due to increased vulnerability of fraud, the limited tax purpose (one time use), and the IRS's limited ability to monitor and subsequently revoke the number to eliminate future use. All qualifying applicants must currently provide supporting documentations that proves their identity, foreign status, and continuing existence.⁶⁵ However, we are sensitive to taxpayers' need for a taxpayer identification number to comply with federal tax laws in this situation since decedents do not qualify for a temporary taxpayer identification number. As a result, effective for the 2009 filing season we will make every effort to accommodate decedent ITIN applications on a case-by-case basis after a review of the particular circumstances involved in each such application.

Regarding the recommendation to provide a toll-free number that is answered by an employee of the ITIN operation, we agree that there is a need for Form W-7 applicants to have telephone access to skilled employees. However, this need is already being met without diverting resources from ITIN processing operations. Form W-7 applicant calls are routed to a special toll-free phone area with adequate resources and proficiency in handling a large volume of calls. We provide the employees in this area with the necessary training and access to appropriate databases to address ITIN customer inquiries. In addition to providing good customer service, we also believe this to be the most effective use of limited IRS resources.

We remain committed to the promotion and expansion of the Acceptance Agent Program. The IRS has an effective marketing and outreach strategy that is evidenced in the growth of the program. The number of Acceptance Agents has increased from 1,400 in August 2004 to 5,044 as of November 2008. The current IRS promotion and expansion strategy includes participation in conferences hosted by community-based organizations and other internal and external stakeholders, such as the LITC Conference, colleges and universities, and professional practitioner organizations. Additionally, we conducted outreach and recruitment workshops for Representative Rangel in February of 2007 and Representative Serrano in September 2007 for their non-profit constituents in New York. Information on the Acceptance Agent program is also shared annually at the IRS-sponsored Nationwide Tax Forums.

With regard to LITCs' opportunity to review ITIN forms and publications, the public and all stakeholders have the same opportunity to make suggestions to simplify forms or publications by e-mailing comments to *taxforms@irs.gov or by writing to Internal Revenue Service, Tax Products Coordinating Committee, SE:W:CAR:MP:T:T:SP, 1111 Constitution Avenue NW, IR-6526, Washington, DC 20224. External stakeholders can also e-mail comment or suggestions directly to the ITIN Program Office at ITINProgramOffice@irs.gov.

With regard to the recommendation to revise the ITIN rejection notice, the IRS will add a reference to Publication 4134, Low Income Taxpayer Clinic List, and the LITC webpage in notices for FY2010. In the interim, we will include this publication in our outreach activities.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS expresses a commitment to expanding the Acceptance Agent program, acknowledges the need for improvements in its management information system on suspended ITIN applications, and recognizes the need to accommodate applications for decedent taxpayers. We also commend the IRS for taking steps toward prompt acknowledgement of applicants' requests for the return of original documents and its plan to expand and improve the management reports available from the ITIN Real Time System (RTS) to better monitor the status of suspended applications. We will continue to monitor the IRS's progress in resolving these issues. However, the National Taxpayer Advocate is very concerned that the IRS has not considered viable and less burdensome alternatives to its current policy of requiring the filing of a tax return concurrently with the initial application for the ITIN.

The IRS has stated that receiving a return with the application is the only reliable way to verify that the ITIN number is being requested and properly used for tax administration purposes. The IRS has offered no rationale for this statement. The IRS permits an exception for ITIN assignment for a taxpayer who owns "an asset that generates income subject to IRS information reporting and/or tax withholding requirements," yet the IRS does not permit the assignment of an ITIN based on a comparable showing of earned income (e.g., a pay stub) until filing a tax return.⁶⁶ This inconsistent treatment of unearned and earned income for assigning ITINs essentially ignores the legal requirement to provide the taxpayer identification number regardless of the type of income at issue.⁶⁷ The National Taxpayer Advocate has proposed a well-balanced approach to developing a process for the taxpayers to obtain ITINs during the year, prior to filing season, with proof of employment and withholding (or self-employment), e.g., pay stubs, Forms 1099-MISC, Miscellaneous Income, etc. Such an approach would help the IRS smooth out its workload during the year, especially the logjam of ITIN applications during the filing season.⁶⁸ The IRS maintains that it had and continues to have concerns that ITINs were being requested for non-tax purposes, and therefore the requirement to file a tax return with the ITIN application strikes a reasonable balance between tax compliance and avoiding improper ITIN assignments. However, IRS data clearly indicates the majority of ITIN holders attempt to file returns and comply with the tax laws. Therefore, the IRS should continue to encourage aliens to obtain ITINs because the numbers are the entry point into the tax system for these taxpayers. By restricting ITIN assignment, the IRS risks pushing alien taxpayers into the cash economy.⁶⁹

The National Taxpayer Advocate is also concerned that denying an ITIN to a decedent, on the premise that the number might later be misused for a non-tax purpose, is unfair to the party that has a legitimate need for the ITIN. The IRS should be able to administer tax identification numbers without transferring the associated costs to the estates of the affected taxpayers. The National Taxpayer Advocate also disagrees that a case-by-case approach would resolve this matter, and serve the purpose of fair and uniform tax administration, because of the discretional character of such action.

The National Taxpayer Advocate encourages the IRS to take greater measures to expand the parameters of the Acceptance Agent program as contemplated by the Treasury Regulations.⁷⁰

Recommendations

The National Taxpayer Advocate recommends that the IRS take the following actions to improve the ITIN application process:

• Non-resident alien filing a U.S. tax return and not eligible for an SSN;

• U.S. resident alien (based on days present in the United States) filing a U.S. tax return and not eligible for an SSN;

• Dependent or spouse of a U.S. citizen/resident alien; and

• Dependent or spouse of a non-resident alien visa holder.

³See also Most Serious Problem, Access to the IRS by Individual Taxpayers Located Outside the United States, infra.

⁴ 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).

⁵ IRM 3.21.263.1(6) (Jan. 1, 2008) provides that the ITIN does not:

• Qualify the applicant for Earned Income Tax Credit or Social Security benefits;

• Confer a particular immigration status to the applicant; or

• Qualify the applicant's right to work in the United States.

⁷ For a detailed discussion of the ITIN processing operation, see National Taxpayer Advocate 2004 Annual Report to Congress 143 (Most Serious Problem, Processing ITIN Applications and Amended Related Federal Income Tax Returns).

⁸ IRS, ITIN0850 ITIN Receipt Pattern Report (Sept. 30, 2008).

⁹ IRS, ITIN 4340 Controls Report (Oct. 25, 2008). There were 14,235,915 assigned (accepted) ITIN records out of 15,693,467 total database records.

¹⁰ IRS response to TAS information request (July 25, 2008). "Receipts" include applications and other correspondence. "Assignments" means numbers assigned.

¹¹ IRS, ITIN Report SP001 (Sept. 30, 2008). The final disposition of 14,812 suspended applications could not be determined at the time of the report. 2008 data includes program results for the first nine months of the year. Reject counts include initial and subsequent (re)applications.

¹²See Form W-9, Request for Taxpayer Identification Number and Certification. See also Forms W-8BEN, W-8ECI, W-8EXP, and W-8IMY.

¹³ Forms W-2 and 1099 and its progeny (e.g., 1099-DIV, 1099-INT, and 1099-OID).

¹⁴See, e.g., Forms 8288, 1042, and 1042-S.

¹⁵ IRM 3.30.123.6.10 (Jan. 1, 2008) states that the timeframe should be calculated from IRS received date to the input date into RTS; IRS response to TAS information request (June 20, 2008) specifies that "day" means a non-holiday Monday through Friday. In its response to the National Taxpayer Advocate's 2003 Annual Report to Congress, the IRS committed to processing ITINs within two weeks. See National Taxpayer Advocate 2003 Annual Report to Congress 60-79.

¹⁶ Effectively, the IRS calculates the time for reviewing batches of applications -- that is, the average time it takes to input the application data into the operating system, without regard to additional time needed to resolve errors or omissions. See IRS response to TAS information request (June 20, 2008). But see IRM 3.30.123.6.10 (Jan. 1, 2008) (requiring the processing to be accomplished within the timeframes from the [first] IRS Received Date to the input in the ITIN Real-Time-System (RTS)).

¹⁷ IRS response to TAS information request (June 20, 2008). But see IRM 3.30.123.6.10 (Jan. 1, 2008) (requiring processing to be accomplished within the timeframes from the [first] IRS Received Date to the input in RTS)).

¹⁸ IRS, ITIN SP001 Report (May 19, 2008) reflecting 134,560 suspended; ITIN SP001 Report (June 18, 2008) reflecting 85,672 suspended. See also IRM 3.21.263.4(10) (Jan. 1, 2008). IRS employees notify affected applicants by letter that their ITIN applications are rejected because the federal tax return was not signed, or did not reflect a filing requirement, or the applicant's name did not appear on the return. A Hard Reject is a complete rejection of both the return and the ITIN application. If the IRS rejects the ITIN application but can accept the return, the IRS processes the return using a temporary Internal Revenue Service Number (IRSN). IRM 3.21.263.4.5 (Jan. 1, 2008).

¹⁹ IRS News Release, IRS Announces Revisions to ITIN Applications (Dec. 17, 2003).

²⁰ IRS Pub. 1915, Understanding Your IRS Individual Taxpayer Identification Number (Sept. 2007). An example of an exception is opening an interest-bearing bank account.

²¹ Applicants who are not required to pay income tax but need an ITIN for a purpose other than filing an income tax return, such as to take advantage of a tax treaty provision, may still apply for an ITIN at any time throughout the tax year. IRS Pub.1915, Understanding Your IRS Individual Taxpayer Identification Number (Sept. 2007).

²² IRM 3.21.263.3.1(1) (Jan. 1, 2008) defines an acceptance agent as one authorized to assist aliens in obtaining an ITIN. The acceptance agent reviews the required supporting identification documents; the certified acceptance agent authenticates the same documents and provides a "Certificate of Accuracy" and any required supporting exception documentation.

²³ For example, the California state income tax return requires an SSN or ITIN. See California Resident Income Tax Return 2007, at http://www.ftb.ca.gov/forms/07_forms/07_540a.pdf (Feb. 2008).

²⁴ In her 2003 and 2004 Annual Reports to Congress, the National Taxpayer Advocate identified the IRS's failure to timely process ITIN applications as a Most Serious Problem. Specifically, the National Taxpayer Advocate recommended that the IRS allow taxpayers to file ITIN applications without tax returns before the filing season, if the applicants submit documentation showing they are required to file returns. The IRS did not implement this recommendation.

²⁵ IRS response to TAS information request (June 20, 2008).

²⁶See National Taxpayer Advocate 2003 Annual Report to Congress 66. These figures are based on IRS Modernization & Information Technology Services (MITS) analysis of Individual Master File, Return Transaction File.

²⁷ IRS, Individual Taxpayer Identification (ITIN) Usage Analysis, Project 4-05-25-2-023N, 5-6, 11-12, and 14 (Aug. 2005). The W&I study covered tax years 1996 through 2003 (as of Oct. 1, 2003). For example, in 2001 tax return usage was 73.9 percent.

²⁸ If the taxpayer subsequently receives a SSN and notifies the IRS, the IRS will revoke the ITIN and associate all prior tax information under the ITIN with the new SSN. However, taxpayers are not required to notify the IRS. See IRS Pub. 1915, Understanding Your IRS Individual Taxpayer Identification Number 19 (Sept. 2007). Nor does the IRS receive a notification of status adjustment from the U.S. Citizenship and Immigration Services.

²⁹ 66,449 Forms W-7 were filed without returns, compared to 1,517,473 total Forms W-7 filed. See IRS, ITIN0852 Report (June 18, 2008) (information through June 1, 2008).

³⁰ IRS, W&I Research Group 4, Individual Taxpayer Identification (ITIN) Usage Analysis for 2004; Project # 4-06-25-2-051N 6-7 (Mar. 2007).

³¹ IRM 3.21.263.5.2.8 (1) (Jan. 1, 2008).

³² For example, the IRS issues refunds on electronically filed returns in as little as ten days by direct deposit or in three weeks for a paper check. See IRS, Instructions to Form 1040, U.S. Individual Income Tax Return (2007). See also IRS TAX TIP 2008-29, Direct Deposit and Split Refund, at http://www.irs. gov/newsroom/article/0,,id=179041,00.html (last visited Dec. 12, 2008).

³³ IRS, W&I Research Group 4, Individual Taxpayer Identification (ITIN) Usage Analysis for 2004; Project # 4-06-25-2-051N 6-7 (Mar. 2007).

³⁴ IRS, Instructions to Form W-7, Application for IRS Individual Taxpayer Identification Number 3(Feb. 2008).

³⁵ IRS Pub. 1084, IRS Volunteer Site Coordinator's Handbook (2007).

³⁶ IRM 21.4.1.3(2) (Oct. 1, 2006).

³⁷ IRS, W&I Research Group 4, Individual Taxpayer Identification (ITIN) Usage Analysis for 2004; Project # 4-06-25-2-051N Table 6, 6 (Mar. 2007).

³⁸ Instructions to Form W-7, Application for IRS Individual Taxpayer Identification Number 2 (Feb. 2008).

³⁹ The instructions to Form W-7 list 13 acceptable documents. The National Taxpayer Advocate previously recommended that the "IRS should discourage the submission of original documents and work to find an acceptable and workable substitute for ITIN applicants." National Taxpayer Advocate 2004 Annual Report to Congress 151.

⁴⁰ Instructions to Form W-7, Application for IRS Individual Taxpayer Identification Number 3 (Feb. 2008). If within the U.S., the applicant is advised to call 1-800-829-1040, not the ITIN operation where the application is processed. If outside the U.S., the applicant is advised to call 215-516-2000 (a toll-charge call).

⁴¹ IRM 3.21.263.4.15 (Jan. 1, 2008). When applicants visit IRS Taxpayer Assistance Centers (TACs) to report the loss of original documents, TAC employees prepare Forms 4442, Inquiry Referral, and route them to the AUSPC.

⁴² For example, in one TAS case the loss of the passport left the applicant unable to travel and reenter the U.S. for the three-month period that was required by his government to replace his passport.

⁴³ IRS response to TAS information request (June 20, 2008). From February 2007 through June 13, 2008, the AUSPC had tracked 3,403 original documents that were undeliverable. See also IRM 3.21.263.5.10.4(4) (Mar. 17, 2008).

⁴⁴ IRS response to TAS information request (June 20, 2008). AUSPC procedural deficiency is identified in Systemic Advocacy Management System (SAMS) Project P0028938.

⁴⁵ IRM 3.21.263.5.5 (2) (Jan. 1, 2008).

⁴⁶ IRS, ITIN Reason Code Count Report (Sept. 30, 2008). Code R11 (decedents) reflected 150 denials, cumulative from January 1 to September 30, 2008. However, the total also includes unspecified numbers of decedents when a taxpayer's representative notifies IRS of the death of the taxpayer after the ITIN has been assigned and the number is revoked.

⁴⁷See Pub. 519, 24-26, (2007).

⁴⁸ National Taxpayer Advocate 2004 Annual Report to Congress 143.

⁴⁹ IRS, ITIN Suspense and Reject W-7 Reason Code Count Report (May 31, 2008). Supporting documentation is unacceptable: 135,591; supporting documentation is not original, certified, or notarized: 52,706; applicant's signature is missing or the signature requirement is not met: 75,011. The total of all suspension code counts is 358,344.

⁵⁰ IRS, ITIN Suspense and Reject W-7 Reason Code Count Report (Sept. 30, 2008). Response to CP566 notice was incomplete: 114,033; No response to CP566 notice: 72,700.

⁵¹ For a comprehensive discussion of the problem, see Most Serious Problem, Access to the IRS by Individual Taxpayers Located Outside the United States, infra.

⁵² National Taxpayer Advocate 2004 Annual Report to Congress 143.

⁵³ IRM 3.21.263 Exhibits 22-24 do not reference Publication 4134.

⁵⁴ IRC § 7526(b)(1)(A)(II).

⁵⁵ National Taxpayer Advocate 2004 Annual Report to Congress 143.

⁵⁶ IRS, ITIN 9993 Supporting Document Types Submitted with W-7 Report (Mar. 31, 2008).

⁵⁷See, e.g., Tex. Gov't Code Ann. § 406.016(a)(5).

⁵⁸ Rev. Proc. 2006-10, 2006-1 C.B. 293, § 4.02(1). Eligible persons include federal agencies, colleges and universities, banking institutions, and foreign persons.

⁵⁹ Treas. Reg. § 301.6109-1(d)(3)(iv).

⁶⁰ T.D. 8671, 1996-1 C.B. 314.

⁶¹ Procedures implemented by the ITIN Program Office for more effective tracking of applications and processing.

⁶² IRM 3.21.263 (May 13, 2008).

⁶³Social Security Number and Individual Taxpayer Identification Number Mismatches and Misuse, Joint Hearing Before the Perm. Subcomm. on Oversight and Perm. Subcomm. on Social Security of the H. Comm. on Ways and Means, 108th Cong. (Mar. 10, 2008).

⁶⁴ IRS, ITIN Production Report, Yearly Comparative Data for week ending Sept. 27, 2008 vs. Sept. 29, 2007; Suspense and Reject W-7 Reason Code Count Report (Sept. 30. 2008).

⁶⁵ IRM 3.21.263.5.3.2 (Feb. 19, 2008).

⁶⁶ IRS Pub. 1915, Understanding Your IRS Individual Taxpayer Identification Number 11 (2004).

⁶⁷ IRC § 6109; Treas. Reg. § 301.6109-1(d)(3).

⁶⁸ Of the 1,409,903 ITIN applications with tax returns received by September 30, 2008 at the AUSPC, 1,201,109 (or 85 percent) had been received by May 19, 2008. IRS, ITIN SP001 Reports (May 19, and Sep. 30, 2008).

⁶⁹Social Security Number and Individual Taxpayer Identification Number Mismatches and Misuse, Joint Hearing Before the Perm. Subcomm. on Oversight and Perm. Subcomm. on Social Security of the H. Comm. on Ways and Means, 108th Cong. (Mar. 10, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate; Mark Everson, former IRS Commissioner; Raul Yzaguirre, President of the National Council of La Raza; and Linton Joaquin and Marielena Hincapié, National Immigration Law Center).

⁷⁰ Treas. Reg. § 301.6109-1(d)(3)(iv).

Richard E. Byrd Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Frank Y. Ng, Commissioner, Large and Mid-Size Business Division

Jim Falcone, Acting Deputy Commissioner, Operations Support

Frank Keith, Chief, Communications and Liaison

Definition of Problem

The United States taxes the worldwide income of U.S. citizens, resident aliens, and domestic corporations as well as the U.S.-sourced income of nonresident aliens and foreign corporations.¹ The current system of worldwide taxation is extremely complicated and difficult to understand.² Individual taxpayers located outside the United States need a venue to seek assistance in complying with their U.S. tax obligations.³ The IRS provides toll-free customer service to taxpayers within the United States and in some U.S. territories. However, those outside the country generally incur greater communication expenses, such as international telephone charges, transportation, and carrier mailing costs in trying to communicate with the IRS. One of the Wage and Investment (W&I) Operating Division's goals is "to ensure accurate, timely, accessible responses to tax law and tax account inquiries," but the IRS does not provide taxpayers with all the necessary resources.⁴ Although the IRS has developed a number of customer service initiatives as a part of its strategy for international tax administration, it does not devote enough resources to meet the needs and preferences of taxpayers outside the United States, jeopardizing the declared goal of improving taxpayer service.⁵

Analysis of Problem

Background

Approximately five million American citizens (excluding the military) currently live outside the U.S.⁶ In addition, there are about 511,000 U.S. troops stationed in foreign countries.⁷ Civilian taxpayers living outside the U.S. filed more than 380,000 tax returns in tax year 2005, while military personnel overseas filed over 205,000 returns.⁸ These taxpayers need a venue to contact the IRS for the resolution of their account-specific and tax law inquiries.

Taxpayers Located Outside the United States Have Limited Options to Access the IRS.

Taxpayers receive assisted and self-assisted services from the IRS via telephone, face-toface meetings, electronic communication, and mail. The IRS provides a toll-free telephone line for taxpayers residing in the United States and some U.S. territories to access multiple tax help topics, or reach a Customer Service Representative with inquiries ranging from tax law questions to adjusting their accounts.⁹ However, most taxpayers outside the U.S. cannot access the toll-free number for help with account problems, notices, and bills or to request a publication. These taxpayers must use a regular toll telephone number.¹⁰

Taxpayers Located Outside the United States Cannot Use Free Services to Pay Their Tax Liabilities.

The IRS advertises that taxpayers may use the Electronic Federal Tax Payment System (EFTPS) free of charge to pay federal taxes via the Internet or phone, 24 hours a day, seven days a week.¹¹ However, taxpayers outside the U.S. who do not have access to the Internet may incur international long distance phone charges.¹²

Taxpayers Located Outside the U.S. May Need More Time to Respond to IRS Notices and Requests for Information Documents.

In fiscal year (FY) 2007, the IRS sent more than 770,000 balance due notices, more than 93,000 math error notices, and approximately 2,500 Automated Underreporter (AUR) program notices to military addresses (e.g., APO, FPO) and foreign addresses.¹³ More than 17,500 of these notices (sent to foreign locations and some U.S. territories) included a toll-free number that is generally not accessible from these locations.¹⁴ When taxpayers cannot reach the IRS by phone, they have to use foreign postal providers to respond to IRS correspondence.¹⁵ Taxpayers in countries lacking reliable postal systems may experience extended delays receiving time-sensitive documents from the IRS, or may not receive them at all.

The IRS generally grants a 30-day grace period before taking action against taxpayers residing overseas. However, since the IRS counts the period as starting on the date it mails the correspondence, and not on the date the taxpayer receives it, 30 days may be too short a time for the overseas taxpayer to respond.¹⁶ The IRS should consider allowing an additional 60 days for overseas taxpayers to reply to all IRS correspondence, similar to the additional 60 days provided by statute for these taxpayers to respond to notices of deficiency.¹⁷ The IRS should also consider using a delivery confirmation service to verify receipt of correspondence by taxpayers outside the United States.

The IRS Provides Limited Face-to-Face Assistance to Taxpayers Located Outside the United States.

Taxpayers with U.S. filing obligations may reside in 194 countries, and more than 60 territories, colonies, and dependencies of these countries.¹⁸ Table 1.9.1 below lists the top ten countries where Americans reside outside the United States. The IRS, however, has offices in only four foreign nations,¹⁹ and even at these locations, the IRS tax attachés' main responsibilities focus on examinations and exchange of information agreements with foreign governments.²⁰ While these offices also assist American taxpayers living abroad, only a limited number of employees are assigned to taxpayer service in the foreign posts.²¹ The number of phone lines dedicated to customer service averages from two to four per office.²²

 Table 1.9.1, Top Ten Countries Outside the U.S. Where Americans

Taxpayers outside the U.S. rely on the IRS.gov website as the main source of information on international tax matters. The site directs taxpayers to various forms and publications, but the materials do not offer consistent information on how to reach the IRS. For example, Publication 593, Tax Highlights for U.S. Citizens and Residents Going Abroad, provides instructions on how to file returns and describes resources for taxpayers seeking assistance. The publication lists three telephone numbers at U.S. embassies and recommends that the taxpayer write to the Philadelphia Service Center (PSC).²⁴ Surprisingly, the publication does not list the toll number for the PSC. Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, does include the number, but only after directing taxpayers to the embassy phone numbers.

To help taxpayers with tax law questions (not account-related), the IRS implemented Electronic Tax Law Assistance (ETLA) in 1996, allowing taxpayers to ask general tax law questions via the Internet. In 2004, however, as the feature became more popular, and the volume of inquires grew, the IRS moved the link "deeper" into its website.²⁵ This link is now at the very bottom of the International web page and is difficult to find. As a result, ETLA usage by taxpayers overseas has dropped by 95 percent from its peak in FY 2003, as evidenced by the table below.²⁶

 TABLE 1.9.2, ETLA Web Mail FY 1998-2008*

The IRS Provides Limited Access to Forms and Publications in Foreign Languages for Persons with Limited or No English Proficiency.

As a part of the federal government's effort to expand and integrate products and services for Limited English Proficient (LEP) taxpayers, the IRS established the Multilingual Initiative program.²⁸ The IRS committed to help taxpayers understand and meet their tax responsibilities regardless of their inability to understand and speak English. IRS strategic plans include removing impediments for groups with language, cultural, and other barriers, and increasing the scope and accessibility of services offered electronically.²⁹

However, the IRS has translated only a limited number of forms and publications into foreign languages.³⁰ The information in foreign languages is not easily accessible from the IRS website, which lists forms and publications by date and by number, but not by language.³¹ Nor does the Spanish version of the site contain all the information and resources available on the main English site.³² In contrast, the revenue agencies of many other countries translate their entire sites and many tax assistance materials into various languages.³³

Taxpayers outside the United States may have limited English proficiency and thus experience difficulties in understanding their U.S. tax obligations. As Spanish is the third most common language in the world, the IRS should consider completely translating its website and all forms and publications into Spanish.³⁴ The IRS should supplement its online resources with a list of easily accessible forms and publications in other widespread world languages.

Taxpayers Located Outside the United States Incur Downstream Costs to Receive the Information or Services They Need to Comply with Federal Tax Laws.

Taxpayers outside the United States incur phone charges when calling the international toll line at the PSC. Overseas taxpayers must navigate through two menus before placement in the queue, and then the average wait time in the queue exceeds five minutes.³⁵ Taxpayers frustrated with navigating through menus and holding after being placed in a queue often disconnect before reaching an assistor. Those who cannot obtain necessary assistance and face the complexity of international tax laws and regulations may resort to hiring tax practitioners, who pass on their communication costs in reaching the IRS to the same taxpayers.

The IRS Joint Operations Center (JOC), which monitors calls to the international toll line, reports the number of callers who hang up before placement in the queue has increased by 95 percent from 2004 to 2007, while the number who hang up after being placed in the queue has risen 407 percent.³⁶ The average wait time once in the queue has increased by 125 percent from 2004 to 2007.³⁷ The IRS should take steps to minimize the wait time for overseas taxpayers reaching the toll line and consider providing alternatives, such as call back and estimated wait time options.³⁸

Inefficient Customer Service to Taxpayers Outside the U.S. Contributes to Noncompliance.

Generally, a U.S. citizen or resident residing outside the U.S. must file a U.S. income tax return unless his or her total income, without regard to the foreign earned income exclusion, is below an amount based on filing status.³⁹ However, a substantial percentage of Americans residing abroad fail to file U.S. tax returns.⁴⁰ A General Accounting Office (GAO, now the Government Accountability Office) report concluded that although the scope of noncompliance abroad is largely unknown, evidence suggests that it may be prevalent and the revenue impact significant.⁴¹

The IRS does not measure the level of noncompliance by U.S. taxpayers abroad that is attributable to ineffective customer service.⁴² The IRS recognizes a significant amount of noncompliance is due to tax law complexity, which leads to errors of ignorance, confusion, and carelessness.⁴³ This problem especially applies to taxpayers outside the country who may experience difficulties with the complexity of international tax laws and regulations, the inability to reach the IRS to obtain assistance, and the unavailability of necessary forms and publications. Some individuals may be unaware of their status as U.S. taxpayers with an obligation to file a U.S. tax return.⁴⁴

An Increasing Number of Overseas Taxpayers Seek Assistance from the Taxpayer Advocate Service.

Taxpayers unable to reach the IRS often seek the assistance of the Taxpayer Advocate Service (TAS).⁴⁵ TAS case receipts for taxpayers with military and foreign addresses increased 550 percent between FY 2005 and FY 2007.⁴⁶ A review of cases involving civilian taxpayers with foreign addresses reveals that 24 percent of the inquiries came from just two countries.⁴⁷ Twenty-two percent of all inquiries involved three TAS primary issue codes:

• Form W-7, Individual Taxpayer Identification Number (ITIN);

• Original return processing; and

• Reconsideration of assessment (Substitute for Return, IRC § 6020(b), Audit).⁴⁸

IRS Plans Improvements to International Taxpayer Service.

The W&I division suggests as part of a servicewide approach to international tax administration a number of measures, which, if adopted, will increase the accuracy and speed at which employees respond to international taxpayers calling the toll telephone number at the PSC. These initiatives include:

• Creation of an online reference library to provide research support to IRS employees assisting overseas taxpayers at the Philadelphia Accounts Management (AM) function;⁵⁰

• Review and update of the IRM, the Probe and Response (P&R) Guide, and Technical Communication Documents to include current and accurate guidance that has an impact on international tax and U.S. territory issues;⁵¹

• Conversion and upgrade of the existing International P&R Guide Tax Law Categories into the Interactive Tax Law Assistant (ITLA) enhanced guidance interface, now underway with a phased approach to continue deployment of ITLA content internally through FY 2009;⁵² and

• The Customer On-Line Decision Support Tool (COLDS), releases 1 and 2, is planned for deployment on IRS.gov in FY 2009 and 2010 for use by internal and external customers.⁵³

• Exploration of options to improve the quality of IRS outreach materials available to taxpayers outside the U.S;⁵⁴

• Development of an opinion survey to address the unique needs, preferences, and behaviors of overseas taxpayers;⁵⁵

• Focus group discussions with tax practitioners at the FY 2008 Nationwide Tax Forums in Atlanta, Chicago, and San Diego, addressing the services the IRS should provide for international taxpayers;⁵⁶ and

• LMSB outreach for the international taxpayer population, including citizen nights, tax assistance tours, tax forum presentations, publications in consular news letters, news circulars, and tax journals, tax pamphlet distribution, and updates to the international section on IRS.gov.⁵⁷

The IRS suspended many prior toll-free initiatives due to the funding constraints that often affect customer service initiatives. Once the IRS develops new initiatives, it submits a budget request to the IRS Oversight Board for approval, then to the Department of Treasury, then to the Office of Management and Budget, and finally to Congress as a part of the President's budget.⁵⁸ Since desirable projects compete for limited resources, the IRS cannot timely fund many of the projects.⁵⁹ Unfortunately, funding issues often lead to rejected or delayed initiatives for enhancing customer service.⁶⁰

During the third quarter of FY 2008, TAS joined forces with W&I, LMSB, and the JOC Business Requirements Integration and Deployment Group to develop business requirements for international toll-free telephone access. This effort led the IRS to make a Change Request (CR) to MITS that, if approved for funding, would provide international toll-free telephone access to the AM function in Philadelphia and National Taxpayer Advocate (NTA) toll-free line for U.S. taxpayers in Canada and Mexico. Both TAS and AM functions have requested toll-free access in Canada and Mexico, later followed by expansion to other countries with large U.S. taxpayer populations.⁶¹ The work request went forward as a priority. However, the IRS reported the resources needed to implement this initiative exceed what MITS has available. Another CR has been submitted requesting costing for this initiative, and it is anticipated the initiative may be incorporated in the Modernization Vision and Strategy Process (MV&S).⁶²

Conclusion

Insufficient customer service places overseas taxpayers at a clear disadvantage compared to their counterparts located in the United States. These taxpayers face significant difficulties in obtaining the necessary information from the IRS to comply with their tax obligations. International taxpayers need adequate taxpayer service before they file their returns, due to the complexity of international tax law. Such taxpayer service could significantly reduce unintentional errors and improve voluntary compliance. The IRS should provide these taxpayers with adequate options to obtain information, and also to resolve their account issues without additional financial burden.

The IRS should consider taking the following actions to improve customer service for taxpayers overseas: provide international toll-free telephone access to the Accounts Management function in Philadelphia and NTA toll-free line for U.S. taxpayers in Canada and Mexico, later followed by expansion to other countries with large U.S. taxpayer populations;⁶³ provide taxpayers located outside the United States with first access to the Internet Customer Account Services (ICAS) system; prominently display the ETLA on the IRS international web page; and implement Estimated Waiting Time (EWT) functionality on IRS toll customer service lines.

IRS Comments

International tax law can be extremely complex and, as the international community continues to grow, it is essential to enhance the level of assistance to these taxpayers. In 2007, the IRS implemented the Servicewide Approach to International Tax Administration; a farreaching plan that engages every operating division to strategically address international tax issues. Improving international customer service is a key component of this approach and each division is committed to doing its part.

One of the primary elements of our focus is to provide U.S. citizens living abroad, international taxpayers, and taxpayers in the U.S. territories, with pre-filing assistance that includes clear and accurate information before they file their tax return. A number of strategic initiatives have been adopted or implemented to achieve this goal. For example, an IRS task force is working with the State Department to develop consistent, comprehensive, tax information that will be placed on every U.S. Embassy/Consulate web page in the world. Enhancements have been added or expanded on the IRS.gov website, such as the International Frequently Asked Questions, monthly International Tax Gap Articles, comprehensive information on our tax treaties, and information on the expatriation tax provisions, foreign earned income exclusion, and housing cost limitations. Presentations on "International Tax Issues" were delivered to thousands of tax professionals in six cities at the 2006, 2007, and 2008 IRS Tax Forums. During the 2008 filing season, IRS employees at the London, Frankfurt, and Paris posts assisted over 30,000 taxpayers in countries under their jurisdiction. These employees also delivered nine tax seminars to groups of U.S. citizens residing abroad, and participated in seven American citizen nights where tax questions were answered.

Throughout the years, the IRS has provided a number of customer services to the international taxpayer. Approximately 300 employees in Accounts Management (AM) are dedicated to answer both written and telephone inquiries on international tax law and account related issues. AM partnered with Compliance to develop training tracks and to expand the Probe and Response Guide to include a number of additional international tax issues to increase the scope of questions Accounts Management will address, as well as improve the accuracy of their responses. These new topics will be converted to the Interactive Tax Law Assistant in 2009. Additionally, monthly conference calls are conducted by headquarters quality analysts with the international tax law department manager, team leaders, and work leads to share information about trends and improvement opportunities related to international telephone service. Other international services provided by the IRS include the U.S. Residency Certification, the International Centralized Authorization File, International Employer Identification Number, the Military Cover-Over program (a government to government program whereby IRS remits to certain U.S. territories taxes paid by former territory residents currently serving in the U.S. armed forces), and the processing of a variety of tax and information returns unique to the international customer.

Generally, online links, such as the Electronic Tax Law Assistant (ETLA), are strategically placed on IRS.gov to encourage the customer to first research and use self-service applications to find answers to their questions before using ETLA. IRS web pages are designed to optimize the self-service resolution of customer inquiries first, and then provide a venue for assisted resolution.

As noted by the National Taxpayer Advocate, there were a total of 251,000 balance due and math error notices sent to foreign addresses during FY 2007. A review of these notices revealed that in some cases the toll-free number was incorrectly listed in the space where the international toll number should have been listed. However, of these notices less than 1,000 erroneously included a toll-free number that cannot be accessed from locations outside the United States and U.S. territories.⁶⁴ A programming change will be requested to correct this error.

With regard to the recommendation that the IRS allow an additional 60 days for overseas taxpayers to reply to all IRS correspondence, as noted by the National Taxpayer Advocate, the IRS already allows additional time for overseas taxpayers to respond. This additional time varies depending on the type of correspondence involved. While the IRS will review the timeframes allowed for responses to international correspondence, we are unaware of any data that supports the supposition that current timeframes are inadequate or that the costs associated with using international delivery confirmation services are warranted.

The IRS continually strives to provide optimum customer service to all customers and has continually explored opportunities to provide cost free/low cost telephone service to the international customer segment. However, in addition to the IRS's obligation to provide the best possible service to all customers, there is an equal responsibility to balance that service with the associated costs. The potential financial burden to provide "no cost" telephone service to all international customers is prohibitive and is the primary reason that this service has not been instituted to date. For example, based on FY 2008 international service circuitry occupancy for calls received, and applying the average cost ($1.49) for each minute, the circuitry cost would be roughly $9.8 million for FY 2008. This represents an average circuitry cost of $38.39 per handled call, 79 times higher than comparable circuitry usage charge for domestic calls.⁶⁵ This cost estimate is for usage only and does not factor in any Modernization and Information Technology Services (MITS) costs associated with design, operations and maintenance, nor any potential increase to staffing to meet the demand which would likely result from offering international toll-free service. However, as we continue to assess this issue we will explore the most cost effective options on a country by country basis, including the recommended service for Canada and Mexico.

Although the IRS does not provide a toll-free channel for international callers at this time, military personnel stationed overseas can get help with meeting their tax obligations through support services such as Volunteer Income Tax Assistance (VITA) and the Armed Forces Tax Council, which provide assistance to all branches of the Armed Services. Moreover, the Military OneSource online system provides free online tax preparation and filing for members of the armed forces and their families, along with guidance and answers to their tax questions.

We agree that it would be desirable to provide an accurate EWT on current international service lines as we do with many of the toll-free product lines. However, international calls are processed using a different telecommunications platform than toll-free calls and there are technology limitations that affect our ability to accurately project EWT. We do not believe it would be appropriate to provide an EWT for these lines when we can not be confident of its accuracy.

The National Taxpayer Advocate also recommends completely translating the IRS website into Spanish and providing forms and publications in other widespread worldwide languages. Translating the entire IRS website into Spanish would be cost prohibitive, entailing creation of a duplicate Spanish-speaking staff to support IRS.gov. However, the IRS Language Services Council prepared a list of approximately 110 vital documents to be translated into Spanish based on input from internal and external stakeholders. All of these documents have been translated and are currently available on IRS.gov and El IRS en Español. A further needs assessment is being conducted to identify additional products and services needed by non English-speaking taxpayers. Current and future translations of forms and publications into languages other than English will be determined using the data from this needs assessment.

Lastly, regarding the recommendation to make My IRS Account or MIRSA, previously known as Internet Customer Accounts Services (ICAS), available to international taxpayers, a recent business decision was made to indefinitely suspend this project in light of continuing security concerns and competing modernization priorities.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends the IRS for the implementation of the Servicewide Approach to International Tax Administration, and offers TAS assistance in this important effort. We are both appreciative of and pleased with the initiatives to improve taxpayer service described in the IRS comments, especially free tax help provided to the members of the armed forces and their families through VITA and the Armed Forces Tax Council. We also applaud the IRS for changing the IRS.gov website to prominently display ETLA as the first link on the IRS international web page,⁶⁶ and for adding the missing PSC toll number for international taxpayers in Publication 593.⁶⁷

However, the National Taxpayer Advocate believes the IRS should and can do more toward meeting its number one strategic goal of improving taxpayer service.⁶⁸ The complexity of international tax law calls for free and effective customer service to taxpayers located outside the United States. The IRS provides substantially fewer resources to such taxpayers compared to those in the U.S., effectively putting international taxpayers at a disadvantage and jeopardizing voluntary compliance. In many situations, e.g., responding to IRS correspondence or inquiring about the information needed to file compliant returns, international taxpayers may have a vital need to speak with a live IRS customer service representative. In the absence of a toll-free line, such taxpayers must call the IRS toll telephone number, incurring an average cost of $1.49 per minute (according to the IRS comments). This cost places a significant financial burden on international taxpayers who are making every effort to comply with their tax obligations. It is disingenuous for the IRS to state that providing toll-free access for individual taxpayers outside the U.S. is cost prohibitive while it requests over $116 million for international enforcement initiatives in FY 2010, including increased examinations of individual taxpayers, compared to the $9.8 million needed to establish international toll-free telephone lines for these taxpayers.⁶⁹

The National Taxpayer Advocate is also concerned about the 17,565 balance due and math error notices sent to foreign addresses and addresses in some U.S. territories, including Guam and American Samoa, which listed the international toll-free number that is inaccessible from those locations.⁷⁰ We hope the IRS will promptly resolve the associated programming error.

We agree that the IRS has broad discretion in establishing the time periods allowed for international taxpayers to respond to various IRS inquiries. Such timeframes may vary from 60 to 15 days. The National Taxpayer Advocate believes the IRS should allow a uniform 60-day grace period for overseas taxpayers to reply to all IRS correspondence before taking action, similar to the additional 60 days provided by statute for these taxpayers to respond to notices of deficiency.⁷¹ The IRS needs to look beyond the mere legal requirements and "focus on the taxpayer's experience . . . walk a mile in the taxpayers' shoes and help them navigate the system."⁷² It is obvious that the taxpayers residing in some foreign countries may need additional time to respond to IRS letters and notices because of common delays in mail delivery. In such cases, we recommend the IRS design a test to determine what mail delivery delays the taxpayers experience in particular international locations and implement specific timeframes accordingly.⁷³

The IRS has stated it cannot accurately project estimated wait times for international callers because the calls are processed using a different telecommunications platform. However, the average wait time for international taxpayers, incurring international phone charges at an average rate of $1.49 per minute, has increased 125 percent from 2004 to 2007.⁷⁴ The IRS should update the telecommunications platform to allow EWT functionality and reduce the wait time for overseas taxpayers, adhering to its strategic goal of improving service to the international taxpayers.

The National Taxpayer Advocate fundamentally disagrees with the IRS's statement that translating the IRS website into Spanish would "entail creation of a duplicate Spanishspeaking staff to support IRS.gov, making it cost prohibitive." In light of the additional $116 million requested for international enforcement initiatives, and absent the estimated cost for the translation, we find it difficult to understand why providing essential tax information in Spanish on the website would be cost prohibitive. As stated above, many countries and U.S. states translate their entire websites into Spanish and other languages.⁷⁵ The IRS should reconsider the need for a complete translation of IRS.gov into Spanish. TAS offers its assistance and experience in developing this and other multilingual products and services as part of the federal government's effort to expand and integrate products and services for Limited English Proficient (LEP) taxpayers.⁷⁶

The IRS has stated that security concerns and competing modernization priorities have made it necessary to indefinitely suspend the "My IRS Account" (formerly ICAS). Tax agencies in other countries and many states have overcome the security issues and instituted customer-friendly applications similar to the suspended "My IRS Account."⁷⁷ Taxpayers compare the service they receive from the IRS with the service they receive from other organizations, where accessing account information, resolving problems, and sending and receiving information 24 hours a day with minimal inconvenience and cost have become the norm. Suspension of the "My IRS Account" project is a huge step backward for both the taxpayers and the IRS, and adversely affects the declared strategic goal of improving taxpayer service. The National Taxpayer Advocate is concerned that abandonment of this project will leave international taxpayers without an alternative, no-cost tool to comply with their U.S. tax obligations, in the absence of a toll-free access to the IRS. We urge the IRS to resolve the security issues with this application and reinstate this vital initiative.

Recommendations

The National Taxpayer Advocate recommends that the IRS consider taking the following actions to improve customer service for taxpayers overseas:

² International tax treaties play an important role in international taxation. The U.S. currently has tax treaties with 66 countries. See http://www.irs.gov/businesses/international/article/0,,id=96739,00.html (last visited July 21, 2008). These treaties provide for reduced rates and exemptions from U.S. taxes or foreign taxes on certain items of income from U.S. or foreign sources. These reduced rates and exemptions vary among countries and specific items of income, thus increasing the complexity.

³ IRC § 7701(a)(9) defines the term "United States" to include the 50 states and the District of Columbia.

⁴ IRS, W&I Division, Wage & Investment Strategy & Program Plan FY 2008 -- FY 2009 33-34.

⁵See IRS Large & Mid-Size Business Division (LMSB), Servicewide Approach to International Tax Administration, Strategic Goal 1: Improve Taxpayer Service, at http://lmsb.irs.gov/international/dir_compliance/global/sis1.asp (last visited Oct. 29, 2008).

⁶ Teleconference with the Office of Policy Coordination and Public Affairs, Bureau of Consular Affairs, U.S. Dept. of State (July 21, 2008). The Department of State estimated 3,784,693 U.S. citizens (excluding U.S. Government (military and non-military) employees and their dependents) resided outside the U.S. in July 1999. See General Services Administration, Federal Citizen Information Center, at http://www.pueblo.gsa.gov/cic_text/state/amcit_numbers.html (last visited July 21, 2008).

⁷ Personnel and Procurement Statistics, U.S. Dept. of Defense, at http://siadapp.dmdc.osd.mil (last visited July 21, 2008). The total of 510,927 personnel includes 288,627 troops stationed abroad, 196,600 troops deployed in Iraq, and 25,700 troops deployed in Afghanistan (data as of Dec. 31, 2007). The number does not include 43,009 civilian defense employees stationed abroad (July 1, 2008).

⁸ Compliance Data Warehouse, Individual Returns Entity Table, Tax Year 2005.

⁹ Internal Revenue Manual (IRM) 21.1.1.6, Customer Service Representative (CSR) Duties (Oct. 6, 2005).

¹⁰ Taxpayers must search the IRS.gov website to find the toll number at the Philadelphia Service Center, which is three links deep. Such a search is not easy to complete and may take an extended time. A taxpayer who does not have Internet access or cannot download IRS forms and publications may find it difficult, if not impossible, to figure out how to contact the IRS. Currently, the IRS provides customer service to international taxpayers through toll telephone service at the Philadelphia Accounts Management Center (PAMC).

¹¹ The Electronic Federal Tax Payment System is administered by the U.S. Department of Treasury, and enables businesses and individuals to pay all their federal taxes electronically. See http://www.irs.gov/efile/article/0,,id=98005,00.html (last visited Nov. 24, 2008).

¹² Taxpayers in 25 countries and territories of the total number of 194 countries and 67 territories may use AT&T international access telephone code to connect to the EFPTS system from these locations. Even though, when the taxpayers reach the AT&T toll free line in these locations, the AT&T voice prompt requests a calling card number and PIN before connecting to the EFTPS toll free line (i.e. the taxpayers should sign up for an AT&T calling card and may incur international long distance charges). Taxpayers in countries that do not have the code must use the EFTPS direct toll telephone number. See U.S. Department of the Treasury, International Electronic Federal Tax Payment Deposit Instruction Booklet 18 (Feb. 2006). This booklet, which is not available to the general public in paper form or at the IRS website, was internally provided to TAS in an email communication. See also U.S. Department of State Fact Sheet, Independent Countries of the World, at http://www.state.gov/s/inr/rls/4250.htm (Mar. 20, 2008); AT&T International Dialing Guide, at http://www. business.att.com/bt/dial_guide.jsp (last visited Nov. 4, 2008).

¹³ APO stands for "Army Post Office" and is associated with U.S. Army or Air Force installations. FPO stands for "Fleet Post Office" and is associated with Navy installations and ships in the United States. Regarding the balance due and math error notices, IRS sent 581,035 to individuals, and 285,916 to entities. W&I response to TAS information request (July 24, 2008). Automated Underreporter notices were sent only to individuals. SB/SE response to TAS information request (June 17, 2008).

¹⁴ The IRS sent over 4,400 notices to foreign addresses. Guam and American Samoa taxpayers received more than 13,000 notices, which included a toll-free number generally not accessible by the taxpayers in these territories. W&I response to TAS information request (July 24, 2008).

¹⁵ The reasons why taxpayers cannot reach the IRS toll phone number from overseas may range from individual financial difficulties to lack of international long-distance phone service.

¹⁶ IRM 3.30.123.5.1 (Jan. 1, 2008) provides suspense purge dates for taxpayer correspondence in response to IRS letters and notices. The time the taxpayer is given to answer generally amounts to 30 calendar days for domestic taxpayers and an additional 30 days for those residing overseas. In trust fund recovery penalty (TFRP) cases, the IRS gives only 15 additional days to taxpayers outside the country to consent to or protest the proposed assessment (75 days to taxpayers outside the U.S.; 60 days to domestic taxpayers). See Rev. Proc. 2005-34 § 4.01, 2005-24 I.R.B. 1233; IRM 5.7.6.1.1 (Feb.1, 2007).

¹⁷ IRC § 6213(a) restricts assessment of a deficiency in respect of any tax against "a person outside the United States" until the expiration of 150-day period after the notice of deficiency is mailed (90 days for domestic taxpayers). See id.; see also IRM 25.6.5.7.2 (Mar. 1, 2006). In another example, U.S. citizens and resident aliens who file calendar year returns are required to file tax returns by April 15. However, taxpayers located overseas on the due date receive an automatic extension of two months or 60 days (until June 15 for calendar year filers). See IRM 3.38.147.3.12, Extension of Time to File International Returns (Jan. 1, 2008). Thus, a minimum additional 60-day timeframe for responding to all IRS correspondence by taxpayers outside the country should apply uniformly across the board to all types of IRS correspondence. This would provide taxpayers located overseas an adequate time to respond to IRS inquiries and notices. Currently, Accounts Management allows response times as long as 60 days in some cases (depending on the country in which the taxpayer resides). See W&I response to TAS research request (July 23, 2008). LMSB suspense dates for international correspondence are based on the facts and circumstances of the case and examiners/managers use their professional judgment in determining these dates and granting extensions when necessary. See LMSB response to TAS research request (July 18, 2008).

¹⁸See U.S. Department of State Fact Sheet, Independent Countries of the World, at http://www.state.gov/s/inr/rls/4250.htm (Mar. 20, 2008).

¹⁹ The IRS posts are located in Frankfurt, Germany; London, United Kingdom; Paris, France; and Beijing, China. See IRM 4.30.3, Overseas Posts (Sept. 12, 2006). See also IRM 4.30.3.3 (Sept. 12, 2006) for post jurisdictions. The IRS announced the opening of a new tax attaché office in Beijing, China on November 3, 2008. See http://lmsb.irs.gov/international/dir_treaty/eoi_overseas/postnews.asp (last visited Oct. 29, 2008). The office in China will serve approximately 65,157 U.S. citizens residing in China. See Federal Citizen Information Center, U.S. General Services Administration, at http://www.pueblo.gsa.gov/cic_text/state/amcit_numbers.html (last visited July 21, 2008). While the number of overseas posts providing taxpayer service declined from seven to three, the number of overseas posts dedicated to Criminal Investigation (CI) steadily increased. In 2002, the IRS had seven overseas posts of duty (PODs), in Berlin, London, Mexico City, Paris, Rome, Singapore, and Tokyo. CI had Country Attachés stationed in Frankfurt, Mexico City, Bogota, Hong Kong, and Ottawa. See IRM 4.30.3.1 (Feb. 1, 2002). In 2004, the IRS added a CI POD in London and reduced the number of tax attachés that provide customer service to three -- in Berlin, Paris, and London. See IRM 4.30.3.1 (Aug. 1, 2004). Since 2006, the IRS added two more CI PODs, in Baghdad and Barbados, for a total of eight, while the number of PODs dedicated to customer service remained the same. See IRM 4.30.3.1 (Sept. 12, 2006).

²⁰ Attachés also work directly with IRS agents in LMSB, SB/SE, TE/GE, and CI who need information about ongoing audits. See IRS Today, Vol. 4 No.1, (Jan./Feb. 2008), A Day in the life of the Paris Tax Attaché, at http://communications.no.irs.gov/ProductIndex/IRSToday/IRST200801/story10.asp (last visited Aug. 8, 2008). The main purpose of attaches is to exchange information and provide taxpayer assistance to Americans living abroad. See id.

²¹ LMSB response to TAS research request (July 15, 2008). The London office has four Taxpayer Service Specialists, while both the Frankfurt and Paris offices have two Taxpayer Service Specialists.

²²Id.

²³See Federal Citizen Information Center, U.S. General Services Administration, at http://www.pueblo.gsa.gov/cic_text/state/amcit_numbers.html (last visited July 21, 2008).

²⁴See Publication 593, Tax Highlights for U.S. Citizens and Residents Going Abroad 11 (Jan. 2008); Publication 54, Tax Guide for US Citizens and Resident Aliens Abroad 45 (2007).

²⁵ W&I Research Group 4, Analysis of Communication Channel Migration in Private Industry Report Project: 4-04-04-2-036N (Sept. 2004); see Joint Operations Center (JOC) ETLA Reports, at http://joc.enterprise.irs.gov (last visited Nov. 24, 2008). In the beginning of FY 2004, the IRS had a direct link on the website home page. The increase in web mail volume in the first month of the tax season (Jan. 2004) led the IRS to move the link "deeper" into the site with the only access through the site map (i.e., no links from other pages). See IRM 21.2.1.4.24.1.2, Electronic Tax Law Assistance (Oct. 1, 2004). The research report concluded that the movement of the link led to the decreased usage by taxpayers.

²⁶ IRS, Joint Operations Center (JOC) ETLA reports FY 1996 thru FY 2007 and June 2008, at http://cpmm6.ausc.irs.gov/ETLA/scripts/test/ReportPicker.cfm (last visited Nov. 24, 2008). Some questions may be from resident aliens and taxpayers within the U.S. asking about international issues. However, the number is unknown.

²⁷ One recent example of changes in the international tax law was the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005, which reduced the foreign earned income (and foreign housing costs) exclusion amounts by the aggregate amount of any deductions or other exclusions otherwise disallowed. In many cases, TIPRA increased the federal income tax imposed on U.S. taxpayers residing overseas to an amount greater than it would have been under previous law. See TIPRA, § 515, Pub. L. No. 109-222 ,120 Stat 345 (2006); see also IRC § 911(f); Notice 2006-87, 2006-43 I.R.B. 766; Notice 2007-25, 2007-12 I.R.B. 760.

²⁸See Executive Order 13166, Improving Services for Persons with Limited English Proficiency (LEP), 65 FR 50121 (2000); see also Policy Statement P-22-3, IRM 22.31.1.1.2 (Apr. 1, 2006).

²⁹ W&I, Strategy & Program Plan FY 2008 -- FY 2009 33.

³⁰ The MLI provides minimal written translation of vital IRS documents in the following languages: Spanish, Chinese (simplified), Chinese (traditional), Korean, Russian, and Vietnamese.

³¹See IRS website, at http://www.irs.gov/formspubs/index.html (last visited June 26, 2008).

³²See http://www.irs.gov/espanol/index.html (last visited Nov. 24, 2008).

³³ For example, the Canada Revenue Agency's website is viewable in English and French, at http://www.cra-arc.gc.ca/menu-e.html; Mexican Tax Administration website -- in Spanish and English, at http://www.sat.gob.mx; Netherlands Tax Agency -- in Dutch, English, and German, at http://www.belastingdienst.nl/; Chinese State Administration of Taxation website -- in Chinese and English, at http://www.chinatax.gov.cn/n480462/index.html; and the Australian Taxation Office has its website translated into 19 languages other than English, at http://www.ato.gov.au/default.asp?menu=6753 (all sites -- last visited June 26, 2008).

³⁴ English is the fourth most common language, with 340 million speaking it as a first language. The three most spoken languages are: Chinese -- 873 million; Hindi -- 370 million; and Spanish -- 350 million. See Top 30 languages of the world, at http://vistawide.com/languages/top_30_languages.htm (last visited June 26, 2008).

³⁵ IRS toll line places taxpayers not connected immediately with a live call center representative in a queue. IRS call center representatives take the calls placed in a queue in the order they were received. JOC FY 2007 Average Speed of Answer (ASA) for International phone number 215-516-2000 was 301 seconds. See Enterprise Snapshot Report (Sept. 30, 2007), at http://joc.enterprise.irs.gov/etd/snapshots/fy07/snapshotres.asp (last visited Nov. 4, 2008).

³⁶ JOC, International Toll Number 215-516-2000, at http://joc.enterprise.irs.gov. (last visited Nov. 4, 2008). Telephone abandonment is a call terminated by the taxpayer when he/she hangs up before being routed to the next automated menu topic or before he/she speaks with a Customer Service Representative (Assistor). Thus, primary abandonment refers to termination by the taxpayer before being placed into the "queue." Secondary abandonment refers to termination by the taxpayer after placement in the queue, but before connection to an assistor. A queue is a holding place for incoming calls waiting for an available resource. A queue keeps calls in sequence so they will be answered in the order received.

³⁷ JOC, International Toll Number 215-516-2000, at http://joc.enterprise.irs.gov. (last visited Nov. 4, 2008).

³⁸ Participants in a recent toll-free survey rated "the time it took to reach the IRS" the highest in dissatisfaction and the top opportunity for improvement. Telephone charges did not influence the responses from the taxpayers, as they called the toll free number. The survey also piloted an estimated wait time option, that two-thirds (66 percent) of taxpayers heard. Just under one-half (46 percent) of the taxpayers, who heard the estimated wait time message, said that hearing the message had a positive effect on their overall call experience. See Pacific Consulting Group, Internal Revenue Service Customer Satisfaction Survey, Toll-Free National Report 6 (May 2008).

³⁹See IRC § 6012(a); Treas. Reg. § 1.1-1(b); IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad 3 (2007). For 2007, the threshold amounts were $8,750 for a single individual under the age of 65 and $17,500 for a married couple filing jointly, both of whom were under age of 65.

⁴⁰See IRS Information Letter, IRS INFO 2001-0198 (Sept. 28, 2001). U.S. citizens and residents residing abroad have an obligation to file U.S. tax returns while overseas even if they earn less than the excludable amount under IRC § 911.

⁴¹ GAO, GAO/GGD-98-106, Tax Administration Nonfiling Among U.S. Citizens Abroad 21-22 (May 1998).

⁴² Department of the Treasury, Budget in Brief FY 2007 60, at http://cl.no.irs.gov/la/BranchB/Budget/FY07%20irs%20bib.pdf (last visited Nov. 24, 2008).

⁴³ IRS, Reducing the Federal Tax Gap, A Report on Improving Voluntary Compliance 6 (Aug. 2, 2007).

⁴⁴ For example, an individual who was born outside the U.S. may be a U.S. citizen by reason of his parents' U.S. citizenship and subject to U.S. tax. Similarly, green card holders who no longer reside in the U.S. but have not surrendered their green cards remain subject to U.S. tax. Department of Treasury, Office of Tax Policy, Income tax Compliance by U.S. Citizens and U.S. Lawful Permanent Residents Residing Outside of the U.S. and Related Issues 14 (May 1998).

⁴⁵ IRS has a link on the International Taxpayer web page for the TAS. The link provides several phone numbers for TAS (depending on where the taxpayer resides).

⁴⁶ Taxpayer Advocate Management Information System (TAMIS) database, FY 2005, FY 2006, and FY 2007.

⁴⁷ Canada submitted 15 percent of total inquiries, followed by the United Kingdom with nine percent. Id.

⁴⁸ An Audit Reconsideration is the process the IRS uses to reevaluate the results of a prior audit where additional tax was assessed and remains unpaid, or a tax credit was reversed, and the taxpayer does not agree with IRS's determination. It is also the process the IRS uses when the taxpayer contests a Substitute for Return (SFR) determination by filing an original delinquent return. An SFR is a return prepared by IRS for a taxpayer under IRC § 6020(b). The IRS will prepare the return using information they have received from third parties. The return will not include any additional exemptions or expenses. An audit is a return selected for examination.

⁴⁹ For additional information on ITIN problems, see Most Serious Problem, IRS Processing of ITIN Applications Significantly Delays Processing of Taxpayer Returns and Refunds, supra.

⁵⁰ W&I Strategy Document, Support for Servicewide Approach to International Tax Administration 10 (May 9, 2008).

⁵¹Id.

⁵² ITLA is a logic driven, interactive tool that provides the probes, responses, and answers needed for assistors to address customer tax law inquiries in accounts management (AM) and field assistance (FA) functions. W&I, Customer On-line Decision Support Tool Release 1 (June 12, 2008).

⁵³ COLDS release 1 will be launched in FY 2009 and upgrade the existing Frequently Asked Questions (FAQ). COLDS release 2 will display an enterprise tax law guide for the internal assistors in both AM and FA functions and for the use of taxpayers and practitioners. The tool will enhance the assistor and taxpayer self service capability by guiding them to accurate answers to tax law questions not addressed by the FAQ section on the web. Id.

⁵⁴ W&I Strategy Document, Support for Servicewide Approach to International Tax Administration 14 (May 9, 2008).

⁵⁵Id. at 15.

⁵⁶Id. at 8. W&I incorporated questions concerning taxpayer service suggested by TAS. See id. at 15.

⁵⁷ LMSB response to TAS information request (May 25, 2008).

⁵⁸ SB/SE, Roles & Input in the IRS Budget Formulation Process: A Framework for Strategy & Finance/Business Unit Collaboration, at http://sbse.web.irs.gov/SF/Finance/Formulation/Budget_Formulation_Process.pdf (last visited May 6, 2008).

⁵⁹ IRS, In the Know, Modernization Vision and Strategy Program Completes FY 2009 IT Portfolio Selection Cycle, Vol. 3, Issue 13 (June 28, 2007), at http://mits.web.irs.gov/NoSearch/M_Communications/IntheKnow/20070628Vol3Iss13/MV&ScompletesITPortfolioSelectionCycle.htm (last visited Nov. 24, 2008).

⁶⁰ In October 2003, AM initially submitted a Change Request (CR) 2004-009 to Modernization Information Technology Services (MITS) requesting development and implementation of cost-free phone service for U.S. taxpayers residing outside of the continental United States. The request was re-numbered and re-submitted as CR 2007-026 in October 2006. MITS operational and maintenance budgets have been unable to incur additional costs associated with providing this service. W&I response to TAS research request (July 23, 2008).

⁶¹ On May 30, 2008, CR 2007-026 was renumbered as CR 2008-115 (International Call Processing -- AM). This CR requests access to IRS services via no-cost/low-cost telephone service for customers residing outside the United States with IMF, BMF, EIN, and Tax Law issues. In addition, CR 2008-116 (International Call Processing -- TAS) was submitted requesting similar functionality for customers seeking TAS assistance. Ranking for both CRs are high priority (ranked seven and eight out of 29) by the business units. Consideration will be given to both change requests, with other business priorities competing for limited MITS resources and funding. W&I response to TAS research request (July 23, 2008).

⁶² Conference call with IRS (Sept. 4, 2008).

⁶³ The IRS has already informed TAS that the resources needed to provide toll free-telephone service for taxpayers located outside the United States exceeds the available resources that MITS currently has available. However, we recommend that costing of this initiative be completed, and a business case developed and submitted for prioritization in the MV&S process.

⁶⁴ Notice Gatekeeper, Fiscal Year 2007 Math Error and Balance Due Notices.

⁶⁵ AT&T JOC, Fiscal Year 2008 Snapshot Product Line Report.

⁶⁶See IRS public website, International Taxpayer web page, at http://www.irs.gov/businesses/small/international/index.html (last visited Nov. 24, 2008).

⁶⁷See Publication 593, Tax Highlights for U.S. Citizens and Residents Going Abroad 12 (Dec. 10, 2008).

⁶⁸See IRS LMSB, Servicewide Approach to International Tax Administration, Strategic Goal 1: Improve Taxpayer Service, at http://lmsb.irs.gov/international/dir_compliance/global/sis1.asp. (last visited Oct. 29, 2008).

⁶⁹See FY 2010 Proposed Resource Initiative -- Pending in Treasury, Reduce the Tax Gap Attributable to Globalization (last visited Nov. 24, 2008).

⁷⁰ Notices with the toll-free number were sent to 2,628, 1,763, and 61 taxpayers outside the U.S., i.e. total of 4,452. A total of 13,113 of these notices were also sent to taxpayers in Guam and American Samoa, which cannot generally access a toll-free number or incur a long distance charge. W&I response to TAS information request (July 24, 2008).

⁷¹See IRC § 6213(a); see also IRM 25.6.5.7.2 (Mar. 1, 2006). Cf. IRM 3.30.123.5.1 (Jan. 1, 2008); Rev. Proc. 2005-34 § 4.01, 2005-24 I.R.B. 1233; IRM 5.7.6.1.1 (Feb.1, 2007).

⁷² IRS Commissioner Douglas Shulman, Remarks Before Tax Analysts Conference on Ten-Year Anniversary of the IRS Restructuring and Reform Act of 1998, at http://www.irs.gov/newsroom/article/0,,id=184857,00.html (last visited Dec. 11, 2008).

⁷³E.g., taxpayers residing in countries with efficient postal systems, such as France, Germany, or the United Kingdom, may be subject to a 30-day grace period, while those residing in distant locations, such as Australia, New Zealand, or South Africa, or in locations with underdeveloped infrastructure, such as Mongolia, Somalia, or Uzbekistan, may need extended timeframes of 60 days or more to respond to IRS correspondence.

⁷⁴ JOC, International Toll Number 215-516-2000, at http://joc.enterprise.irs.gov (last visited on Nov. 4, 2008).

⁷⁵ Spanish currently is the third most populous language in the world with 350 million speaking it. Population projections for the U.S. alone expect the Hispanic population (already the largest minority group) to triple in size by 2050, and comprise 29 percent of the U.S. population. Pew Hispanic Center, U.S. Population Projections: 2005-2050 (Feb. 11, 2008).

⁷⁶See Executive Order 13166, Improving Services for Persons with Limited English Proficiency (LEP), 65 FR 50121 (2000); see also Policy Statement P-22-3, IRM 22.31.1.1.2 (Apr. 1, 2006). E.g., TAS employees have participated significantly in the production of the Basic Tax Responsibility DVD in Russian in partnership with the recently established Multilingual Initiative Program.

⁷⁷See Canada Revenue Agency, at http://www.cra-arc.gc.ca/eservices/tax/individuals/myaccount/vrtltour/menu-e.html, and U.S State tax agencies such as Pennsylvania, at http://www.doreservices.state.pa.us/Individual/default.htm; California, at http://www.ftb.ca.gov/online/myacct/index.asp; Colorado at https://www.myincometax.state.co.us/status/login.asp; Illinois, at http://www.revenue.state.il.us/Individuals/index.htm; and Michigan, at http://www.michigan.gov/taxes/0,1607,7-238-43513---,00.html (all sites last visited Nov. 24, 2008).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self Employed Division

Steven T. Miller, Commissioner, Tax Exempt and Government Entities Division

Frank Y. Ng, Commissioner, Large and Mid-Size Business Division

Sarah Hall Ingram, Chief, Appeals

Definition of Problem

IRS business strategies and measures do not adequately emphasize a balanced approach between taxpayer service and enforcement within the IRS's compliance organizations. Current strategies and standards fail to integrate, recognize, and promote the concept of customer service within compliance activities in order to achieve long-term voluntary taxpayer compliance. Even though each IRS operating division (OD) has a customer service component in its mission statement, no division evaluates its compliance performance based on the level of "world class" customer service provided. At every level, the IRS rates operational performance against business measures focused on efficiency (e.g., cycle time, case closures, average call time), instead of measuring operational effectiveness (i.e., did the IRS's actions achieve the desired voluntary compliance results?).

Simply stated, the IRS gets what it measures. When a phone assistor is rated based on time utilization, he or she will not risk a poor performance appraisal to take the additional time necessary to address all issues apparent on a taxpayer's account.¹ By focusing only on the efficiency of a phone call, the IRS loses sight of whether the contact was effective.² Similarly, if an employee's successful performance is based on how much mail she or he opens and not whether she or he associates it with the right case, the IRS gains efficiency but loses effectiveness.

The downstream consequences of not considering both efficiency and effectiveness in performance standards can be severe and costly to taxpayers and the government. Taxpayers who cannot obtain the information or services they need to comply with federal tax laws, or to resolve an issue on the first attempt, can generate additional budget costs for the IRS and expenses for themselves. Potential downstream costs may include repeat contacts on the same issue, errors on returns, the need for Taxpayer Advocate Service assistance, revenue loss, and possibly the costs of activities such as audits, collection activity, appeals, and litigation.³

Analysis of Problem

Background

The IRS Restructuring and Reform Act of 1998 (RRA 98) dramatically changed the way the IRS conducts and reviews its business operations. Congressional concern arose in part from the IRS's use of performance goals based on standards such as dollars assessed per hour, number of seizures, and assets sold, which were potentially driving inappropriate actions by employees and decisions by managers. To address this concern, RRA 98 mandated that the IRS strengthen its performance management system by establishing goals for individual, group, and organizational performance consistent with the IRS's performance planning procedures, and consider deficiencies noted in customer service surveys.⁴

RRA 98 represented a major step toward recognizing the importance of customer satisfaction.

For the first time, the IRS encouraged employees to think of the individuals and businesses they serve as customers. Congress directed the IRS to place "greater emphasis on serving the public and meeting the taxpayer's needs."⁵ Congress challenged the IRS to "develop a procedure under which, to the extent practicable and if advantageous to the taxpayer, one Internal Revenue Service employee shall be assigned to a taxpayer's matter until it is resolved."⁶ In response, every IRS OD and function developed mission and/or vision statements:

Small Business/Self-Employed (SB/SE) Mission: To provide Small Business/Self-Employed customers with top-quality service by educating and informing them of the tax obligations, developing educational products and services, and helping them understand and comply with applicable laws and to protect the public interest by applying the tax law with integrity and fairness to all.⁷

Tax Exempt and Government Entities (TE/GE) Mission: To provide Tax Exempt and Government Entities customers top-quality service by helping them understand and comply with applicable tax laws and to protect the public interest by applying the tax law with integrity and fairness to all.⁸

Large and Mid-Size Business (LMSB) Vision Statement:

• We are a world-class organization responsive to the needs of our customers in a global environment while applying innovative approaches to customer service and compliance.

• We apply the tax laws with integrity and fairness through a highly skilled and satisfied workforce, in an environment of inclusion, where each employee can make a contribution to the mission of the team."⁹

Office of Appeals Mission: To resolve tax controversies, without litigation, on a basis which is fair and impartial to both the Government and the taxpayer in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the Service.¹¹

While each area of the IRS addresses service to taxpayers within its mission or vision statement, the function or OD does not support these pronouncements with quantifiable customer service measures at every level or in every program. The failure to establish and provide adequate customer service measures within compliance functions could lead to disparate treatment of taxpayers.¹²

Efficiency vs. Effectiveness

IRS Commissioner Douglas Shulman highlighted the importance of being both efficient and effective from the taxpayer's perspective in a July 9, 2008, e-mail communiqué:

The National Taxpayer Advocate has noted the IRS has an "increased tendency to look for efficient approaches to tax administration (from the perspective of IRS resources) and a resistance to undertaking analysis from the taxpayer's perspective."¹⁹

You Get What You Measure

Each division sets fiscal year strategic initiatives to support the OD's mission statement and establish operational goals.²⁰ Progress toward strategic initiatives rolls into the IRS Business Performance Review (BPR). In addition to highlighting current performance, the BPR addresses goals for the future, including Level of Service (LOS) metrics.²¹ The majority of these goals represent efficiency measures such as case closures, phone calls answered, correspondence contacts, currency of years under examination, proper use of levy actions, and the number of taxpayers served at a Taxpayer Assistance Center (TAC). Achieving strategic initiatives determines the "success" of the OD. While some initiatives for compliance functions have a customer satisfaction component, this component does not assess the effectiveness of contacts, promote efforts to strengthen service to taxpayers, or measure the impact on future compliance by taxpayers.

Pursuant to RRA 98 § 1204, the IRS evaluates employees under a "Balanced Measure" system including the following critical job elements (CJEs):²²

• Employee Satisfaction;

• Customer Satisfaction -- Knowledge;

• Customer Satisfaction -- Application;

• Business Results -- Quality; and

• Business Results -- Efficiency.²³

For example, in SB/SE Collection balance due cases, SB/SE expects the revenue officer (RO) to prepare a financial analysis of the taxpayer's ability to pay and secure a payment agreement with the taxpayer as a basic task of the taxpayer contact. The RO's analysis should include the taxpayer's current financial position and the business practices leading the taxpayer to balance delinquencies.²⁶ Current operational, critical, and quality measures demonstrate the IRS field collection achieved an 84 percent quality score for fiscal year (FY) 2007.²⁷ However, 22 percent of payment agreements defaulted and TAS has received more than 4,500 cases where the payment amounts were too high, leading to rework and increased taxpayer burden.²⁸ The addition of an outcome measure for the program, such as the percentage of taxpayers fulfilling their payment agreement and remaining compliant for a given period, would direct the IRS's strategies toward developing a taxpayer-centric approach.

Consider the case of a levy, filed due to nonpayment of a tax deficiency, which creates a hardship for the taxpayer.²⁹ TAS cases reflect numerous instances where the IRS refers the taxpayer to TAS to obtain a lien or levy release instead of securing the information needed to simply resolve the case and the hardship at the first point of contact with the IRS, i.e., provide one-stop service.³⁰ The business plan measures the number of levies and liens successfully completed, giving the employee no incentive to release the levy and provide relief to the taxpayer.³¹

Current Measurement Pitfalls

The National Taxpayer Advocate's previous Annual Reports to Congress highlighted opportunities to improve the effectiveness of IRS correspondence exam processes.³² For example, when the IRS sends taxpayers math error notices that are hard to understand, taxpayers may find it difficult to reach someone at the IRS to answer questions. While the notices may be a very effective way to correct a tax return, the IRS misses the opportunity to educate taxpayers on how to avoid this problem in the future.³³ The IRS should also track the types of math errors made to develop proper educational efforts for taxpayers and IRS employees, and ultimately increase effectiveness.³⁴

From the IRS standpoint, correspondence examination is very efficient at assessing tax. The effectiveness of the overall program is called into question, however, when considering the outcome of EITC cases.³⁵ When TAS case advocates became involved, the taxpayers received on average two personal contacts (either letters or calls) to request documentation, and achieved significantly better audit results than in cases where the correspondence exam unit used letters as the only method of contact.³⁶ This is an excellent example of how failure to establish and provide adequate customer service measures within Compliance functions leads directly to disparate treatment of taxpayers, as well as incorrect audit results.³⁷

The IRS similarly misses the opportunity to consider the organizational effectiveness of the offer in compromise (OIC) program. The IRS bases the success of the program solely on efficiency standards relating to processing times and case standards. By reviewing cases where it rejected or returned the OIC, the IRS could compare the amount of the rejected or returned offer versus the amount the IRS ended up collecting.³⁸ By establishing a program measure focusing on the long-term compliance of the taxpayer, the IRS could assess the effectiveness of the program and determine whether it is in the government's benefit to settle on a lesser amount of money via an offer, or allow a balance due to be lost because the statutory period for collecting the tax has expired.³⁹

Services Provided by Other Taxing Authorities

Strengthening customer service to improve compliance is not new. Tax agencies from around the world have addressed this issue. Inland Revenue Service, New Zealand's tax agency, completed a business plan for 2006 -- 2011 entitled "Our Way Forward."⁴⁰ The plan outlined the following goals:

• Target and tailor activities through understanding the customers;

• Optimize organizational efficiencies and reduce compliance cost over time;

• Create an environment that promotes compliance; and

• Continually invest in people and the tools to deliver future outcomes.⁴¹

Inland Revenue uses a system to measure outcome achievement and studies the impact of the intervention selected. Employing a research-based approach, the agency determines both the impact and cost-effectiveness of actions taken.⁴³ In addition, Inland Revenue established performance measures relating to different activities and aspects of performance. Performance evaluation is designed to be viewed in the aggregate due to the interrelated nature of the performance measures.⁴⁴

In the United Kingdom, Her Majesty's Revenue and Customs (HMRC) established benchmarks for the high level of service taxpayers should expect when dealing with HMRC.⁴⁵ The world's taxing agencies monitored the success of the program, and IRS representatives recently visited the United Kingdom to learn more. HMRC built upon the success of the initial program by developing a taxpayer-centered vision for small businesses.⁴⁶ The vision calls for a "Whole Customer View," which includes a single point of contact for taxpayers or their representatives to obtain information on tax forms, receive better help and support, and improve compliance by using real-time data. The taxpayer will have a "single customer account" showing all liabilities and payments as well as enabling taxpayers to make monthly payments on accounts.⁴⁷ Future HMRC plans include designing a strategy to target the right support to the right business at the right time.⁴⁸

The Swedish Tax Agency focuses on behavioral attitudes of taxpayers impacting compliance with tax laws. The agency's strategic plan states: "It is important to treat people fairly, with respect, to listen to them and explain decisions."⁴⁹ The Swedish Tax Agency focus moved from a focus on control to a focus on service.

The Australian Tax Organization's Strategic Statement for 2006-2010 shifted its emphasis from revenue collection to optimizing voluntary compliance by creating the right environment for people to pay taxes.⁵⁰ Australia provides customer service by way of "three Cs": Consultation, Collaboration, and Co-design.⁵¹

In the United States, Missouri's Department of Revenue established goals for its 2005-2009 Implementation Plan to:

Emphasis Placed on Enforcement

The National Taxpayer Advocate has expressed concern that the IRS has been emphasizing tax law enforcement at the expense of taxpayer service in recent years. After the administration issued its FY 2008 budget proposal last year, the Government Accountability Office (GAO) analyzed recent IRS funding trends. Over the five-year period FY 2004 through FY 2008, it concluded that funding for enforcement had increased substantially while funding for taxpayer services had been reduced. Based on the administration's proposal for FY 2008, the GAO pointed out that funding over the FY 2004 through FY 2008 period would have increased by 19.4 percent for enforcement while funding for taxpayer services would have declined by 3.8 percent.⁵⁴ The final appropriations bill for FY 2008 made a modest adjustment to the administration's proposal, providing about $46.9 million more for taxpayer service and $145.5 million less for enforcement.⁵⁵

However, the IRS budget proposal for FY 2009 continued the trend of spending relatively more on enforcement. The president's proposal would have increased enforcement spending by $490 million (7.0 percent), while increasing spending for taxpayer services by only $23 million (0.6 percent).⁵⁶ Thus, after inflation, the proposal would reduce taxpayer services spending still further.

Moreover, the broad budget category titles "Taxpayer Services" and "Enforcement" do not tell the full story. Of the $2.2 billion in the "Taxpayer Services" category, only $645 million, or six percent of the IRS budget, is currently allocated for "Pre-filing Taxpayer Assistance and Education."⁵⁷ A significant majority of funds under the "Taxpayer Services" category is allocated for "Filing and Account Services," which largely covers the processing of tax returns. Returns processing is hardly a pure service activity. While it does enable the IRS to issue tax refunds, it is an internal processing function that also constitutes the first step in screening returns for audit. It is far removed from the type of taxpayer service that informs taxpayers about their tax obligations and assists them in complying with the laws. Notably, the IRS budget proposal for FY 2009 would have reduced this relatively low level of funding for taxpayer assistance and education from $645 million to $617 million -- a reduction of over 4.3 percent in nominal terms and a larger reduction after taking into account inflation.⁵⁸

Compliance Opportunities Promoted by the IRS

The 2008-2009 IRS Strategic Initiative includes the goal to "Improve service to make voluntary compliance easier."⁵⁹ This goal has four objectives:

• Incorporate taxpayer perspectives into all service interactions;

• Expedite and improve issue resolution across all interactions with taxpayers;

• Make it easier to navigate the IRS, provide targeted, timely guidance and outreach to taxpayers; and

• Strengthen partnerships with tax practitioners, preparers, and other third parties to ensure effective tax administration.⁶⁰

• Create a cognitive learning lab where the IRS conducts research with taxpayers to discover what actions or initiatives drive the desired compliance behavior;⁶¹

• Conduct comprehensive taxpayer surveys addressing taxpayer needs and preferences;⁶²

• Involve TAS, as the voice of the taxpayer, in discussions about designing and developing programs; and

• Research the causes of taxpayer noncompliance, similar to the research the Swedish government conducted.⁶³

• Were all related tax issues addressed during the taxpayer contact?

• Was one employee able to resolve all the taxpayer's issues?

• Has the employee incorporated the taxpayer's perspective in resolving the tax issue(s)?

Failure to educate taxpayers about the causes of their problems is a missed opportunity to bring about long-term voluntary compliance. For example, in 2007 IRS assessed nearly $276 million and then abated over $211 million in penalties that related to charities not including a specific form with their original tax returns.⁶⁴ Once the organization submits the form, the IRS abates the penalties, but does little to educate the charity on how to comply with the requirements and may find itself assessing and abating the same penalty each year.⁶⁵

The Automated Underreporter (AUR) unit sends notices to taxpayers concerning underreported income. Every year, the IRS issues more than ten percent of these notices to repeat underreporters,⁶⁶ but fails to review their accounts to determine if they received similar notices in previous years, and does not send the notices timely, thereby missing the chance to educate the taxpayer on how to avoid errors.⁶⁷ The IRS thus creates a greater burden on taxpayers and expends resources in a continuous cycle of rework.

Conclusion

The IRS faces a complex challenge in balancing service and enforcement. Current measures do not promote customer service and may ultimately lead to noncompliant behavior by taxpayers.

The National Taxpayer Advocate believes the IRS should balance enforcement and customer service. In 2005, the Deputy Commissioner for Operations Support identified "one-stop customer service" as a priority for the organization.⁶⁸ The four goals were:

• To have a single point of entry accountable for customer requests;

• To collaborate within and between support functions;

• To communicate effectively with customers; and

• To redesign internal processes to expedite service.⁶⁹

By failing to establish business strategies or measures addressing customer service within compliance, the IRS fails to balance its approach to tax compliance. The current metrics support efficiency, not effectiveness. These measures do not drive the behavior needed for IRS employees to educate taxpayers or to provide the taxpayer with the tools to prevent non-compliant activity.

Each OD needs consistent strategic initiatives and mission statements to allow the taxpayer to address all issues with a single point of contact. Each division must also establish specific goals with the same emphasis on effective customer service as well as employee performance. While serving different taxpayer populations, all ODs and functions should share the common goal of achieving a seamless taxpayer experience.

The IRS should consider taking the following actions to strengthen customer service within compliance: create an IRS Cognitive Learning Lab;⁷¹ review its programs to identify opportunities for taxpayers to work with one employee from start to finish; involve TAS in program design discussions to incorporate the taxpayer perspective in any proposed programs; and incorporate effectiveness measures in the ODs' quality reviews or other program reviews to address long-term taxpayer compliance and identify areas for improvement in service.

IRS Comments

In this Most Serious Problem, the National Taxpayer Advocate suggests that the IRS does not establish goals or measures for its compliance programs that adequately evaluate their performance or long-term effects on voluntary compliance from the taxpayer's perspective.

In support of this hypothesis, numerous anecdotal examples are offered by the National Taxpayer Advocate of where the IRS fails in this regard. The IRS disagrees with these examples and has already addressed most of them in responses to prior National Taxpayer Advocate Annual Reports to Congress or elsewhere in response to this year's report.⁷² However, the IRS completely agrees that it must drive its operations and customer services through a balanced set of measures that address business results, employee satisfaction, and customer satisfaction. With regard to the latter, for the IRS functions that directly interact with taxpayers, including compliance organizations, the customer is the taxpayer.

All such organizations currently have metrics specifically geared to measuring taxpayer satisfaction and that are used to continually improve the IRS' performance in the eyes of the taxpayer. These measures are established as part of the IRS Strategic Planning and Budgeting process and included in IRS budget submissions. They are communicated to the IRS Oversight Board and reported on regularly for IRS Business Performance Reviews, the Department of Treasury, the President's Office of Management and Budget, and other external stakeholders.

For example, the LMSB division measures Customer Satisfaction at the division level for Coordinated Cases and it is measured all the way down to the Director of Field Operations level for Industry Cases. The scores are included in the Balanced Measure scorecards that are distributed monthly down to the Territory level. SB/SE division field and campus compliance functions measure customer satisfaction monthly using survey data and improvement goals are set each year. In the W&I division, feedback from campus compliance customer service surveys has been used to revise letters and tax forms to make them clearer and to revamp procedures to improve the taxpayer's experience.

As importantly, as alluded to in the National Taxpayer Advocate's report⁷³ the IRS is embarking on a new Strategic Plan for FY 2009-2013 that has a taxpayer focus at its core. The intent is to foster individual and organizational ownership of the taxpayer experience to make compliance as easy as possible. This plan will encourage all employees, not just those who are customer facing, to look for ways to provide taxpayers, partners and stakeholders with information that will be helpful and understandable by addressing questions such as "How would I feel if I were in the taxpayers' shoes?" and "Who will be using this material and what will they need?" The IRS is already making progress in socializing the goals and themes around which the new plan will be focused and managers and employees are already beginning to have conversations about how they can contribute to an improved customer experience.⁷⁴ Once the new strategic plan is finalized, all IRS functions will evaluate and, as needed, revise or create new measures that support the goals that will be expressed in the new IRS Strategic Plan. The National Taxpayer Advocate's views will be considered during this process.

The National Taxpayer Advocate's report also surfaces several issues that warrant specific rebuttal. The National Taxpayer Advocate implies that taxpayer default on installment agreements (IAs) is attributable to IRS employees failing to properly establish the agreements or setting the payments too high. In fact, approximately 97 percent of all IAs are streamlined. This allows taxpayers to reach payment agreements with minimum intrusion by IRS employees, and may also allow the taxpayer to make substantial payments until he or she is in a better position to make full payment, or take advantage of other options for resolving the case. IRS employees give taxpayers the opportunity to provide additional financial information when they indicate they cannot meet the terms of a proposed streamlined IA. The IRS believes its responsibility for each case is to take the right action at the right time. This includes taking actions to correct the balance due through an adjustment or declaring the account currently uncollectible.

Further, the National Taxpayer Advocate postulates that "(t)he business plan measures the number of levies and liens successfully completed, giving the employee no incentive to release the levy and provide relief to the taxpayer." Although IRS tallies the number of liens filed and levies served at a high level, these data are not measures, nor are they associated with targets or goals. These numbers cannot be tracked back to individual employees and no compliance employee is evaluated using the number of liens or levies issued. In fact, IRS Collection employees, whether Revenue Officers or Collection Representatives, are all expected to determine cause and cure for each case and to resolve that case at the earliest opportunity, including release of a lien or levy when appropriate. In further support of this allegation, the National Taxpayer Advocate refers to "numerous instances where the IRS refers the taxpayer to TAS to obtain a lien or levy release instead of securing the information needed to simply resolve the case and the hardship at the first point of contact . . . ." In this regard, the IRS notes that IRS employees must refer cases to TAS when they meet TAS criteria. This is a requirement whenever a taxpayer requests TAS assistance or the IRS employee is unable to take steps to resolve the taxpayer's issue within 24 hours, including hardship cases in the collection stream.⁷⁵

With regard to the assertion and abatement of exempt organizations penalties for failure to include a specific form with their original tax returns, the National Taxpayer Advocate implies the IRS failed to educate taxpayers about the causes of their problems which resulted in a missed opportunity to bring long-term voluntary compliance. To the contrary, part of the process in educating taxpayers is communication. Before the IRS assesses a penalty, it communicates with the charity by sending two letters explaining the required information and that the return is not considered complete until the information is provided. These letters include a dedicated toll-free number should the organization have questions or need to speak with a specialist. There is also information available in publications, the tax return instructions, and on the IRS website to inform and educate tax exempt organizations regarding the penalties for filing incomplete returns. These charitable organizations are given ample opportunity to correct their filings. In most cases, the organizations respond to the first or second letter with the required information. If there is no response to either of the letters the IRS issues a penalty notice, again explaining the missing or incomplete information and giving the filer yet another opportunity to supply the required form. There is nothing in IRS records to support the National Taxpayer Advocate's conjecture that the IRS "may find itself assessing and abating the same penalty each year."

With respect to the National Taxpayer Advocate's specific recommendation to establish an IRS Cognitive Learning Lab, the IRS responded to this same issue for the NTA's 2007 Annual Report to Congress.⁷⁶ As noted in that response, the Taxpayer Assistance Blueprint (TAB) project has begun the process of assembling what is known in this area and supplementing that work with original survey research focused on the needs and desires expressed by individual taxpayers about the services they would like to be able to access. More recently, the President's FY 2008 Budget Request included a $5 million initiative specifically aimed at improving and understanding the link between provision of services to taxpayers and their impact on taxpayer compliance. This initiative allowed the IRS to embark on a multi-year research agenda that could eventually pay large dividends through improved voluntary compliance. However, these results may or may not validate the National Taxpayer Advocate's proposal that utilizing a cognitive and behavioral lab would be an effective strategy for advancing research in this area. Because of the extensive research already completed for the TAB, the IRS now knows more than ever before about taxpayer needs, preferences and behaviors. The IRS is evaluating these studies and it should lead to a better understanding of the role of complexity in service, and how complexity contributes to taxpayer errors and misunderstanding that result in taxpayer burden and noncompliance. At this point, the IRS believes a cognitive learning lab would be redundant in light of the research efforts already underway.

With regard to the recommendation to identify opportunities for taxpayers to work with one employee from start to finish, the National Taxpayer Advocate also raises this issue elsewhere in this year's report.⁷⁷ In response, the IRS stated that it has taken well-considered and industry-proven steps to service large volume and wide-ranging subject matter inquiries from taxpayers through its web, toll-free telephone, and TAC services. Further, the IRS strives, to the extent possible, to allow taxpayers to address all issues with a single point of contact; and more importantly, with one contact. For example, field and office examinations are conducted by one Revenue Agent or one Tax Compliance Officer and the taxpayer has an immediate opportunity to pay the deficiency at the conclusion of the examination without the need for referral to the Collection function. The Automated Collection System is designed to close the balance due account in one contact. Taxpayers contacted by IRS in the AUR program can often fax in needed documents and resolve the AUR issue while on the phone. As another example, W&I correspondence examination telephone operations have implemented universal call routing to facilitate taxpayers' one-stop telephone interactions with the IRS by allowing them to talk to the next available examiner on any case, rather than having to wait and connect only with the examiner assigned to their case.

The National Taxpayer Advocate also recommends that the IRS involve the Taxpayer Advocate Service in program design discussions. The IRS regularly solicits, and always welcomes the National Taxpayer Advocate's perspective on new or ongoing programs, and will continue to do so. In this regard, the IRS acknowledges the National Taxpayer Advocate's many helpful contributions, such as her insightful suggestions for addressing cancellation of debt income issues discussed in more detail elsewhere in this report.

However, because the views and recommendations of the Taxpayer Advocate Service are unconstrained by considerations of business, staffing, or budgetary limitations, on occasion the IRS is unable to adopt or fully accept the National Taxpayer Advocate's suggestions for IRS programs.

Finally, regarding the suggested incorporation of effectiveness measures in OD quality reviews, IRS quality reviews already include metrics that are designed to incorporate the taxpayer's point of view. For example, embedded quality reviews, tied to employee CJEs, assist in driving employees' behavior toward the goal of a quality taxpayer experience.

Technical employees are held accountable for these quality measures, as are managers through performance expectations to provide feedback to their employees and to use these quality attributes to improve operations. The National Taxpayer Advocate's report gives the example of a phone assistor being measured on time utilization and states that "(b)y focusing only on the efficiency of a phone call, the IRS loses sight of whether the contact was effective." Time utilization is an appropriate measurement in the telephone assistance environment. However, it does not stand alone and is but one of a number of evaluative factors, including effectively addressing the taxpayer's issues and appropriately tailoring calls to meet the needs of the taxpayer.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased that the IRS intends to focus on the perspective of the taxpayer in its upcoming Strategic Plan. Creating a culture where employees think about the needs of the taxpayer is an important step towards effective customer service.

However, several aspects of the IRS response raise concerns.⁷⁸ First, the National Taxpayer Advocate specifically recommended the creation of a Cognitive Learning Lab in the 2007 Annual Report to Congress.⁷⁹ The IRS provided a nearly identical response last year to the suggestion of creating a Cognitive Learning Lab. While we are pleased that the IRS is studying the results of the Taxpayer Assistance Blueprint, we are disturbed that in a year's time the IRS has not been able to provide any further information from its review of the TAB research on the merits of establishing a Cognitive Learning Lab. Further, the National Taxpayer Advocate disagrees with the IRS's assessment that the lab would be redundant to efforts currently underway. A Cognitive Learning Lab would provide the IRS with an environment to effectively test new forms and publications, outreach and education efforts, and to evaluate aspects of IRS actions and initiatives that make voluntary compliance difficult for the taxpayer. Through such a comprehensive understanding of how taxpayers perceive the IRS, use its resources, and interact with the agency and its employees, the IRS could better understand taxpayer behavior and make voluntary compliance easier.

Second, perhaps we were not clear in our treatment of effectiveness versus efficiency measures; however, the IRS seems to confuse customer satisfaction measures with effective customer service measures. Effective customer service is not synonymous with customer satisfaction, and to treat the two as such does a disservice to the taxpayer. The IRS needs to establish measures that reach the effectiveness of the service in order to determine if taxpayers are receiving the information and products they need to voluntarily comply with the tax laws. Customer service effectiveness measures should be part of the IRS strategic planning and budgetary process.

Finally, the IRS states "the views and recommendations of the Taxpayer Advocate Service are unconstrained by considerations of business, staffing, or budgetary limitations . . . " as a rationale for not implementing or fully accepting the National Taxpayer Advocate's suggestions. The IRS can implement many of these suggestions within current staffing and budgetary constraints so long as the IRS is willing to prioritize taxpayer service. Congress has previously shown significant support for customer service efforts within the IRS. Instead of decrying the lack of resources available to taxpayer service initiatives (including those within compliance), the IRS can and must make a business case to the incoming Congress to demonstrate the need for further improvements.

Recommendations

The National Taxpayer Advocate recommends the IRS take the following steps to provide taxpayers with service within compliance:

² Wage and Investment (W&I) Division, Fiscal Year (FY) 2008 Accounts Management Program Letter, at http://win.web.irs.gov/accountsmgmt/amdocs/FY08_Program_Letter_Measures/FY%202008%20Program%20Letter.doc (last visited on Nov 24, 2008).

³ IRS, 2007 Taxpayer Assistance Blueprint, Phase II, at 53.

⁴ Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, Title I, Subtitle C, § 1204, Basis for evaluation of Internal Revenue Service employees, § 9508 General Workforce performance management system (a)(2), 3525.

⁵ Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, Title I, Subtitle A, § 1002, Internal Revenue Service Mission to Focus on Taxpayers' Needs, 3504.

⁶ Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No 105-206, Title V, Subtitle H, § 3705, Internal Revenue Service Employee Contact, 3580.

⁷ SB/SE, About SB/SE, at http://mysbse.web.irs.gov/AboutSBSE/default.aspx (last visited on Sept 9, 2008).

⁸ TE/GE, About TE/GE, at http://tege.web.irs.gov/templates/TEGEHome.asp?MWContent=/content/TEGEMainWindow/linkedHTMLDocuments/ab out_te_ ge.htm(last visited on July 14, 2008).

⁹ LMSB, Field Focus Guide 2008, at http://core.publish.no.irs.gov/docs/pdf/33972j07.pdf (last visited on Nov. 24, 2008).

¹⁰ W&I, Wage and Investment Mission and Goals, at http://win.web.irs.gov/aboutus/aboutus_goals.htm (last visited on July 14, 2008).

¹¹ IRS Office of Appeals, About Appeals, at http://appeals.web.irs.gov/about/about.htm (last visited on July 14, 2008).

¹² Each OD does conduct "Customer Satisfaction Surveys" but those are not customer service measures.

¹³ IRS Commissioner Douglas Shulman, e-mail to all IRS employees (July 9, 2008).

¹⁴ W & I, Strategy & Program Plan Document 11622, FY 2008-2009 90 (Sept. 2007).

¹⁵ W & I, Business Performance Review 21-23 (May 20, 2008).

¹⁶ IRM 4.19.20.1, Batch Processing Overview: Batch Processing is an IRS-developed, multifunctional software application that fully automates the initiation, aging, and closing of certain EITC and non-EITC cases. Using the batch system, Correspondence Exam can process specified cases with minimal to no tax examiner involvement until a taxpayer reply is received. Because the batch system will automatically process the case from creation to closing, it eliminates tax examiner involvement on no-reply cases.

¹⁷ National Association of Enrolled Agents, Letter Regarding Concern over Recent Enforcement Actions by IRS (Nov. 28, 2007) at http://www.naea.org/MemberPortal/Advocacy/Comments/letter_nov_28_2007.htm (last visited June 4, 2008); W&I, Business Performance Review 21 (May 20, 2008).

¹⁸ For a detailed discussion of the impact of the batch system on taxpayer correspondence in the examination process, see Most Serious Problem, The IRS Correspondence Examination Process Promotes Premature Notices, Case Closures, and Assessments, infra.

¹⁹ National Taxpayer Advocate 2006 Annual Report to Congress, Preface X.

²⁰See, e.g., W & I, Strategy & Program Plan Document 11622, FY 2008-2009 (Sept. 2007) at 63 where W&I sets the operational priority of identifying efficiencies; and SB/SE Plan: 2008-2009 Plan at 57 where SB/SE sets the goal of exploring methods to align inventory with resources to maximize efficiencies.

²¹ Metrics quantify how processes are working in comparison with goals.

²² Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No 105-206, § 1204.

²³ IRS, Organizational Performance Management and the IRS Balanced Measurement System, at http://www.irs.gov/pub/irs-pdf/p3561.pdf 3 (Dec. 1999) and http://www.irs.gov/pub/irs-regs/td8830.pdf (last visited on Sept 17, 2008).

²⁴ IRM 21.10.1.2.5 (Oct. 1, 2008), and 5.13.1(Sept. 1, 2007).

²⁵ IRS, Organizational Performance Management and the IRS Balanced Measurement System, at http://www.irs.gov/pub/irs-pdf/p3561.pdf 3 (Dec. 1999) and http://www.irs.gov/pub/irs-regs/td8830.pdf (last visited on Sept 17, 2008).

²⁶ IRM 5.15 (May 9, 2008).

²⁷See http://sbse.web.irs.gov/SF/PPM/OPR/BPR/FY08_2ndQ_BPR.pdf 17(May 2008). This is on a 100-point scale.

²⁸ Collection Activity Report for IADEFAULT for cycle 39. Rates are increasing as indicated by the 2006, 2007, and 2008 rates of 18.26, 19.75, and 22.31 percent respectively. Business Performance Management System indicates for FY 2007 that TAS received more that 4,525 cases under PCI code 759 in which the installment agreement payments were too high. Taxpayer Advocate Management Information System (TAMIS) Primary Core Issue Code 759 indicates Installment Agreements, Other.

²⁹ IRC § 6343 (a)(1)(d) and IRM 5.11.2.2.1 (Jan 1, 2006).

³⁰ TAMIS research indicates over 11,000 referrals from IRS employees. See also IRM 5.10.3.5(8) (Sept. 7, 2007).

³¹ IRS SBSE Business Performance Review, Performance Data Tables Only, 26 Aug 2008; at http://sbse.web.irs.gov/SF/PPM/OPR/BPR/FY08_3rdQ_BPR_ Perf_Data_Tables.pdf. The measure actually serves to undermine instead of promote efficiency. If the RO released the levy on the first taxpayer contact, the taxpayer would experience seamless, efficient, and effective service. Since the current measure does not incorporate effectiveness, a taxpayer will contact TAS when the RO does not provide relief, then TAS will refer the case to the RO, creating extra steps and lower efficiency for both the IRS and the taxpayer.

³²See National Taxpayer Advocate 2006 Annual Report to Congress 289-310 and National Taxpayer Advocate 2003 Annual Report to Congress 87-98 and 135-144.

³³See National Taxpayer Advocate 2001 Annual Report to Congress 34.

³⁴See National Taxpayer Advocate 2002 Annual Report to Congress 19-31.

³⁵See National Taxpayer Advocate 2004 Annual Report to Congress vol. 2, 10, 35.

³⁶ National Taxpayer Advocate 2004 Annual Report to Congress vol. 2, 10, 35.

³⁷Id.

³⁸See IRS, Offer in Compromise: Analysis of Various Aspects of the OIC Program (Sept. 2004).

³⁹ IRM 5.19.1 (Apr. 28, 2008). IRC § 6503 provides that the length of period for collection after assessment of a tax liability is ten years. The collection statute expiration ends the government's right to pursue collection of a liability. Each tax assessment has a Collection Statute Expiration Date (CSED).

⁴⁰ New Zealand Inland Revenue Service, Our Way Forward, at https://www.ird.govt.nz/resources/file/eb3c8201af5d6c8/way-forward-2006.pdf (last visited on Aug 22, 2008).

⁴¹Id.

⁴²Id.

⁴³ New Zealand Inland Revenue, Statement of Intent 2006-2009 19-21.

⁴⁴Id. at 46-47.

⁴⁵ Inland Revenue, The Government's Expenditure Plan, 1999/2000-2001/2002, March 1999 at http://www.hmrc.gov.uk/pdfs/dptrpt99.pdf (last visited on Sept 15, 2008).

⁴⁶ HMRC, Making the New Relationship a reality: HMRC's response to small businesses' priorities for reducing the administrative burden of the tax system 5 (Nov. 2005).

⁴⁷Id. at 6 (Nov. 2005). In contrast, the IRS systems are module based and employees must look at separate systems to construct a global view of the taxpayer's account. Taxpayers may not access their accounts on their own.

⁴⁸Id.

⁴⁹ Swedish Tax Agency, Right from the Start, Research and Strategies 46 (Aug. 2005) (translated version), at http://www.skatteverket.se/download/18.6121 43fd10702ea567b80002569/rapport200501_eng.pdf.

⁵⁰ M. McKerchar, University of New South Wales, Tax Complexity and its Impact on Tax Compliance, The IRS Research Bulletin, Proceedings of the 2007 IRS Research Conference 196-197.

⁵¹Id. at 198.

⁵² Missouri Department of Revenue, Strategic Plan, 2005-2009, 6.

⁵³Id. at 12.

⁵⁴ Government Accountability Office, GAO-07-673, Internal Revenue Service: Interim Results of the 2007 Tax Filing Season and the Fiscal Year 2008 Budget Request 27 (April 2007). These numbers are apparently not adjusted for inflation. GAO reported that overall IRS funding would increase, on an inflationadjusted basis, by a mere 0.5 percent from FY 2004 to FY 2008 under the Administration's proposals. Id. at 26.

⁵⁵Compare H.R. 2764 110th Cong. § 6 (2007) with Department of the Treasury, FY 2008 Budget in Brief at 55.

⁵⁶ Department of the Treasury, FY 2009 Budget in Brief at 54. These dollar amounts include the allocation of the Operations Support budget to the Taxpayer Services and Enforcement categories.

⁵⁷Id. at 53.

⁵⁸ Department of the Treasury, FY 2009 Budget in Brief at 54. These dollar amounts include the allocation of the Operations Support budget to the Taxpayer Services and Enforcement categories. Id. at 53.

⁵⁹ IRS, 2008-2009 Strategic Initiative.

⁶⁰ IRS, I will (handout for IRS executives at Commissioner's meeting on FY 2009 Strategic Initiative) (Aug. 2008).

⁶¹See National Taxpayer Advocate 2007 Annual Report to Congress Most Serious Problem, Taxpayer Service and Behavioral Research, 156-161 and Marjorie E. Kornhauser, Normative and Cognitive Aspects of Tax Compliance: Literature Review and Recommendations for the IRS Regarding Individual Taxpayers, National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, 138-180.

⁶²See National Taxpayer Advocate 2004 Annual Report to Congress, Most Serious Problem, Education and Outreach Issues, 51-66; National Taxpayer Advocate 2007 Annual Report to Congress, Most Serious Problem, Exempt Organization Outreach and Education, 197-209; IRS, Taxpayer Assistance Blueprint: Phase I (April 16, 2006); and IRS, Taxpayer Assistance Blueprint: Phase II (2006).

⁶³See Swedish Tax Agency, Right From the Start and Leslie Book, The Poor and Tax Compliance: One Size Does Not Fit All, 51 Kan. L. Rev. 1145 (2003), citing, Robert Kidder & Craig McEwen, Taxpaying Behavior in Social Context: A Tentative Typology of Tax Compliance and Noncompliance, 2 Taxpayer Compliance 57 (1989).

⁶⁴ IRS, Enforcement Revenue Information System (ERIS) for EO returns, 2007 Daily Delinquency Penalty assessed during 2007 and abated as of March 2008.

⁶⁵ National Taxpayer Advocate 2005 Annual Report to Congress 299.

⁶⁶ IRS, AUR Two Year Study Profile, 2005, at http://win.web.irs.gov/Research/resdocs/4-05-07-2-025N_%20AUR_Two_Year_Profile.doc 19 (last visited on Sept. 15, 2008).

⁶⁷Id.

⁶⁸ E-mail from Deputy Commissioner, Operations Support to all Operation Support Employees, One-Stop Customer Service Efforts (Jan. 11, 2005).

⁶⁹Id.

⁷⁰ Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No 105-206.

⁷¹See National Taxpayer Advocate 2007 Annual Report to Congress 156-161 (Most Serious Problem: Taxpayer Service and Behavioral Research) and vol. 2, at 158-167 (Research Report: Normative and Cognitive Aspects of Tax Compliance: Literature Review and Recommendations for the IRS Regarding Individual Taxpayers).

⁷²See for example IRS response at: National Taxpayer Advocate 2001 Annual Report to Congress 37, with regard to EITC notices; National Taxpayer Advocate 2002 Annual Report to Congress 28, with regard to math error authority; National Taxpayer Advocate 2004 Annual Report to Congress 330, with regard to offers in compromise; National Taxpayer Advocate 2004 Annual Report to Congress 60, with regard to education and outreach; National Taxpayer Advocate 2005 Annual Report to Congress 115, with regard to EITC examinations; National Taxpayer Advocate 2005 Annual Report to Congress 309, with regard to penalties; National Taxpayer Advocate 2007 Annual Report to Congress 204, with regard to Exempt Organizations outreach and education; National Taxpayer Advocate 2007 Annual Report to Congress 159, with regard to behavioral research; and National Taxpayer Advocate 2008 Annual Report to Congress, Most Serious Problem: The Correspondence Examination Process Promotes Premature Notices, Case Closures, and Assessments, with regard to the batch processing system and the alleged premature issuance of notices of deficiency.

⁷³See footnote 60, supra.

⁷⁴ IRS Commissioner Douglas Shulman e-mail to all IRS employees July 9, 2008, stating, among other things: "First, in every interaction, every transaction we conduct with a taxpayer, we should think about it from the outside-in -- from the taxpayer's point of view, even though we may not ultimately agree with the taxpayer. Taxpayers will be judging their interactions with the IRS and the government based on their most recent experiences with other world-class service organizations. This should be our standard." And, "While there are many critical components to taxpayer service; there are two I'd like to highlight today. First, we should aim to resolve any open issues at the earliest moment possible. This will save both the IRS and the taxpayer extra work down the line. Second, if a taxpayer deals with more than one business group within the IRS, we should coordinate with each other so the hand-off is quick and troublefree."

⁷⁵See IRC § 7803(c)(2)(C)(ii) and IRM 13.1.7.

⁷⁶ National Taxpayer Advocate 2007 Annual Report to Congress 159.

⁷⁷See Most Serious Problem: Navigating the IRS, supra.

⁷⁸ Elsewhere in this report we address IRS responses to specific programs, including offers in compromise, installment agreements, liens, levies, and penalty abatements. With respect to the IRS's assertion that it must refer a case to TAS whenever the IRS employee is unable to take steps to resolve the taxpayer's issue within 24 hours, we agree with that statement. However, we fail to see how a collection employee, once he or she determines that the taxpayer is experiencing economic hardship, cannot take steps within 24 hours to resolve that hardship, especially since TAS ultimately will refer the case back to the collection employee for action anyway. Collection's failure to address the economic hardship at the first point of contact simply represents a shirking of its responsibility to the taxpayer and a serious lapse of taxpayer service.

⁷⁹ National Taxpayer Advocate 2007 Annual Report to Congress 156-61.

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Richard E. Byrd Jr., Commissioner, Wage and Investment Division

Definition Of Problem

Over 15 years ago, the IRS acknowledged it could be more effective in improving tax compliance if it understood and addressed the local reasons for noncompliance.¹ Local organizations (e.g., small business groups) and local sources of information (e.g., local government lists of license or permit holders) can help the IRS identify, understand, and address noncompliance at the local level. Research suggests that concentrated IRS activity to reverse noncompliance norms among local businesses may have a greater "ripple effect" on voluntary compliance by other taxpayers than seemingly random examinations.² In addition, the IRS can learn about what works and what does not work by conducting and documenting small-scale compliance initiative projects (CIPs) at the local level. CIPs are projects that allow IRS employees to address a specific compliance problem using examinations or alternative treatments, such as outreach, education, form changes, legislative or regulatory changes, or agreements with the states.³ As a result, local CIPs have the potential to improve voluntary compliance, reduce the tax gap, and significantly contribute to the IRS's store of knowledge.⁴

However, the IRS's Wage and Investment Division (W&I) does not use CIPs and the Small Business/Self-Employed Division (SB/SE) CIP Program faces significant challenges.⁵ The IRS does not have adequate measures to evaluate the CIP program as a whole. Even if employees identify local areas of noncompliance that the IRS should address using a local CIP, the IRS's organizational structure, CIP approval process, and focus on examination productivity metrics may discourage them from proposing alternative treatments, such as education and outreach, to proactively address them. Moreover, the IRS should do more to capture, analyze, distribute, and work with IRS research to follow up on the lessons it learns from local CIPs.

Analysis of Problem

Background

Historically, the IRS's Geographic Organization Had More Local Focus. Before the IRS reorganized in the early 2000s, a single local office at the IRS -- the District Director's office -- had information about local noncompliance and the incentive and authority to act on that information (e.g., the authority to allocate examination, collection, research, and communication resources) by making local IRS functions work together to address local compliance problems.⁶ In the early 1990s, the IRS attempted to leverage its geographically based organization using a strategy called Compliance 2000, with the goal of increasing voluntary compliance.⁷

The premise of Compliance 2000 was that because noncompliance is often inadvertent, the IRS could efficiently increase voluntary compliance by focusing on removing barriers to compliance and reserving expensive enforcement tools for situations where less expensive approaches would not be effective. With the assistance of a District Office of Research and Analysis (DORA), the districts were supposed to measure the effect of Compliance 2000 projects on voluntary compliance rather than narrower examination metrics.⁸ The IRS ultimately abandoned Compliance 2000, primarily because it was difficult to quantify the effects of its projects on voluntary compliance.⁹ However, Compliance 2000 achieved some instructive successes.

As an example, in the early 1990s, the IRS initiated a Compliance 2000 project to address noncompliance by commercial fishermen in Alaska resulting from confusion as well as community norms and attitudes.¹⁰ With the assistance of local authorities, the IRS merged a list of fishing permit and license holders with existing IRS data to identify nonfilers. It used a mass summons to obtain information about the recorded value of their catches -- information unavailable to the IRS's automated nonfiler programs -- to generate substitute returns for the nonfilers. The IRS worked with state and local officials to identify payments from local fish processors, state-issued fishing rights, and other payments that it could levy. Local IRS officials also proposed changes to federal and state laws to reduce confusion, promote compliance, and facilitate collection.¹¹

The IRS simultaneously launched extensive outreach and education efforts in remote fishing villages and on fishing vessels, preparing returns and training local volunteers to assist taxpayers. The IRS also enlisted the help of local community organizations, which hired a full-time Yupik-speaking individual to help local residents with tax problems, provided loans of up to $30,000 to help fishermen pay delinquencies, and helped to publicize the IRS's compliance initiatives. These efforts brought in over 1,000 unfiled returns, approximately $4.6 million in new assessments, and ten guilty pleas. More importantly, the project significantly improved voluntary compliance among the target population, reducing nonfiling from 13.1 percent in tax year 1990 to 9.2 percent in tax year 1992.

The IRS Currently Addresses Local Compliance Problems Using Local Compliance Initiative Projects.

As noted above, the IRS now uses CIPs to address specific compliance problems rather than Compliance 2000 projects.¹² The primary differences between a CIP and a Compliance 2000 project are that the IRS does not try to measure the effect of a CIP on voluntary compliance, and CIPs go through a different approval process that reflects the IRS's current organizational structure.¹³ A limited "Part One" CIP -- a CIP involving 50 or fewer taxpayers (or 100 or fewer in Collection or Service Center Examination) generally requires concurrence or approval at five levels, including "other affected function(s)," if any.¹⁴ A larger "Part Two" CIP in SB/SE generally requires additional justification and concurrence or approval of the same parties as a Part One CIP plus four more.¹⁵ Unlike Compliance 2000 projects, the success or failure of a CIP is measured by traditional examination metrics, such as proposed adjustment dollars per hour and the rate at which an examination results in no changes (called the "nochange" rate), rather than its impact on voluntary compliance.¹⁶ Local CIPs Are an Important Tool for Increasing Voluntary Compliance.

Local CIPs Can Help the IRS Focus Its Efforts in Areas Where National Return Selection Formulas Are Ineffective.

Taxpayer compliance varies from one region to another, as does the IRS's ability to detect it using the Discriminant Index Function (DIF), a return selection algorithm that does not incorporate data regarding specific local compliance problems.¹⁷ For example, in fiscal year (FY) 2007, individual returns selected using DIF and examined by Revenue Agents produced a 36 percent no-change rate in SB/SE's North Atlantic Area but only a 25 percent no-change rate in its Gulf States Area.¹⁸ Similarly, corporate returns selected using DIF and examined by Revenue Agents had a 55 percent no-change rate in the Gulf States but a 41 percent no-change rate in the North Atlantic.¹⁹

Especially in areas where noncompliance is high and the DIF is least effective, it is important for the IRS to develop good local CIPs, which can sometimes use local data that the IRS has not incorporated into DIF or other return selection programs. For example, through one recent CIP the IRS identified unreported income using information provided by the local government, which was not available on a nationwide basis.²⁰ Thus, CIPs enable the IRS to take advantage of such local information and partnerships.

Concentrated Compliance Activities Resulting from Local CIPs Can Have Greater "Indirect" Effects on Voluntary Compliance Than Seemingly Random Audits.

When the IRS focuses on particular taxpayer segments within a local community, especially small business segments (e.g., construction contractors in a given city), word of the IRS activity spreads. Tax practitioners have observed this creates a ripple effect, driving the entire segment of the community, including many taxpayers who are not under audit, to seek out practitioners to help them comply. Those good compliance habits may remain long after IRS activity ceases, at least if the IRS is not perceived as going away (i.e., continues some activity in the community), creating a "halo" effect. IRS researchers have estimated that indirect effects of an examination on voluntary compliance are between six and 12 times the amount of the proposed adjustment.²¹

In contrast, seemingly random examinations (e.g., examinations of returns selected using DIF or other national criteria) of taxpayers in different communities who do not communicate or compete with each other may not have the same indirect effects. In such cases, taxpayers are less likely to hear that more than one of their friends, associates, or competitors are working to get into compliance in response to the IRS's activities. As a result, they may believe the IRS is not very likely to audit them and may be less likely to take additional steps to become compliant.

Tax compliance research supports these intuitive notions. Researchers have suggested that local tax "morale" -- non-rational factors and motivations, such as social norms, personal values and various cognitive processes -- strongly affects an individual's voluntary compliance and his or her response to IRS enforcement activities.²² Other researchers have concluded that once the IRS focuses on a geographic area and improves compliance norms and habits within that community, high levels of compliance will persist even after the IRS reduces (but does not abandon) its compliance activity.²³ Thus, the IRS could probably improve both examination results and voluntary compliance by initiating more good local CIPs.

CIPs Could Allow Multifunctional Teams to Maximize the Effect of IRS Activities on Voluntary Compliance.

CIPs could allow IRS employees in a given geographic area to assemble multifunctional teams, including Examination, Collection, Communications, and Taxpayer Advocate Service (TAS) employees, to collaborate with local stakeholders to identify and address the root causes of local compliance problems.²⁴ As illustrated by the example above, such a multifunctional approach could be more effective in improving voluntary compliance than a single IRS function could achieve on its own. For example, the Communications & Liaison (C&L) function could help educate taxpayers so the IRS does not need to conduct as many examinations. The Collection function could help to ensure that the IRS promptly collects any examination assessments. TAS could voice the taxpayer's perspective in planning the CIP and help taxpayers and the IRS resolve complex problems that result from it.

This multifunctional approach could maximize the ripple effect of the CIP on voluntary compliance.

Local CIPs Can Generate Valuable Information.

The IRS generally does not select returns pursuant to a CIP using random methods that would allow it to reliably project the results to a larger population. Each local CIP is nonetheless similar to a small research study. The IRS identifies a compliance problem, identifies a target population, proposes an approach to address the noncompliance, and when the CIP ends, the CIP Coordinator writes a termination report that describes the results.²⁵ Such information about what works and what does not is a valuable resource. The IRS could use this information to develop effective CIPs to use in other communities or to identify areas where it needs to focus additional research.

The IRS Faces Challenges in Addressing Local Compliance Problems Using CIPs.

The CIP Program Has an Increasingly National Focus.

As noted above, the IRS has eliminated its geographically based district structure and formed operating divisions focused on national taxpayer segments. Today, the IRS only has seven offices (rather than the 33 or 63 it previously had) that coordinate CIPs -- called Planning & Special Programs Offices (or PSPs) -- one in each of the seven areas.²⁶ PSPs allocate examination resources to ensure the areas meet national examination goals, and participate in the local CIP submission and approval process.²⁷ The PSP representatives that we spoke with believe they retain a sufficiently local focus.²⁸ However, consolidating the PSP offices -- making them more centralized and less local -- may have reduced the IRS's ability to identify local compliance problems, at least in the absence of additional outreach to local employees.²⁹

Indeed, the IRS approved only seven local Part Two CIPs in 2006-2007,³⁰ and two of those were prompted by the need to generate work for displaced IRS employees rather than a local compliance problem. Thus, the IRS does not appear to be using local CIPs very frequently.

Moreover, a recent operational review of the CIP program suggests a primary goal of the program is to develop local CIPs that the IRS can replicate nationwide, rather than to improve voluntary compliance at the local level.³¹ While nationwide CIPs are important, they may not generate the same ripple effects as local CIPs.³²

There Are No Good National Measures for the CIP Program.

On average, local CIPs generate seemingly unimpressive results based on traditional examination metrics. The IRS is supposed to terminate a CIP if returns selected for audit as a result of the CIP do not produce better examination results than those selected by computer using the DIF.³³ While some local CIPs are better than others, over the last ten years, on average, they have had higher no-change rates than returns selected using DIF.³⁴ CIPs are similarly unimpressive when evaluated based on the dollars per hour the IRS generates auditing CIP-selected returns. For example, in FY 2007, the Western Area had a higher percentage of CIPs that exceeded the area DIF results based on the dollars per hour metric than any other area.³⁵ Even so, only 14 out of 25 of its CIPs (or 56 percent) exceeded the dollars per hour generated by DIF-selected returns in that area.³⁶ Moreover, DIF-selected return results are likely to improve in comparison to CIP results as the IRS updates the DIF formulas to incorporate data from the IRS's National Research Program.³⁷ There are a number of possible explanations for the seemingly poor CIP results.

Comparisons of CIP and DIF results aggregated above the local level may be misleading. The IRS generally evaluates CIP results at the area level,³⁸ and area CIP results vary widely. ³⁹ However, national and area comparison of CIP and DIF examination results may be misleading if the IRS uses CIPs to select returns in localities where DIF does not work very well. If so, CIP results could exceed the DIF results at the local level, even if not at the area or national levels.

Comparisons of CIP and DIF examination results may also be misleading if the examinations do not involve the same types of IRS examiners and the same types of returns. Tax Compliance Officers (i.e., employees who generally conduct office audits of individuals and businesses) generally produce better examination results than Revenue Agents (i.e., employees who generally conduct field audits of businesses) simply because they audit different types of tax returns using different methods.⁴⁰ Tax Compliance Officers and Revenue Agents may audit CIP and DIF selected returns in different proportions. As a result, if Revenue Agents examine more CIP-selected returns, DIF may appear to generate better results than CIPs, even if the CIP would generate better results for a specific type of taxpayer or audit using these metrics.

More importantly, examination measures are imperfect because they do not capture the effect of CIPs on voluntary compliance. These difficulties leave the IRS with few good ways to measure the overall success or failure of the CIP program at the national level.⁴¹ Thus, it should consider ways to measure, recognize, and encourage success at the local level.

In addition, the IRS should not lose sight of the fact that because CIPs are experimental (i.e., the first stage of a test) even good ones will not always initially produce better results than DIF -- the IRS's state-of-the-art return selection algorithm. Ideally, there should be multiple stages. First, the IRS should use CIPs to test theories about local compliance problems and solutions without the expectation that they will always exceed DIF return examination results. Second, the IRS should update its CIP return selection criteria and outreach methods to incorporate learning from its initial activities. Finally, if the IRS wants a more accurate measure of CIP results, it may need to conduct a study to evaluate the immediate and long-term effects of the CIP (or its methods) on voluntary compliance.

The Incentive for Local IRS Employees to Identify Local Compliance Problems May Need to Be Strengthened.

Local examination managers, area Coordinators, and area PSP managers are the types of local IRS employees who most often propose CIPs to national decision makers.⁴² Some of these decision makers are not responsible for compliance in any particular locale and some are not in the same chain of command as the employee making the submission.⁴³ In some areas, the PSP or CIP Coordinator may encourage local employees to submit CIPs and send a memo of thanks to those that do.⁴⁴ However, PSPs do not manage most of these field employees.

Such encouragement is probably less motivating than helping a District Director, a person in the field employee's direct chain of command, achieve one of his or her primary objectives -- to improve compliance in the employee's community -- as was the case prior to the reorganization.⁴⁵

No Resources Are Specifically Allocated to Allow Local IRS Employees to Identify and Work Local CIPs.

Pursuant to the national examination plan, each IRS area is required to examine a specific number of returns of various types of taxpayers each year.⁴⁶ The plan does not allocate resources to pursue new CIP work identified during the year.⁴⁷ Because the plan does not give CIP selected returns priority, and most IRS areas feel they are already fully utilizing all available resources,⁴⁸ area managers are less likely to encourage employees to seek out more work by proposing a CIP, especially if that work does not fit into the national examination plan. In a sample of 14 CIP termination reports that we reviewed, three indicated the CIP was abandoned in part because it did not fit the national plan.⁴⁹ These factors likely reduce the incentive for field employees to identify good CIPs.

Although the IRS Has Streamlined the CIP Approval Process, It Is Still Lengthy.

A 2002 report by the Treasury Inspector General for Tax Administration (TIGTA) indicated the length of time and number of approvals required to initiate CIPs discouraged IRS employees from recommending them.⁵⁰ The IRS has since automated the process so employees can submit CIPs for approval electronically. The raw number of local CIPs generating examination results has increased in recent years, from 22 in FY 2005 to 81 in FY 2007, perhaps because of steps taken to address the 2002 report.⁵¹ As noted above, however, the IRS still approved only seven local Part Two CIPs during 2006-2007. According to the IRS, it has reduced the median time to approve a Part Two CIP from 105 days in FY 2006 to 93 days in FY 2007, but a delay of 93 days (or three months) may still be enough to discourage some employees from submitting a CIP.⁵² These figures suggest the IRS should consider additional ways to streamline the approval process, while maintaining appropriate oversight. For example, it could establish a written approval process that provides for reasonably short deadlines at each level. Alternatively, if the IRS established additional guidelines and training about how to develop good CIPs and made additional research resources available for drafting them, approvers might receive better-developed CIPs that take less time to approve.

Another Challenge Is to Ensure That CIPs Utilize Alternative Treatments -- Such as Education and Outreach -- In All Appropriate Instances.

The Internal Revenue Manual (IRM) states that because audits are the most expensive way to improve compliance, the IRS should consider "alternative treatments" such as outreach and education, revisions to forms or publications, legislative or regulatory changes, and agreements with state or local business licensing authorities.⁵³ While the Part One CIP approval form does not mention alternative treatments, the Part Two CIP approval form requires submitters to discuss them.⁵⁴ In addition, all Part Two CIPs require approval of the Area Manager, Stakeholder Liaison Field, who is supposed to provide guidance and suggestions on alternative treatments.⁵⁵ The PSP is also supposed to ensure the CIP authorization request includes the "proper" alternative treatments.⁵⁶ Yet the IRS does not track the number of CIPs that propose such treatments.⁵⁷ As a result, it may be difficult for the IRS to evaluate the extent to which employees are using them.

The 2002 TIGTA report found that CIP submissions often missed opportunities to include alternative treatments.⁵⁸ We reviewed seven local Part Two CIP submissions that the IRS approved in FY 2006 -- 2007. Of these seven, four suggested alternative treatments, but none proposed any concrete plans to implement them.⁵⁹ Some CIP submissions may omit alternative treatments because CIPs proposing them require concurrence by the division commissioner of the "other affected functions," which could further delay or even prevent implementation of the CIP.⁶⁰ Those other affected functions are also juggling competing priorities, so in some cases they may not concur with a CIP proposal for alternative treatments solely because it would require significant resources.

More importantly, the benefits of proactive alternative treatments that could be included in a CIP do not show up in IRS examination metrics. As a result, field examination employees may have less of an incentive to propose using alternative treatments to prevent noncompliance as part of a CIP, even if such solutions would ultimately be more efficient for the IRS and less burdensome for taxpayers. Thus, it may be appropriate for the IRS to take additional measures to ensure that CIPs use alternative treatments in all appropriate cases.

It may be helpful for the IRS to revise the Part One CIP approval form so that submitters need to consider alternative treatments. Tracking these treatments and their results would also help the IRS obtain a more complete picture of the effectiveness of a given CIP.

The IRS Needs to Do More Follow-Up on CIPs to Identify, Document, and Disseminate Lessons Learned from Them.

As a successful CIP addresses a local compliance problem, it may become less productive over time (based on traditional examination metrics), until the IRS eventually discontinues it.⁶¹ IRS procedures call for the CIP Coordinator to write a CIP termination report addressing the CIP examination results, whether the results justified the time and resources, what difficulties the IRS encountered and how they were resolved, and successful procedures and audit techniques.⁶² These CIP termination reports should contain a good deal of useful information.

However, the quality of the CIP termination reports varies widely. After reviewing a sample of 14 reports from FY 2005 through FY 2007, we found most of them to be perfunctory, often leaving questions blank or providing one-sentence answers.⁶³ Moreover, SB/SE was unable to locate any CIP termination reports for years before FY 2005.⁶⁴ Nor does SB/SE regularly analyze them, summarize them, use them as the basis for further research, or make them widely available on the IRS intranet.⁶⁵ It should consider doing so.

IRS Researchers Could Help in Formulating and Evaluating Local CIPs.

Like a good CIP termination report, a good CIP submission includes extensive documentation and analysis. For example, according to IRS guidance it should describe the issue, how it was identified, the impact on compliance, the objectives and expected results, and information from a search for similar projects or data, if applicable.⁶⁶ The CIP approval form also asks the submitter to identify measures to evaluate noncompliance for purposes of monitoring and follow-up, as well as the costs and benefits of the project.⁶⁷ As noted above, we reviewed all seven of the Part Two CIPs approved in 2006 -- 2007.⁶⁸ Only one included specific quantitative data from the Part One CIP or any other source to justify its approval. Although four identified possible alternative treatments, none of the submissions proposed to measure the results from any alternative treatments or evidenced any intent to implement them.⁶⁹ Thus, CIP submissions might improve if IRS researchers played a more active role in helping to formulate and evaluate CIPs in appropriate circumstances.

Conclusion

The CIP program has the potential to be a more valuable tool for improving voluntary compliance. The IRS should consider taking the following actions to improve the program:

• Update the IRM and CIP forms to provide additional guidance regarding when to propose CIPs, how to implement alternative treatments, approval timeframes, reasons for involving the IRS research or other functions, and how to measure and report CIP results.

• Provide local areas the flexibility to work good CIPs that do not necessarily fit into the categories currently reflected in the examination work plan. Consider modifying the examination plan to require each area to devote some resources to identifying and addressing local problems, working with local partners, and local sources of data; or at least allow the areas to divert resources from plan work to complete CIPs that are producing good results at the local level with appropriate national approval.

• Generate reports that show a better apples-to-apples comparison of CIP and DIF selected return results (and alternative treatment results) at the local level using both traditional measures, and to the extent practical, measures of the impact of these activities on voluntary compliance.

• Work with the IRS research function to develop better measures of the impact of CIPs and traditional examinations on voluntary compliance.

• Provide additional training or recognition to employees aimed at improving the quality of CIP submissions and CIP termination reports.

• Compile, analyze, follow-up on, and disseminate the results of local CIPs (including the impact of CIPs on voluntary compliance measures) on a regular basis to preserve for future decision makers, stakeholders, and researchers, the benefits of any lessons learned.⁷⁰

The IRS agrees that CIPs possess an increasingly national focus. However, most CIPs begin at the local level. When we identify issues that are common across the country, we leverage that knowledge to expand the local CIP to a national CIP. This process serves to improve voluntary compliance, reduce the tax gap, and significantly contribute to the IRS's store of knowledge.

Each Area monitors the success of a CIP by comparing Area CIP results against Area DIF results at the Tax Compliance Officer (TCO) and Revenue Agent (RA) level. Part I CIPs are designed to allow a small number of returns to be examined to test compliance using the key measures we utilize for our overall inventory. This provides the best measure to make appropriate resource decisions.

Our CIP approval process includes multiple levels of concurrence to ensure there is transparency and accountability in the CIP process. We need to ensure we are using our resources effectively, treating taxpayers fairly, and appropriately addressing areas of noncompliance.

We agree that alternative treatments should be utilized when warranted and will continue to work with our Communication and Liaison employees to further explore outreach and education opportunities.

Our examiners take pride in the identification of a unique issue and are encouraged to consider the applicability of identified issues to multiple taxpayers. The IRS has several current CIPs that were referred by local field employees. The Area CIP coordinators have responsibility for indentifying new areas of noncompliance and encourage field employees to contact them with referrals. Coordinators make presentations at group meetings where they receive recommendations from field employees for possible CIPs. In the FY 2009 Examination Program letter, Areas are specifically encouraged to use CIPs to help identify egregious areas to close the tax gap.

CIPs are discussed during monthly teleconferences between headquarters and the Areas and best practices are shared to improve submissions. Lessons learned upon the CIP's conclusion are captured on Form 13497, Compliance Initiative Termination Report. This form is currently being revised to provide more detailed information. We will continue to take steps to ensure we have proper follow-up on CIP results.

In her report, the National Taxpayer Advocate makes six specific suggestions to improve voluntary compliance. We are taking, or have taken, the following actions with respect to these issues: The IRS is in the process of finalizing the revision to the IRM section on CIPs (IRM 4.17).

The revised CIP IRM addresses how to implement alternative treatments, authorization approval timeframe guidelines, and methods to measure and report CIP results.

The returns examined under CIPs are considered discretionary work. The national examination plan and each area plan contain allocations for discretionary work. In the FY 2009 Examination Program letter, Areas were specifically encouraged to use CIPs to help identify egregious areas of noncompliance in order to close the tax gap.

Reports comparing local CIP results against local DIF results are generated and analyzed. The CIP results are further broken down to the RA and TCO level and then compared against the DIF results for each at the local level. This provides a valid comparison of CIP and DIF selected return results. Although a further analysis of the deterrent affects on noncompliance of alternative treatments may be helpful, we have not found a meaningful way to measure this effect.

We currently have research focusing on tax gap issues and measures, such as evaluating the effectiveness of the Form 1040 DIF scores, to enable selection of the most productive inventory for audit. Research, Analysis and Statistics and the National Research Program (NRP) are responsible for updating the voluntary compliance measure and updating the tax gap data. The Form 1040 NRP is now conducted annually, with yearly data updates to the voluntary compliance information. Concentrating our research efforts in this manner is the best way to efficiently focus our resources.

CIP training for the Area coordinators is in the planning stages, pending budgetary restrictions. The topics of the CIP training will include properly preparing CIPs, preparing timely and thorough CIP Termination Reports, and exploring alternative treatments. This training will be a train-the-trainer session so the Area CIP Coordinators can train field employees. The CIP coordinators encourage the field employees to call them with ideas for CIPs or to submit completed CIP authorization requests for review and approval.

We agree to perform a more thorough analysis of CIP results than currently conducted. Information on CIPs can be found on the CIP web page, which is available internally to all business units. From the web page, there is access to the CIP database, which describes current and terminated CIPs. The CIP coordinators for each CIP are listed and can provide detailed information on individual CIPs as necessary.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate is pleased the IRS plans to:

• Update its CIP IRM (IRM 4.17) to address how to implement alternative treatments, establish approval timeframe guidelines, and ways of measuring and reporting CIP results;

• Revise Form 13497, Compliance Initiative Termination Report, to provide more detailed information;

• Annually update Form 1040 compliance research and evaluate the effectiveness of the Form 1040 DIF scores;

• Train the Area Coordinators in preparing CIPs, writing CIP termination reports, and exploring alternative treatments; and

• Perform a more thorough analysis of CIP results.

National Focus

The comments suggest the IRS plans to continue to focus on identifying national CIPs, rather than local ones. These comments do not address the fact that local business groups, local IRS staff from other functions, and local sources of information can sometimes help the IRS identify, understand, and address noncompliance at the local level more effectively than national groups and national sources of data. As noted above, research suggests concentrated IRS activity to reverse noncompliance norms among local businesses may have a greater "ripple effect" on voluntary compliance by other taxpayers than seemingly random examinations.⁷¹ We acknowledge it is useful for the IRS to identify local CIPs that it can replicate at the national level, but the IRS should not ignore the benefits of local CIPs that it cannot necessarily replicate nationwide. The two types of CIPs are not mutually exclusive. The National Taxpayer Advocate believes both are essential components of effective tax administration.

Measures

The IRS's comments confirm that it measures local CIP results using traditional measures (e.g., no change rates and dollars per hour) at the area level, but IRS areas may encompass a multi-state footprint, which may be too large for valid comparisons against returns selected using other selection criteria. Moreover, the IRS has no good national measures for the program. We recognize the difficulty the IRS faces in designing measures for the CIP program and gauging the success of alternative treatments at both the local and national levels, but the IRS's comments suggest it has given up on designing better measures.⁷² Because employees focus on measures, the IRS's efforts will not be as efficient or effective if it does not at least try to measure the impact of its activities (including CIPs) on the goal it wishes to achieve -- increasing voluntary compliance. Moreover, the IRS will continue to struggle to identify and use effective alternative treatments if it does not try to measure whether and how employees use them.

Examination Plan

The IRS's comments suggest it included language in its FY 2009 Examination Program Letter encouraging the local areas to use CIPs.⁷³ However, the letter does not give the areas any specific resources to work CIPs.⁷⁴ According to the comments, CIPs are "discretionary" work and the examination plans provide resources for discretionary work. The plans have a discretionary component in the sense that they do not require the IRS areas to select all of the returns they audit using specific return selection criteria (e.g., DIF selected returns), but contain no specific resource allocation for "discretionary" work. Rather, the examination plans require the areas to examine a certain number of returns from various types of taxpayers each year, so the areas only have enough resources to examine CIP generated returns as part of their discretionary workload if the CIP generates the right types of returns.⁷⁵ As noted above, in the sample of 14 CIP termination reports we reviewed, three indicated the IRS abandoned the CIP in part because it was not generating returns that fit into the categories required by the examination plan. Thus, without specifically allocating resources for CIPs or imposing a requirement that the areas use CIPs, the language in the 2009 Examination Program Letter is likely to have an important but limited impact.

Analysis of CIP Results and Access to Termination Reports

The IRS plans to revise the termination report form and provide additional training to CIP Coordinators about how to prepare these reports. In addition, the IRS pledges to "perform a more thorough analysis of CIP results." These are steps in the right direction. The IRS comments suggest, however, that it is not inclined to initiate additional research to analyze CIP results. Nor does the IRS propose to make its CIP Termination Reports more widely available. It may be difficult for the IRS to make the most of the lessons it has learned from CIPs without taking these simple steps.

Recommendations

The National Taxpayer Advocate recommends the IRS:

²See, e.g., Jon S. Davis, et al., Social Behaviors, Enforcement, and Tax Compliance Dynamics, 78 Acct. Rev. 39 (2003).

³See IRM 4.17.4.4.1 (Feb. 1, 2004).

⁴ The "tax gap" is the amount of tax that is imposed by law for a given tax year, but not voluntarily and timely reported and paid.

⁵ Our discussion focuses on small business taxpayers, which are the responsibility of SB/SE, for several reasons. First, unreported business income (rather than non-business income) is responsible for the largest portion of the tax gap. See, e.g., National Taxpayer Advocate 2007 Annual Report to Congress vol. II (A Comprehensive Strategy for Addressing the Cash Economy). The IRS needs additional tools to address this problem because unincorporated business income is subject to little information reporting and is difficult to detect using traditional enforcement tools. Id. Second, local CIPs may be less useful in addressing noncompliance among large businesses with a nationwide footprint, which are the responsibility of the Large and Midsize Business Division (LMSB). Third, the Tax Exempt and Government Entities Division (TE/GE) structures its program somewhat differently and it may not face the same challenges discussed below. Finally, although IRM 4.17.2.4 (Feb. 1, 2004) suggests that W&I has a CIP program, W&I does not currently use CIPs. IRS response to TAS information request (Oct. 8, 2008).

⁶See, e.g., General Accounting Office, GAO/GGD-98-39, IRS's Use of Information Gathering Projects 8 (Feb. 1998) (noting that the IRS consolidated its 63 district offices into 33 in 1994); IRM 1.1.2 (Feb. 2, 1999) (describing the most recent IRS reorganization); Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2003-10-134, The Structures of the Internal Revenue Service and the National Treasury Employees Union Are Not Effectively Aligned (June 2003) (same). See also, IRM 4568.1 (Mar. 27, 1999) (describing the pre-reorganization process); IRM 45(12)(5) (June 27, 1989) (same); IRM 4568.4 (Mar. 27, 1999) (same).

⁷ Unless otherwise indicated, the discussion of Compliance 2000 is drawn from the following documents: IRS Strategic Business Plan FY 1992 and Beyond, IRS Document 7382 (Sept. 1991); IRS, Compliance 2000: Orientation Guide, Doc. 9102 (Rev. 7-1993); IRS Research, ELN-2003730103820-617, Compliance 2000 Focus Group Report (May 1, 1992); Government Accountability Office (GAO), GAO/GGD-96-109, TAX RESEARCH, IRS Has Made Progress but Major Challenges Remain (June 1996).

⁸See, e.g., GAO, GAO/GGD-96-109, TAX RESEARCH, IRS Has Made Progress but Major Challenges Remain (June 1996) (noting, however, that DORA personnel who were supposed to measure Compliance 2000 results sometimes lacked proper training, were hampered by delays to IRS computer systems upgrades, and did not systematically design or track their research results). See also IRM 1.7.4.4(2) (Nov. 1, 2007) (describing the reorganization of the IRS research function).

⁹See, e.g., GAO, GAO/GGD-96-109, TAX RESEARCH, IRS Has Made Progress but Major Challenges Remain (June 1996).

¹⁰ Memorandum from District Director, Anchorage District, to Chief Compliance Officer, Western Region, Compliance 2000 -- Prototype Completion (Aug. 23, 1994).

¹¹ The state passed a law to allow for involuntary transfers of fishing permits. Memorandum from District Director, Anchorage District, to Chief Compliance Officer, Western Region, Compliance 2000 -- Prototype Completion (Aug. 23, 1994). At the federal level, small fishing crews were exempt from FICA and FUTA, a source of confusion that the IRS proposed to address. Id.

¹²See IRM 4.17.4.4.1 (Feb. 1, 2004).

¹³ We do not suggest that it was easier for a local employee to initiate a Compliance 2000 project in the past than it is to initiate a Part I CIP today. Obtaining the District Director's approval was likely more difficult. Nor do we suggest that CIPs should be subject to less oversight.

¹⁴See, e.g., Compliance Initiative Projects, Central Area Desk Procedures (Nov. 14, 2006); Compliance Initiative Projects, Western Area Desk Procedures (Oct. 16, 2006); Memorandum for All Examination Area Directors From Director, Examination Planning and Delivery, SBSE-04-0608-037, Interim Guidance on Part I Compliance Initiative Project: Taxpayer Contact Increase (June 12, 2008) (increasing the number of taxpayers that may be examined pursuant to a Part I CIP). These procedures supplement IRM 4.17.4.3 (Feb. 1, 2004).

¹⁵See, e.g., Compliance Initiative Projects, Central Area Desk Procedures (Nov. 14, 2006); Compliance Initiative Projects, Western Area Desk Procedures (Oct. 16, 2006). See also IRM 4.17.4.4.4.1 (Feb. 1, 2004).

¹⁶See, e.g., Compliance Initiative Projects, Western Area Desk Procedures 5 (Oct. 16, 2006). Although § 1204 of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685, 713 (1998) and 26 C.F.R. § 801.3T(e), prohibit the IRS from using "records of tax enforcement results" (e.g., dollars per hour) to evaluate individual employee performance, such measures can be used to evaluate initiatives and programs.

¹⁷See, e.g., Jon S. Davis, et al., Social Behaviors, Enforcement, and Tax Compliance Dynamics, 78 Acct. Rev. 39 (2003) (citing literature that observed geographic variations in compliance rates); Kim M. Bloomquist and Zhiyong An, Geographic Variation in Schedule H Filing Rates: Why Should Location Influence the Decision To Report "Nanny" Taxes?, Proceedings of the Annual Conference on Taxation (2005), at http://www.irs.gov/pub/irs-soi/05bloom.pdf (concluding that variations in Schedule H filing rates likely reflect geographic variations in compliance and that geographic differences in compliance with the nanny tax rules can be explained, in part, by local economic, cultural, and behavioral factors).

¹⁸ IRS response to TAS information request (Apr. 28, 2008) (providing Table 37 data for FY 2007).

¹⁹Id. (providing Table 37 and local CIP examination results by area for FY 2007). These areas had only marginally better results using CIPs. In FY 2007, the local CIP no-change rate for all types of returns was 34.3 percent in the Gulf States Area and 43.2 percent in the North Atlantic Area. Id. However, the CIP results may not be comparable since they do not necessarily reflect results from corporate returns.

²⁰ IRS response to TAS information request (Apr. 28, 2008) (Compliance Initiative Project Termination Report for Project 514).

²¹ Alan H. Plumley, Pub. 1916, The Determinants of Individual Income Tax Compliance: Estimating The Impacts of Tax Policy, Enforcement, and IRS Responsiveness 35-36 (Oct. 1996); Jeffrey A. Dubin, Michael J. Graetz and Louis L. Wilde, The Effect of Audit Rates on the Federal Individual Income Tax, 1977-1986, 43 Nat. Tax J., 395, 396, 405 (1990).

²²See, e.g., National Taxpayer Advocate 2007 Annual Report to Congress vol. II 138 (Marjorie E. Kornhauser, Normative and Cognitive Aspects of Tax Compliance: Literature Review and Recommendations for the IRS Regarding Individual Taxpayers).

²³ Jon S. Davis, et al., Social Behaviors, Enforcement, and Tax Compliance Dynamics, 78 Acct. Rev. 39 (2003).

²⁴ Under the old district structure, the District Offices of Research formed Compliance Planning Councils (CPC) to build district support for compliance research, oversee district compliance programs, and provide a multifunctional group to oversee district compliance workload. GAO, GAO/GGD-96-109, IRS Has Made Progress but Major Challenges Remain 9 (June 1996). Similarly, the IRS could use CIPs to promote more multifunctional coordination at the local level.

²⁵See generally IRM 4.17.4 (Feb. 1, 2004).

²⁶ On October 1, 2000, the IRS consolidated its 33 PSP offices into 16, one in each area, and on October 1, 2004, it consolidated these into only seven areas. IRS response to TAS information request (Apr. 28, 2008).

²⁷See generally IRM 4.1.1 (Oct. 24, 2006); IRM 4.1.2 (Oct. 24, 2006); IRM 4.1.3 (Oct. 24, 2006); IRM 4.1.4 (Oct. 24, 2006).

²⁸ Teleconference with three PSP Territory Managers and SB/SE HQ personnel (July 8, 2008).

²⁹See, e.g., IRM 1.7.4.4 (Nov. 1, 2007). Interviews with PSP Territory Managers and IRS Research employees who were employed before the reorganization, as well as TAS employees with similar backgrounds, suggest that in most cases the IRS Research function has never played a very active role in most CIPs or Compliance 2000 projects. Teleconference with three PSP Territory Managers and HQ personnel (July 8, 2008). However, the role of IRS research employees varied from one district to another and their input could be very useful in some cases. Id. For a general discussion of centralization, see Most Serious Problem, The Impact of IRS Centralization on Tax Administration, infra.

³⁰ We requested five approved Part Two local CIPs for FY 2006 and FY 2007, selected as randomly as possible. TAS information request (July 15, 2008). However, the IRS provided only seven for 2006 and 2007 because "the Areas were working the National Office Part Two CIPs." IRS response to TAS information request (Aug. 4, 2008).

³¹ IRS response to TAS information request (June 1, 2008) (stating in the November-December 2007 operational review of the CIP program: "when you identify a Part I CIP with attractive results, is it viable as a Part II CIP for national consideration? You should always be asking this question which demonstrates the need to be proactive in culling through the Part I's looking for the next National CIP." The review does not mention the benefit of looking for CIPs that may significantly improve voluntary compliance at the local level.).

³² Relatively few Part I CIPs become Part II CIPs. From FY 2005 through May of FY 2008, about eight percent of all Part I CIPs became Part II CIPs. IRS response to TAS information request (Apr. 28, 2008). This may suggest either that the field employees could benefit from additional guidance or training about how to identify a good CIP or that the IRS should reexamine how it evaluates Part II CIP applications.

³³ IRM 4.17.4.7 (Feb. 1, 2004).

³⁴ AIMS Database (September 2008) (excluding correspondence and training examination results).

³⁵ IRS response to TAS information request (Apr. 28, 2008) (response to item 1h, excluding training returns).

³⁶Id. In comparison, only seven out of 29 (or 24 percent) of the CIPs in the Gulf States Area exceed the area DIF on the dollars per hour measure. Id.

³⁷ SB/SE Research -- Philadelphia, Project # PHL0026, 4-Model Workload Selection System Comparison to the New DIF Formulas (May 2007) (indicating that the IRS implemented revised DIF formulas in January 2007).

³⁸ IRS response to TAS information request (Apr. 28, 2008) (providing DIF and local CIP examination results by area for FY 2007).

³⁹ For example, in FY 2007 the Western Area apparently developed better CIPs than other areas based on no-change metrics. In FY 2007, the local CIP no-change rate for the Western Area was 10.2 percent as compared to 43.2 percent for the North Atlantic Area. IRS response to TAS information request (Apr. 28, 2008) (providing DIF and local CIP examination results by area for FY 2007). In comparison, DIF-selected returns in the Western Area examined by Revenue Agents in FY 2007 resulted in a 29 percent no-change rate for individuals and a 51 percent no-change rate for corporations. Id. (file 206999T372009 on pages 3 and 4 of 35). Individual DIF-selected returns examined by Tax Auditors or Tax Compliance Officers resulted in a 17 percent no-change rate in the Western Area during FY 2007. Id. (file 206999T372009 on page 2 of 26). However, DIF-selected returns in the North Atlantic Area examined by Revenue Agents in FY 2007 resulted in a 36 percent no-change rate for individuals and a 41 percent no-change rate for corporations. Id. (file 201999T372009 on page 3 and 4 of 35). Individual DIF-selected returns examined by Tax Auditors or Tax Compliance Officers resulted in a 14 percent no-change rate in the North Atlantic Area for FY 2007. Id. (file 206999T372009 on page 2 of 26).

⁴⁰ For example, in FY 2007, DIF-selected return examination results varied by type of examiner as follows: Revenue Agents auditing individual returns produced $333 per hour and had a 30 percent no-change rate, but Tax Compliance Officers auditing individual returns produce $477 per hour and had a 12 percent no-change rate. IRS response to TAS information request (Apr. 28, 2008) (providing Table 37 examination results by area for FY 2007). This data does not suggest that Tax Compliance Officers are better than Revenue Agents, only that they audit different types of returns using different methods.

⁴¹ Although the IRS can generate reports showing CIP examination results at various levels, it does not include CIP results on the same internal reports used to report other types of examination results. IRS response to TAS information request (Apr. 28, 2008) (showing that "Table 37" -- the internal IRS report that shows examination results from returns selected by various methods, including DIF -- does not break out results for CIP selected returns as it had in prior years). As noted above, however, aggregated comparisons above the local level may be misleading.

⁴² IRM 4.28.1.3(5)(c) (Apr. 1, 2004); IRS response to TAS information request (Apr. 28, 2008).

⁴³ For example, cross-divisional CIPs require the approval of the applicable Division Commissioner or his/her delegate. IRM 4.17.4.9.4 (Feb. 1, 2004).

⁴⁴ Compliance Initiative Projects, Central Area Desk Procedures 3 (Nov. 14, 2006); Compliance Initiative Projects, Western Area Desk Procedures 3 (Oct. 16, 2006); Teleconference with three PSP Territory Managers and SB/SE HQ personnel (July 8, 2008).

⁴⁵ We do not suggest here that the IRS should revert to its old District structure.

⁴⁶See generally IRM 4.1.1.1 (Oct. 24, 2006).

⁴⁷ IRS response to TAS information request (Apr. 28, 2008) (FY 2008 exam plan).

⁴⁸ The areas generally responded to the proposed FY 2008 IRS examination plan by explaining why existing resources were insufficient to meet proposed targets. IRS response to TAS information request (Apr. 28, 2008) (area responses to FY 2008 exam plan).

⁴⁹ IRS response to TAS information request (Apr. 28, 2008) (a FY 2005 CIP termination report stated: "no returns were examined due to the Area's focus on only examining returns from the Strategic Priorities Program;" a FY 2006 termination report stated: "No returns were examined under this CIP. Work plan accomplishments for flow-through work were met through other means of workload selection;" a FY 2007 termination report stated: "The ATAT Coordinator has indicated that PSP has sufficient SEP inventory . . . ").

⁵⁰See TIGTA, Ref. No. 2002-30-171, Controls Over Compliance Initiative Projects Have Improved, but Use of the Process Is Limited (Sept. 2002).

⁵¹ IRS response to TAS information request (Apr. 28, 2008) (providing local CIP examination results by area for FY 2005 -- FY 2007).

⁵² IRS response to TAS information request (June 13, 2008). The average approval time for FY 2007 was 79 days, down from 114 in FY 2006. Id.

⁵³ IRM 4.17.4.4.1 (Feb. 1, 2004).

⁵⁴ Form 13502, Compliance Initiative Project Authorization, Part One (2003); Form 13498, Compliance Initiative Project Authorization (2003).

⁵⁵See, e.g., Compliance Initiative Projects, Central Area Desk Procedures (Nov. 14, 2006); Compliance Initiative Projects, Western Area Desk Procedures (Oct. 16, 2006); Memorandum for All Examination Area Directors, from Director, Examination Planning and Delivery, Interim Guidance on Part I Compliance Initiative Project: Taxpayer Contact Increase (June 12, 2008); IRM 4.17.4.3 (Feb. 1, 2004); IRM 4.17.2.7 (Feb. 1, 2004).

⁵⁶ IRM 4.17.2.5 (Feb. 1, 2004).

⁵⁷ IRS response to TAS information request (Apr. 28, 2008); IRS response to TAS information request (June 26, 2008).

⁵⁸See TIGTA, Ref. No. 2002-30-171, Controls Over Compliance Initiative Projects Have Improved, but Use of the Process Is Limited (Sept. 2002).

⁵⁹ IRS response to TAS information request (Aug. 4, 2008).

⁶⁰ IRM 4.17.4.9.4 (Feb. 1, 2004). Although all Part Two CIPs require approval of the Area Manager, Stakeholder Liaison Field, this approval is not required for a Part One CIP, unless Stakeholder Liaison is an "affected function." The IRS may be less likely to include alternative treatments such as education in a Part Two CIP approval request if the treatment was not included in the Part One CIP.

⁶¹ Employees must provide a special justification to continue a CIP beyond a two-year period. IRM 4.17.4.1 (Feb. 1, 2004). We note that the IRS may need to continue some level of activity among the target population even after it reduces CIP activity so it can extend the halo effect of the CIP on voluntary compliance and prevent noncompliance from increasing again.

⁶² IRS Form 13497, Compliance Initiative Project Termination Report (Aug. 2003).

⁶³ IRS response to TAS information request (Apr. 28, 2008) (providing five termination reports for FY 2007, five termination reports for FY 2006, and four for FY 2005).

⁶⁴ IRS response to TAS information request (Apr. 28, 2008). The IRS explained: "Information is consistently available only from 2005 forward due to the many reorganizations that took place in the PSP/Area offices." IRS response to TAS information request (June 6, 2008).

⁶⁵ Teleconference with three PSP Territory Managers and SB/SE HQ personnel (July 8, 2008).

⁶⁶See, e.g., IRM 4.17.4.3 (Feb. 1, 2004).

⁶⁷ Form 13498, Compliance Initiative Project Authorization (2003).

⁶⁸ IRS response to TAS information request (Aug. 4, 2008).

⁶⁹ We understand the IRS Research function was never very involved in the CIP process (or the predecessor of the CIP process). See, e.g., GAO, GAO/GGD-96-109, TAX RESEARCH, IRS Has Made Progress but Major Challenges Remain (June 1996) (noting that DORA personnel sometimes lacked proper training, were hampered by delays to IRS computer systems upgrades, and did not systematically design or track their research results).

⁷⁰ TE/GE posts some of its compliance initiative program reports on the IRS website. See, e.g., TE/GE, Resource Materials -- Compliance Initiatives for Tax-Exempt Organizations, at http://www.irs.gov/charities/article/0,,id=162493,00.html (last visited Dec. 8, 2008); TE/GE, Political Activities Compliance Initiative (2008 Election), at http://www.irs.gov/charities/charitable/article/0,,id=181565,00.html (last visited Dec. 8, 2008).

⁷¹See, e.g., Jon S. Davis, et al., Social Behaviors, Enforcement, and Tax Compliance Dynamics, 78 Acct. Rev. 39 (2003).

⁷² It is obviously possible to measure local changes in voluntary compliance by analyzing samples of the target population over time. As illustrated in the Alaskan Compliance 2000 project (above), in past years the IRS did, in fact, develop and use various measures (e.g., increases in the number of filers, decreases in the penalty rate, etc.) to evaluate the impact of local projects on voluntary compliance.

⁷³ According to the FY 2009 Examination Program Letter: Areas are encouraged to identify egregious activities through Compliance Initiative Program (CIP) returns. Inclusion of these types of cases supports our strategy for addressing egregious non-compliance and our efforts to provide for balanced coverage. Returns with offshore tax issues, identified through CIPs, will be worked during FY 2009. SB/SE, Examination Program Letter for FY 2009 (Oct. 27, 2008).

⁷⁴See generally IRM 4.1.1.1 (Oct. 24, 2006).

⁷⁵ IRS response to TAS information request (Apr. 28, 2008) (FY 2008 exam plan).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

The Automated Collection System (ACS) is an important component of the IRS Collection operation. In fiscal year (FY) 2008, ACS units closed nearly 2.1 million cases, collected $2.4 billion in delinquent taxes, and issued nearly 2.3 million levies on taxpayer's assets.¹ While the ACS succeeds in collecting significant amounts of delinquent tax dollars, TAS frequently hears complaints from taxpayers, tax professionals, and Local Taxpayer Advocates (LTAs) about lapses in ACS customer service. Despite these complaints, the ACS's own assessment of its service reflects high customer satisfaction survey results and quality review scores. However, these measures do not adequately address taxpayer satisfaction in important areas, including:

• The failure of ACS customer satisfaction surveys and internal quality reviews to identify and measure several areas that are critical to taxpayers;

• The failure to promptly release ACS levies for economic hardship, installment agreements (IAs), and other situations in which the law requires prompt levy release;²

• The failure of ACS managers to timely respond to taxpayer requests to speak with them;

• Lengthy delays before a taxpayer's call is properly routed to a Customer Service Representative (CSR) who can handle that call;³

• The inability to work with the same ACS employee, even when the taxpayer must call ACS more than once in complex cases;

• Restrictive use of fax machines as a way for taxpayers to provide supporting documentation; and

• Inconsistent and unclear documentation requirements that burden ACS's customers.

Analysis of Problem

The timing of the ACS customer satisfaction survey during the life cycle of the taxpayer's interaction with the ACS may also impact the perception of the ACS's level of service. In other words, a taxpayer may be very satisfied on any individual call with the ACS when it appears that his or her request for relief was granted or is being considered, but that perception can change if the subsequent relief does not meet the taxpayer's expectations. The survey tends to measure a "snapshot" of ACS service rather than the overall picture by taking into consideration 16 customer service related attributes that exclude taxpayer feedback about the entirety of the ACS experience, including overall satisfaction with the final outcome of the case.¹³

In contrast to the ACS survey, the Collection Field function (CFf) surveys customer satisfaction for cases worked by revenue officers through a mailed questionnaire only after the cases are closed so the entire picture is available (i.e., satisfaction with how the case was resolved and impressions of customer service in light of that resolution). The revenue officer is never notified that his or her case was selected for the customer satisfaction survey. As a result, the survey contains no inherent sampling bias. While the overall customer satisfaction rating for revenue officers is significantly lower than that of the ACS (61 percent favorable rating compared to at least 92 percent),¹⁴ reaction from tax professionals indicates a strong preference for working with revenue officers in the field rather than telephone assistors in the ACS.¹⁵ Thus, the ACS's perception of its customer service does not reconcile with taxpayers' and their representatives' perception of that service.

The ACS also conducts internal quality assessments of its service based on analysis of recorded taxpayer calls. These reviews measure quality in timeliness, customer accuracy, and professionalism by considering 77 attributes, such as whether the employee's greeting was professional, the taxpayer's issues were identified and addressed, and the taxpayer's name and address were verified.¹⁶ While a small number of these attributes measure events following the initial contact with the ACS,¹⁷ the ACS quality review criteria generally do not reflect a number of issues that appear to be very important to ACS customers, such as whether a levy was released in a timely fashion or whether a manager returned a call from a taxpayer or tax professional.

The National Taxpayer Advocate is concerned that significant service-related concerns consistently raised by taxpayers, tax professionals, and TAS case advocates are not reflected in IRS measures designed to track ACS customer satisfaction or quality.¹⁸ Consequently, the IRS may not recognize these issues as problem areas and target them for improvement.

• Failing to disclose to taxpayers that the IRS has an expedited levy release policy that allows releases to be faxed to third parties (such as employers) rather than being mailed; and

• Imposing an additional hurdle on taxpayers who are persistent enough to uncover the expedited process by requiring taxpayers to prove they truly need faxed levy releases.

The IRS can easily stop these unnecessary levy payments by faxing the levy release to the employer. In fact, the IRS has an "expedited levy release" procedure, but does not tell taxpayers this procedure is available unless the taxpayer knows about internal IRS processes or happens to ask the telephone assistor the right questions.²⁴ Moreover, if the taxpayer learns of the expedited procedure and asks for a faxed levy release, the IRS imposes another hurdle by requiring the taxpayer to provide additional information to validate that his or her situation warrants a levy release.²⁵ A taxpayer who has already been determined to have an economic hardship should not have to provide still more information to merit a levy release being faxed instead of mailed.

The result of the ACS's approach is that taxpayers needlessly experience additional wage garnishments. The National Taxpayer Advocate addressed this problem in her 2005 Annual Report to Congress. At that time, the IRS would not agree to either inform taxpayers of the availability of the expedited process or modify its policy to reflect the fact that the cost of an extra levy to taxpayers in economic distress significantly outweighs the administrative inconvenience, if any, to the IRS of having to fax more levy releases rather than mail them.²⁶

The failure of managers to return calls erodes taxpayer confidence in the IRS and should be a measure of the service taxpayers receive. While important taxpayer publications and some portions of the Internal Revenue Manual (IRM) refer to the taxpayer's right to speak to a manager, the ACS procedures contain no such reference.³¹ The IRS does not track the number of manager callbacks requested and completed each year by the ACS and has no plans to develop such a process.³² Nor does the IRS hold managers accountable by making the timely completion of callbacks a requirement in their performance plans each year (i.e., by tying this aspect of performance to the manager's bonus and pay).

Taxpayers also complain about being routed from one function to the next in the ACS. The ACS utilizes an automated routing system that filters out non-ACS cases and routes ACS callers to the first available assistors. However, because not all assistors can handle complex cases, ACS must transfer taxpayers to those capable of dealing with their requests. Consequently, if a taxpayer does not qualify for a basic IA because the delinquency exceeds the threshold for a basic IA, the taxpayer will again be transferred until he or she reaches an assistor who can conduct the analysis.³⁷ The ACS offers no direct-dial option for large dollar cases, so even when callers know they need to speak with the large dollar unit, they must still go through the main ACS extension.³⁸ Such delays cause frustration and in some cases create a loss of service because the customers cannot continue to hold and must hang up, only to try again later. We have identified at least five distinct applications within the ACS that contribute to this problem.³⁹

Historically, the IRS has said it is impractical to maintain toll-free extensions that would allow ACS employees to work inventories. However, the SB/SE ACS sites in Memphis and Nashville are testing the Corporate Approach to Collection Inventory (CACI) ACS Hybrid initiative. This system incorporates transferring calls for individual case assignment to ACS assistors into the processing of cases that ACS would typically transfer to the CFf due to the complexity of the issues involved. The National Taxpayer Advocate applauds the IRS for testing individual case assignment as part of this hybrid initiative and looks forward to reviewing the results. The National Taxpayer Advocate believes the IRS should also consider establishing teams of employees who are responsible for cases, and permit extension dialing, to increase the likelihood that a subsequent telephone assistor will have access to the information the taxpayer has already provided. Further, at a minimum, IRS customer satisfaction surveys and internal quality reviews should capture this taxpayer preference.

Question: How would you describe your overall experience in working with the ACS during the past year?

Sample Responses:

Sample Responses:

Sample Responses:

Conclusion

The ACS serves a large number of taxpayers, who deserve and desire excellent customer service.⁵⁸ The National Taxpayer Advocate has heard widespread complaints about ACS service and has experienced reluctance on the part of the ACS to change its practices. While the information used for this analysis is largely anecdotal, it is consistent across the board. It appears that taxpayers and tax professionals believe the ACS serves taxpayers well in "simple cases." When cases become more complex (e.g., when more than ten pages must be faxed to resolve a case quickly), the ACS becomes less oriented toward customer service.

The ACS spends considerable resources on its customer satisfaction surveys to "identify what ACS staff and managers can do to improve customer service."⁵⁹ These efforts measure important customer observations but ignore some of the most important aspects of ACS service (i.e., the downstream impact on taxpayers dealing with the ACS). When the ACS listens to this information, it will be more apt to change policies that unnecessarily burden taxpayers.

The IRS should consider taking the following actions to improve the ACS program: explain to taxpayers that a levy release will occur sooner if the taxpayer faxes substantiation to ACS and ACS faxes the release while on the call; establish extension dialing capability for cases that require more than one contact with the taxpayer to improve case continuity; develop procedures and measures to track the number of manager callbacks requested by taxpayers and completed by the ACS managers; revise Form 433-F, Collection Information Statement, to provide fields to include federal, state and local taxes; establish a comprehensive fax policy that will allow taxpayers and practitioners to fax any and all documentation to the IRS including documentation that must be mailed under current procedures; eliminate the requirement that a taxpayer provide a loan denial letter when the taxpayer cannot obtain a home loan to pay his or her tax liabilities; provide taxpayers useful information and change the repetitive music they must listen to while on hold; develop a customer satisfaction survey that records taxpayer concerns about the overall handling of their cases; and implement a customer satisfaction survey specifically for tax practitioners.

IRS Comments

Quality customer service is a top IRS priority and our ACS employees take pride in providing the highest level of service to all taxpayers. Obviously, improvements can always be made to fully ensure that all taxpayer concerns are addressed.

We believe our Customer Satisfaction Survey (CSS) and internal quality reviews are adequate to gauge the level of our success in providing this quality service. The current ACS CSS rating is 92 percent favorable. The survey is conducted and verified by an independent third party, Pacific Consulting Group (PCG). Pacific Consulting Group uses statistically valid sampling to ensure the survey is unbiased and representative of the entire ACS customer base. Through the survey, PCG identifies key areas for improvement. These areas are identified as the Top Improvement Priorities for ACS Customers and Top Improvement Priorities for Customer Service Representatives. We concentrate on these key areas by focusing on them in operational reviews and throughout the year as we monitor call site performance.

The IRS has taken numerous actions in response to issues raised by the National Taxpayer Advocate in the 2005 and 2006 Annual Reports to Congress. We have also taken actions in response to recommendations made by IRS employees and the public through the Systemic Advocacy Management System (SAMS).

In July 2008, ACS implemented a reduction in the time it takes to generate the LP68, ACS levy release, and a reduction in the mail-out timeframes from seven days to five days. Additionally, ACS has been pursuing the use of e-fax services for all ACS call sites and support sites. This project is in its early stages and implementation of this initiative is contingent on future funding.

In her report, the National Taxpayer Advocate makes eight suggestions to improve the ACS program. Descriptions of the many actions the IRS has taken or is taking to improve ACS are provided below.

The IRS agrees, and it has always been our policy, that levy releases should be expedited to prevent over-collection and be responsive in resolving hardship situations and we have taken numerous improvement actions in this area. We have revised the IRM 5.19.4.4.10 to provide additional guidance for faxing levy releases and provided more examples in training materials. ACS is also pursuing technological alternatives to improve our efficiency in releasing levies.

In January 2008, the TAS Collection Levy Team (TCLT) was formed to address concerns TAS had with issues raised in the 2005 and 2006 Annual Reports to Congress. The team is comprised of analysts from Collection Policy, ACS, and TAS. One of the issues being addressed is the expedite release procedures. There continues to be discussions as to which situations require an expedite levy release and a resulting faxed levy release. Currently, there are expedite levy release procedures and all taxpayers are afforded the same rights as it pertains to levy releases. SB/SE and W&I currently have a joint effort in process as part of an initiative to look at collection processes that might be impacted by current economic conditions. As part of that effort IRM guidelines are currently under review to ensure levy release actions are expedited when appropriate. In addition current year financial analysis CPE will address hardship indicators and include scenarios to ensure IRS assistors are aware of the options available to expedite levy release action.

While ACS does not have a unique toll-free number for different applications, the technology of Enhanced Business Operating Division Routing (EBR) requests the taxpayer identification number (TIN) of the taxpayer, identifies Large Dollar calls by Business Operating Division (BOD), and routes the call accordingly. In effect, this provides direct-dial service. Callers who do not provide a TIN are default routed to a regular ACS tax examiner for assistance, which may ultimately require a manual transfer to an appropriately skilled tax examiner. Our call routing system does not allow us to direct a caller to a specific agent. Given the large number of ACS employees across the country, to provide extension dialing capabilities, or have the system successfully connect a large volume of callers to specific employees, would not provide timely quality service due to time zones, leave, breaks, hours worked, or various other activities of our employees that take them off the phones.

The IRS acknowledges there may be situations where a taxpayer requests to speak with an ACS manager and the manager is unsuccessful in returning the call. The IRM 1.4.20.1(2)(h) and IRM 5.19.8.4.16.4 provide clear guidance for both the ACS employees and managers. Guidance is also provided on the Electronic Automated Collection Service Guide (E-ACSG) on handling taxpayer requests for a manager callback. To address this issue and identify improvement opportunities, a random sampling of calls will be conducted on a quarterly basis and increased emphasis will be placed on this issue during operational reviews.

The IRS is working to add a field for taxes on Form 433-F, Collection Information Statement. In the interim, IRM 5.19.1.6.3(12) provides clear and concise guidance on determining a taxpayer's disposable income. Federal, state, and local tax obligations are automatically allowed as a deduction from gross pay, as well as FICA, Medicare, other mandatory retirement programs, and health insurance. Additionally, the Desktop Integration (DI) financial screen used by employees to enter financial information provided by the taxpayers automatically subtracts taxes from gross wages to arrive at a net wage amount.

The IRS is committed to providing the highest level of service to all taxpayers and ACS routinely uses fax machines to receive documentation needed to resolve issues. Due to capacity and resource limitations, the IRS established limits on the number of incoming facsimile pages to ten.⁶⁰ This limitation is to ensure that all callers receive prompt service without experiencing lengthy delays, either by taxpayers holding on the line while waiting for the IRS to receive their facsimiles or by callers waiting to speak to a representative.

ACS call sites have limited fax machines, which are not co-located, for the assistors to use. In general, call sites do not have high-speed fax machines capable of handling high volumes. It is challenging for assistors to provide service to customers when phone lines are tied up with taxpayers on hold waiting for their facsimile transmissions. The page limitation is merely a guide to promote equity and efficiency for both the taxpayer and the site. As more resources become available, we will revisit this issue.

Currently, ACS is designed to systemically generate a levy release when it recognizes the account is full paid. This promotes efficiency and equitable treatment for taxpayers. We recognize that systems have their limitations. It is, therefore, our policy to fax a levy release any time a mailed release will not be received by the levy source and processed in time to prevent additional monies from being submitted. We do not limit this policy to hardship situations.

Over the past several years, ACS has worked with Collection Policy to ensure the consistent treatment of taxpayers requesting an installment agreement. The IRM 5.19.1 has been updated to resolve the appearance that ACS and the CFf have different procedures for tax-payers to obtain a basic installment agreement. The requirements for streamlined installment agreements have been revised to make it clear that loan denial letters are not required as part of the necessary documentation for such agreements.⁶¹ In fiscal year 2007, over 97 percent of the installment agreements granted by the IRS were streamlined installment agreements.

The music taxpayers hear while on hold is an enterprise-wide service and is not specific to the ACS operation. The routing system optimization planned in FY 2009 is addressing this issue with the intent of making overall improvements to the queue structure including what music is played, the volume, and what messages are integrated with the music based on relevancy.

ACS utilizes objective and unbiased data collected through our CSS to improve operations. The survey is available for all ACS phone applications, including the Tax Practitioner Line. A tone is heard, generally at the end of a call, to indicate selection to participate in the survey. The IRM 21.10.1.4.2 is being updated to stipulate that the "tone" will be heard near the end of the call. We believe our survey and internal quality reviews are adequate to gauge the level of our success in providing quality service.

In addition to the CSS, correspondence is also received from taxpayers and their representatives expressing either their satisfaction or dissatisfaction of how the IRS handled their situation. All complaints received, through any venue, are thoroughly researched, addressed, and, whenever possible, resolved. The use of Contact Recording has afforded the IRS an opportunity to listen to the actual call that led to the complaint, ensuring management has an accurate portrayal of what occurred during the call. Contact Analytics will be in place within a year and will help us to further identify areas that need improvement.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends the IRS for continuing to make quality customer service a top priority, and acknowledges the pride ACS employees take in striving to provide the highest level of service to all taxpayers. She also appreciates the IRS's candor in its realization that it can also make improvements to fully address taxpayer concerns. The National Taxpayer Advocate is encouraged by the IRS's use of Contact Recording to listen in on actual taxpayer calls and obtain an accurate portrayal of what occurred, and looks forward to learning more about the IRS's Contact Analytics initiative to identify areas for further improvement. Moreover, she acknowledges the IRS's recent efforts to work closelywith TAS and to evaluate her prior Annual Reports to Congress for recommendations to improve ACS as being steps in the right direction.

Customer Satisfaction Survey and Quality Review Concerns

The IRS's belief that its Customer Satisfaction Survey and internal quality reviews are adequate is somewhat disconcerting in light of what TAS has heard and continues to hear from LTAs, taxpayers, and practitioners. As previously noted, TAS's main concern is that the IRS's survey process is too narrow in scope and fails to adequately measure the entire ACS experience. Under current survey procedures, the taxpayer may not receive the opportunity to properly rate the overall outcome, but rather is only able to assess a "snapshot" in time (i.e., the ACS employee's behavior on a particular call). The National Taxpayer Advocate reiterates that the IRS needs to continue to explore ways of measuring the most important aspects of ACS service (i.e., the downstream impact on taxpayers dealing with the ACS).

Restrictive Use of Fax Technology and Timely Release of Levy

The National Taxpayer Advocate is pleased to learn that the IRS is pursuing e-fax services for all ACS sites and that, in the interim, it has reduced the levy release generation times, as well as the mail-out timeframes from seven to five days. Reducing the waiting time between the IRS's levy release determination and the time the release is actually received will help to minimize taxpayer burden or hardship. We also agree that the revision of IRM 5.19.4.4.10 should further improve this area.

However, we respectfully disagree with the IRS's claim that its expedited levy release procedures are adequate. The National Taxpayer Advocate recognizes the ACS handles a large number of cases with limited resources. However, the ACS continues to send millions of levies on an annual basis. The IRS must stop and consider the downstream consequencesof this type of enforcement activity, particularly in light of today's difficult economic times. While we agree that expedited procedures are listed in the applicable IRM sections, we continue to hear complaints that taxpayers are still not being advised of this option, unless they specifically request it. As a result, the National Taxpayer Advocate urges the IRS to include a required discussion of this option in all applicable IRM sections related to levy release. It is not so much a matter of increasing IRS employees' awareness of the existing procedures as it is to require employees to increase taxpayer awareness of this option. The National Taxpayer Advocate believes the IRS should fax or expedite a levy release any time it determines a significant hardship is present. The IRS should consider establishing a centralized ACS or ACS support unit that is dedicated to faxing levy releases and would not detract from a contact employee assisting the next customer.

Lack of Extension Dialing Capability

The National Taxpayer Advocate appreciates the IRS's explanation of its EBR technology, as this helps to better understand how the ACS routes calls. However, she disagrees with the IRS's assertion that the current large dollar case routing procedures in effect serve as direct dialing. In its explanation, the IRS states that when a taxpayer or practitioner with a large dollar case contacts the ACS and provides the taxpayer identification number, the call will be immediately routed to the large dollar case unit. The National Taxpayer Advocate does not consider this to be direct dialing since the caller must wait on hold, speak to someone,and then be routed. The National Taxpayer Advocate believes the IRS should provide true extension dialing capability, at a minimum, for specialized units to enhance customer service.

ACS Manager Callbacks

The National Taxpayer Advocate applauds the IRS for recognizing that its managers are not following through with the managerial callback policy and for proposing quality reviews of these procedures. These efforts should go a long way toward addressing the concerns raised by many of the practitioners TAS spoke with earlier this year. We look forward to hearing more about the methodology to be used for tracking adherence with the IRS's stated policy.

Problems with Collection Information Statement, Form 433-F

The National Taxpayer Advocate is pleased to learn of the IRS's plans to revise the current Form 433-F, Collection Information Statement. The revision will greatly benefit taxpayers by allowing them to include the correct amounts for their local, state, and federal tax obligations when determining their monthly expenses. The National Taxpayer Advocate looks forward to the actual publishing of the form. Moreover, she believes the revision will further strengthen the guidance in the IRM and on the Desktop Integration intranet page for ACS employees helping taxpayers to provide the correct information.

Inconsistent IA Policies

The National Taxpayer Advocate commends the IRS on its recent decision to revise the ACS's streamlined IA procedures and make them consistent with those of the CFf. No longer requiring a loan denial letter as part of the necessary documentation will allow formuch more efficient processing of a streamlined IA and will benefit all parties.

ACS's Fax Policies

The National Taxpayer Advocate recognizes the capacity and resource limitations that preclude the IRS from accepting high volumes of faxed pages. She also appreciates the IRS's response that this "is to ensure that all callers receive prompt service without experiencing lengthy delays." However, the National Taxpayer Advocate is disturbed by the IRS's argument that it is "equitable" and "fair" to refuse faxes based on a ten-page limit when accepting 20 pages by fax might possibly resolve a case for a taxpayer. When a taxpayer is forced to end a call because the assistor will not accept the appropriate number of faxed pages, the ACS unduly burdens the taxpayer by making him or her call back, wait on hold, and expend additional time (if the ACS assistor is unable to locate the mailed correspondence). Providing taxpayers with immediate assistance and resolution is fair and equitable and promotes customer service. The IRS should make co-locating fax machines and investing in high-speed fax machines a priority to allow for more prompt case resolution and fewer taxpayer contacts. Moreover, if the IRS does not have the appropriate resources to provide world class service to its taxpayers, such as being able to receive 20 pages of faxed documents and answer a phone at the same time, then it should raise the issue to Congress and seek additional funding.

Recommendations

The National Taxpayer Advocate recommends that the IRS:

² Internal Revenue Code (IRC) § 6342(a)(1); see also Treas. Reg. § 301.6343-1(b)(4).

³ IRS, Customer Satisfaction Survey, ACS, SB/SE National Report, April through June 2008 (Aug. 2008). IRS, Customer Satisfaction Survey, ACS, W&I National Report, October through December 2007 (Feb. 2008). Nationwide Tax Forums, ACS Focus Groups (July 2008, Aug. 2008, Sept. 2008).

⁴ IRS, Automated Collection System (ACS) Redesign Project (June 1998).

⁵ ACS handles balance due and nonfiler cases that may require telephone contact. ACS employees review taxpayer data, and issue notices, liens, or levies to resolve delinquent tax cases. The IRS implemented ACS in 1983-1984 to replace its Collection Office function, which was a more paper-oriented operation. ACS is the middle stage of what is essentially a three-tier IRS collection pyramid: collection begins with notices, then moves to the ACS, and ultimately escalates to the IRS's field functions. The IRS uses Automated Collection System Support (ACSS) units to support ACS. ACSS handles much of the ACS paperwork, such as mailing notices, responding to taxpayer correspondence, processing Collection Due Process (CDP) hearing requests, mailing transcripts, and resolving diagnostic and error listings. See Internal Revenue Manual (IRM) 5.19.5.2.1 (Dec. 1, 2007) and IRM 5.19.6.1 (July 8, 2008).

⁶ W&I's seven units are in Atlanta, Austin, Buffalo, Fresno, Jacksonville, Guaynabo (Puerto Rico), and Seattle. SB/SE's six units are in Brookhaven, Denver, Detroit, Nashville, Oakland, and Philadelphia. W&I ACSS units are located at the Fresno and Kansas City campuses; SB/SE ACSS units are located at the Cincinnati and Philadelphia campuses. See IRM 5.19.6.1(2) (July 8, 2008).

⁷See Government Accountability Office, GAO-08-728, Tax Debt Collection: IRS Has a Complex Process to Attempt to Collect Billions of Dollars in Unpaid Tax Debts 3 (June 2008). In FY 2008, the ACS units answered nearly 4.1 million incoming calls and placed approximately 250,000 outgoing calls for a total volume of 4.3 million. Additionally, the ACS answered 3.9 million Economic Stimulus calls which diverted resources from collection efforts. See IRS response to TAS research request (Dec. 18, 2008). ACS makes many outbound calls using the predictive dialer system technology in which calls are placed using an attending agent on the originating telephone line. If the dialer makes contact, it transfers the calls along with the other pertinent case data to a waiting IRS representative. When a busy signal or no answer is received, the dialer updates the account and reschedules the case to the predictive dialer queue for another attempt. See IRM 5.19.5.4.1 (Dec. 1, 2007) for a more detailed explanation of the process.

⁸See http://pccc.web.irs.gov/acs%20callsite.htm (last visited Dec. 5, 2008).

⁹ IRM 21.10.1.4.2.3 (Oct. 1, 2003) provides: ACS Phones will be measured for Timeliness, Professionalism, Customer Accuracy, Regulatory/Statutory Accuracy, and Procedural Accuracy. These are the measures that are available and may be reported under the Balanced Measurement System.

¹⁰ IRS, Customer Satisfaction Survey, ACS, SB/SE National Report, April through June 2008 (Aug. 2008). IRS, Customer Satisfaction Survey, ACS, W&I National Report, April through June 2008 (Aug. 2008).

¹¹ IRM 21.10.1.9.4.2 (Oct. 1, 2006).

¹² IRM 21.10.1.9.4.4(1) (Oct. 1, 2008). The ACS uses monitors who listen to taxpayer calls to determine whether the call is from a taxpayer actually seeking the services that ACS provides. If the call is ACS related, the monitor notifies the ACS representative that the caller will be offered an opportunity to take the customer satisfaction survey. See generally IRM 21.10.1.9.4.2 (Oct. 1, 2006). Despite encouraging the monitors to provide the "tone" to the ACS telephone assistors later in the call, neither W&I nor SB/SE has issued written guidance to their monitors on when the "tone" should be provided to the assistors. The lack of procedures to determine when the "tone" is given to the assistors further reduces the reliability of the customer satisfaction survey.

¹³ The 16 attributes are:

• Amount of time given to follow up with the IRS;

• Clarity of IRS notice, bill or invoice;

• Tone of IRS notice, bill or letter;

• Ease of understanding of the Automated Answering System (AAS) menu and instructions;

• After you reached representative, time to complete call;

• Time to get through to the IRS;

• Representative's description of non-compliance;

• Description of what was expected of you;

• Representative's authority to make decisions;

• Reached the right person;

• Representative's flexibility in handling your issue;

• Knowledge of representative;

• Getting all the information you needed during the call;

• Fairness in treatment;

• Friendliness of representative; and

• Representative's willingness to help with your issue.

¹⁴ IRS, Customer Satisfaction Survey, Compliance Services Collection Operation (CSCO), SB/SE National Report, January through March 2008, with Annual Results (July 2008).

¹⁵ A number of prominent tax treatises contain advice to practitioners such as: "In most cases, ACS should be avoided." Arthur H. Boelter, 1 Rep. Bankr. Taxpayer, IRS Tax Collection System: Automated Collection System, § 3.38 (2008), noting problems when dealing with the ACS, including:

• In the ACS it takes two weeks for correspondence to be loaded into the ACS computers;

• The ACS is very stratified, such that the person answering the call will not be the person doing research if the underlying tax is questioned; and

• The ACS levies within four days if the taxpayer promises to make a payment immediately and it is not received within four days.

¹⁶ ACS, Quality Job Aid (Oct. 1, 2007).

¹⁷ For example, one attribute measures whether after the call the IRS employee made the right decision to levy a taxpayer's assets. ACS, Quality Job Aid (Oct. 1, 2007).

¹⁸ Tax professionals from the AICPA, NAEA and LITCs met with TAS employees to discuss their concerns with ACS customer service (May 2008). Representatives from TAS also conducted focus groups on ACS customer service at the IRS sponsored Nationwide Tax Forums (July 2008, Aug. 2008, Sept. 2008). The results of the focus groups at the Tax Forums mirrored the complaints the National Taxpayer Advocate has heard from her own staff; however, the feedback from these focus groups and professional organizations is anecdotal and not intended as a statistically representative sample of all taxpayer experiences with the ACS.

¹⁹ Description by TAS case advocate of a type of case she has seen where the levy release is delayed and the IRS takes an extra garnishment.

²⁰See IRS, Collection Workload Indicators (C23) Report (Oct. 7, 2008).

²¹ IRC § 6343(a)(1) requires levies be released in the following situations:

²³ IRM 5.19.4.4.10 (Sept. 24, 2008).

²⁴Id.

²⁵ IRM 5.19.4.4.10(1) (Sept. 24, 2008).

²⁶See National Taxpayer Advocate 2006 Annual Report to Congress 110; National Taxpayer Advocate 2005 Annual Report to Congress 209; See also http://www.irs.gov/pub/irs-utl/2005_arc_report_card_v2.pdf (last visited Dec. 5, 2008)

²⁷ Nationwide Tax Forums, ACS Focus Groups (Atlanta Forum, July 2008).

²⁸ IRM 3.0.273.7(Jan. 1, 2008) provides:

³⁰ Tax professionals from the AICPA, the NAEA, and LITCs met with TAS employees to discuss their concerns with the ACS (May 2008).

³¹ IRS Pub. 1, Your Rights as a Taxpayer (May 2005); IRS Pub. 594, The IRS Collection Process (July 2007). See generally IRM 5.19.5 (Dec. 1, 2007) and IRM 5.19.6 (July 8, 2008) (where there is no mention of manager callbacks). See also IRM 3.0.273.7 (Jan. 2008) (where reference is made to the manager contact right in the IRM for the Submission Processing function). But see IRM 1.4.20.1(2)h (Jan. 1, 2006) (where reference is made to manager contact by the operations and department manager for the Filing and Payment Compliance function, which includes the ACS).

³² W&I and SB/SE response to TAS research request (July 17, 2008).

³³ Robert E. McKenzie, 1 Rep Before Collection Division of the IRS, § 2:29 (2008).

³⁴ IRS, Customer Satisfaction Survey ACS, SB/SE, April through June 2008 (Aug. 2008); and IRS, Customer Satisfaction Survey, ACS, W&I, October through December 2007 (Feb. 2008).

³⁵See IRS, Customer Satisfaction Survey ACS, SB/SE National Report, April through June 2008, Appendix E-1 (Aug. 2008).

³⁶See IRS, Customer Satisfaction Survey ACS, SB/SE, April through June 2008 (Aug. 2008); IRS, Customer Satisfaction Survey, ACS, W&I, April through June 2008 (Aug. 2008).

³⁷ The most basic IA is known as a "guaranteed IA" because it is statutorily guaranteed to taxpayers under IRC § 6159(c) provided the amount of the delinquency does not exceed $10,000 and the taxpayer has been otherwise compliant for the last five years. The IRS also administratively established another basic agreement known as the "streamlined IA" for accounts in which the delinquency is not greater than $25,000. IRM 5.19.1.5.4.4(8) (Apr. 28, 2008). Installment agreements for amounts above $25,000 require financial analysis of the taxpayer's income, expenses, assets, and liabilities. IRM 5.19.1.5.4.8 (Apr. 28, 2008).

³⁸ IRM 5.19.1.6.6 (Apr. 28, 2008).

³⁹ The ACS uses agent groups to route customers to the correct applications for assistance. The ACS has five distinct agent groups: Alaska Perma Fund, Large Dollar, High Income Non-Filer, Practitioner Priority Service, and Regular ACS. IRS, Seven-Day Comments to Most Serious Problem, Customer Service Issues in the IRS's Automated Collection System (Nov. 10, 2008). Some taxpayers may be transferred from application to application (because the first application was not the right "gate" to solve the taxpayer's problems), causing additional wait time and frustration.

⁴⁰ Systemic Advocacy Management System (SAMS) Issue 29765 (July 2008).

⁴¹ Issue Management Resolution System (IMRS) 06-0000184-Contacting ACS Employees submitted in 2006, at http://www.irs.gov/businesses/small/article/0,,id=168260,00.html (last visited June 5, 2008).

⁴² IRS, Income Statements, at http://www.irs.gov/businesses/small/article/0,,id=168260,00.html (last visited Sept. 30, 2008).

⁴³ Taxpayer complaint to TAS representative after trying to work with the IRS to reduce an IA payment established by the ACS because taxes were not factored into the taxpayer's expenses. Ultimately, the agreement was reduced by an amount equal to the taxpayer's federal, state, and local tax obligations.

⁴⁴ IRS Nationwide Tax Forum, Focus Groups on ACS (Las Vegas Forum, Aug. 20, 2008).

⁴⁵See IRM 5.19.1.6.3 (Apr. 28, 2008).

⁴⁶See id.

⁴⁷ IRS Policy Statement P-6-12 requires a final response to the taxpayer be initiated within 30 calendar days of the earliest IRS received date. If a final response cannot be initiated within 30 calendar days, an interim response will be initiated by the 30th calendar day from the IRS received date. ACSS 2008 Instructor Guide for Continuing Professional Education, Course 10341-201.

⁴⁸ IRS Nationwide Tax Forum, Focus Groups on ACS (Las Vegas Forum, Aug. 20, 2008). Tax professionals from the AICPA, the ABA, the NAEA, and LITCs met with TAS employees to discuss their concerns regarding ACS customer service issues (May 2008) and (Sept. 2008).

⁴⁹ IRS Nationwide Tax Forum, Focus Groups on ACS (Atlanta Forum, July 2008).

⁵⁰ IRS Nationwide Tax Forum, Focus Groups on ACS (Chicago Forum, July 2008).

⁵¹ For example, a tax professional needed to provide documentation to the ACS to support a request for a non-streamlined IA for more than one client. One ACS employee advised him he needed to submit two months of pay stubs while the other ACS employee advised him he needed six months of stubs. Tax professionals from the AICPA, the NAEA, and LITCs met with TAS employees to discuss their concerns with the ACS (May 2008); IRM 5.19.1-14 (Apr. 28, 2008) requires the taxpayer to submit the prior three months of wage statements. TAS employees, taxpayers, and tax professionals have also complained that the ACS rejects documentation that does not match its concept of how it should look. For example, a utility shutoff notice provided to substantiate a hardship was rejected by an ACS employee because it was a checkbox form and the ACS employee believed it was not authentic. Analysis and case examples provided by TAS Internal Technical Advisor Program technical advisors regarding ACS customer service issues (July 17, 2008). See IMRS 06-0000229 - Income Statements, at http://www.irs.gov/businessess/small/article/0,,id=168260,00.html -(last visited Dec. 19, 2008).

⁵² IRM 5.14.1.5 (July 12, 2005).

⁵³ IRM 5.19.1.5.4.2 (Apr. 28, 2008).

⁵⁴ IRM 5.14.1.5 (July 12, 2005).

⁵⁵ IRS, Taxpayer Delinquent Account Cumulative Report, NO-5000-2 (Sept. 30, 2008); IRS, Installment Agreement Cumulative Report, NO-5000-6 (Sept. 30, 2008).

⁵⁶ Louis Uchitelle, Pain Spreads as Credit Vise Grows Tighter, New York Times (Sept. 19, 2008); David Ellis, The Credit Crunch: Loans Out of Reach, CNNMoney.com (Sept. 25, 2008).

⁵⁷ Of the respondents for the ACS Customer Satisfaction Surveys, practitioners accounted for nine percent for SB/SE and three percent for W&I. IRS, Customer Satisfaction Survey, ACS, SB/SE National Report, April through June 2008 (Aug. 2008); IRS, Customer Satisfaction Survey, ACS, W&I National Report, April through June 2008 (Aug. 2008). W&I has informed the National Taxpayer Advocate that it is pursuing the development of a tax practitioner survey as part of its ACS customer satisfaction surveys. IRS, Seven-Day Comments to Most Serious Problem, Customer Service Issues in the IRS's Automated Collection System (Nov. 10, 2008).

⁵⁸ ACS's inventory was 1,568,674 for W&I and 935,410 for SB/SE. See Footnote 1, supra. IRS, Collection Activity Report, NO-5000-2, Taxpayer Delinquent Account Cumulative Report (Sept. 2008).

⁵⁹ IRS, Customer Satisfaction Survey ACS, SB/SE, October through December 2007 (Feb. 2008); IRS, Customer Satisfaction Survey, ACS, W&I, October through December 2007 (Feb. 2008).

⁶⁰ IRM 5.19.1.6.3. The IRM procedure regarding the number of fax pages provides guidance to our employees to ensure all taxpayers receive prompt service without experiencing lengthy delays while on the phone. The IRM instructions generally limit the number of faxed pages; however, the IRM removes the limit for special situations, including hardship.

⁶¹ IRM 5.19.1.5.4.2 (Nov. 19, 2008).

• As early as 2004, the tax gap¹ attributable to small businesses doing business over the Internet was estimated to be as high as $1 billion per year and rising.²

• According to one poll, 38 percent of American adults play computer or console games, and among those, 44 percent play games over the Internet.³

• Over 16 million people are estimated to have active subscriptions to Internet-based multiplayer environments called "virtual worlds,"⁴ many of which have their own economies and currencies.⁵

• As early as 2001, an economist estimated that time spent by "players" in one of the many virtual worlds generated about $3.42 per hour, which represented a gross national product (GNP) of about $135 million and a per capita GNP of about $2,266 - roughly equivalent to Russia and higher than in many developing countries.⁶

• In 2005, about one billion real dollars changed hands in virtual worlds.⁷

• In 2006, about 3,100 "residents" of one of the smaller virtual worlds, called "Second Life," who generated a net profit in virtual transactions had average revenues of $20,000 in real U.S. dollars.⁸

• Some businesses now accept virtual dollars in exchange for real property or services.⁹

• Second Life charges a value added tax (VAT) on certain transactions between European Union residents and Second Life.¹⁰

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Clarissa Potter, Acting Chief Counsel

Definition of Problem

A "virtual world" is a computer-based simulated environment, which allows multiple users to interact using graphical representations of themselves (called "avatars"), typically over the Internet. Economic activities associated with virtual worlds may present an emerging area of noncompliance, in part, because the IRS has not issued guidance about whether and how taxpayers should report such activities.¹¹ To proactively address the tax gap and improve voluntary compliance, when the IRS learns of an emerging economic activity that receives no clear tax treatment under existing guidance, it should quickly promulgate clear rules and enforce them consistently.

The remainder of this discussion illustrates some of the confusion taxpayers may face in reporting economic activities associated with virtual worlds. However, the broader challenge for the IRS is to identify any emerging economic activities with tax implications that taxpayers, especially unsophisticated ones, are likely to misreport without additional guidance, and to issue clarifying guidance quickly.

Analysis of Problem

One category of virtual world, exemplified by the World of Warcraft (WoW), is game-like, has defined objectives, and a significant amount of operator-developed content. WoW describes itself as follows:

Even if virtual property and avatars are not determined to be "property" under state law, they are valuable and can be sold for real dollars or in-world currencies, which can often be converted into real dollars. For example, in early 2008 a person could sell 1,000 WoW gold pieces for between $12 and $22 (an exchange rate of between 83.33 and 45.45 gold pieces per U.S. dollar).²⁰ A person could also sell 1,000 Linden Dollars on an in-world currency exchange for about $3.75 (an exchange rate of 266 Linden Dollars per U.S. dollar).²¹

Taxpayers have a similar duty to report any prizes or awards in excess of $600.³⁹ Virtual world operators may also be concerned that if the virtual property "paid" to participants in virtual worlds is sufficiently analogous to taxable prizes (e.g., a prize for completing a quest), then the IRS could assert the operators need to report the prizes on information returns. In such cases, the virtual world operator might also be required to withhold against the prize if the player was either a foreign person or failed to provide a tax identification number.⁴⁰ Such withholding would be difficult since the prize -- the virtual property -- is not paid in cash.

However, many taxpayers may not be certain that virtual worlds are analogous enough to barter exchanges or that virtual currency is sufficiently analogous to prizes to be subject to such rules, at least before a taxpayer cashes out his or her virtual items for real dollars. Pursuant to various technical rules, tax is often deferred until after an item is transferred for value, as further described below.⁴¹

Although some virtual property is relatively easy to value because it is listed for sale on virtual property auction websites, other virtual property is not so easy to value. Some virtual property is not transferable under the TOS. Moreover, all virtual property is arguably subject to forfeiture at the discretion of the virtual world operator. The virtual world operator could cancel the taxpayer's account, shut down the virtual world, or change the world in a way that eliminates the value of the virtual item. Thus, a taxpayer may wonder if such contingencies make the in-world acquisition and sale or exchange of virtual property nontaxable.

Some people are likely to conclude that if the rules are so complicated that the IRS cannot even figure them out, it is unreasonable for the government to expect taxpayers to do so.⁵⁹ They might also use such reasoning to justify noncompliance in other areas. Moreover, our system of voluntary compliance will break down if it demands that taxpayers report income that is impossible to report, pay tax on "virtual" income that cannot be used to pay real taxes, or makes taxpayers feel like "chumps" if, perhaps mistakenly, they do pay tax on such virtual income.⁶⁰ Thus, promulgating guidance would likely promote voluntary compliance even if it exempts in-world transactions from tax.⁶¹

To its credit, the IRS has recently identified a number of issues presented by Internet auctions of virtual property and other aspects of virtual worlds.⁶² However, the IRS should consider doing more to help taxpayers comply with their tax obligations by quickly issuing guidance addressing how to report economic activities in virtual worlds, as well as in other emerging areas of economic activity.⁶³

IRS Comments

The IRS recognizes the need to address the tax aspects of new e-business activities. For example, the IRS formed the E-Business and Emerging Issues (EBEI) policy group in 2003 to address emerging issues resulting from the growth and expansion of business activities, advances in computer technology, and new developments in the use of e-business technology. This technology includes the advent of Internet-based "virtual world" games that may involve a "virtual economy" for game participants.

The EBEI group has partnered with IRS business units to provide a consistent strategy to address e-business tax issues. The IRS is engaged in the identification of tax issues resulting from new Internet-related activities and recommendation of appropriate strategies to address those issues. Such strategies include internal and external communications such as issuance of interim guidance memoranda, updates to the Internal Revenue Manual (IRM), IRS publications, and website postings.⁶⁴ We also had specific workforce training, research projects, proposals for published guidance, and IRS compliance initiative projects.

The IRS has issued guidance in the past on other activities that raise similar issues to those of "virtual world" game activities.⁶⁵ For example, guidance related to online auctions, bartering, and electronic businesses states that if a taxpayer spends more money on an activity than received, the taxpayer cannot claim a loss on an income tax return. If a taxpayer receives more money from an activity than spent, then the taxpayer may be required to report taxable income. This guidance should be helpful in assisting taxpayers who have questions about the tax consequences of their online "virtual world" game activities.

The IRS will continue to prioritize our guidance to meet taxpayer needs. Virtual world e-business issues and implementation of communication and compliance strategies will continue to be addressed through the EBEI policy group.

Taxpayer Advocate Service Comments

While the National Taxpayer Advocate is pleased the IRS has formed an E-Business and Emerging Issues policy group, provided guidance, and initiated training, research projects, and compliance initiative projects, she finds the IRS comments largely unresponsive to the concerns outlined above. The IRS guidance on barter, online auction sellers, gambling income, found property, etc. described in the IRS comments is helpful. However, this guidance mostly restates existing rules, addressing the relatively easy questions for which clear answers already exist.⁶⁶

As the tax administrator, the IRS has a duty to answer all of the basic questions about transactions undertaken regularly by significant numbers of taxpayers, such as those involving virtual items (described above), especially if the questions are difficult for taxpayers to answer on their own.⁶⁷ It may be unfair to expect the IRS to answer these questions before state property and contract laws have evolved far enough to provide clear guidance about when a transfer of virtual items is a transfer of property rights. These very difficulties, however, support the conclusion that the IRS should issue guidance. If the tax experts at the IRS cannot figure out what the rules are or should be, unsophisticated taxpayers who participate in the virtual economy have little hope of doing so. The IRS could at least make an administrative pronouncement about how taxpayers should treat these transactions in the interim as it studies the issue and the state law rules evolve.

More broadly, the IRS needs to produce specific early guidance on difficult issues confronted by taxpayers on a regular basis in emerging areas of economic activity. Otherwise, it risks turning these taxpayers into unintentional tax cheats, establishing noncompliance norms in the industry, and leaving IRS employees without clear guidance about how to do their jobs.

Recommendations

The National Taxpayer Advocate recommends the IRS:

² Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2005-30-010, The Internal Revenue Service Is Making Progress in Addressing Compliance Among Small Businesses Engaged in Electronic Commerce (Nov. 2004).

³ The Associated Press/America Online Poll, Gaming Study, Conducted by IPSOS Public Affairs, Project No. 81-5139-64, at http://surveys.ap.org/data/Ipsos/national/2007-10-22%20Gaming%20Study.pdf (Nov. 12, 2007).

⁴ A "virtual world," described in greater detail below, is a computer-based simulated environment, which allows multiple users to interact using graphical representations of themselves (called "avatars"), typically over the Internet.

⁵See Bruce Sterling Woodcock, Total MMOG Active Subscriptions, Version 22.0, at http://www.mmogchart.com/Chart4.html (Feb. 12, 2008).

⁶See Edward Castronova, Virtual Worlds: A First-Hand Account of Market and Society on the Cyberian Frontier, CESifo Working Paper No. 618, 33, at http://papers.ssrn.com/abstract=294828 (Dec. 2001).

⁷ Heather M. Rothman, As Congress Considers Online Game Taxes, Linden Lab Contends Law Already Clear, 210 DTR G-2 (Oct. 31, 2006).

⁸ Robert D. Hof, My Virtual Life, Business Week, at http://www.businessweek.com/print/magazine/content/06_18/b3982001.htm?chan=g1 (May 1, 2006). According to Second Life, about 531 unique users had positive monthly in-world cash flow worth more than $2,000 in the month of April 2008. See Second Life, Economic Statistics http://secondlife.com/whatis/economy_stats.php (last visited May 12, 2008). Although still one of the smaller worlds, Second Life was recently estimated to have 93,219 "active subscriptions" and more than 12 million "registered users," the vast majority of whom are in the United States. See Bruce Sterling Woodcock, Total MMOG Active Subscriptions, Version 22.0, at http://www.mmogchart.com/Subscriptions.xls (Feb. 12, 2008) (showing active subscriptions on sheet 4); Robin Sidel, Cheer Up, Ben: Your Economy Isn't As Bad as This One, Wall Street Journal, page A1, Jan. 23, 2008 (reporting registered users).

⁹See Fistpitch, Pizza Enters the Virtual World of Second Life, at http://www.fastpitchnetworking.com/pressrelease.cfm?PRID=8734 (Apr. 21, 2007).

¹⁰See Second Life, Value Added Tax, at http://secondlife.com/corporate/vat.php (last visited May 12, 2008).

¹¹ Heather M. Rothman, As Congress Considers Online Game Taxes, Linden Lab Contends Law Already Clear, 210 DTR G-2 (Oct. 31, 2006) (quoting an IRS spokesman as acknowledging that "we have recognized it as an emerging area of noncompliance.").

¹² Some virtual worlds generate income primarily from advertising revenue.

¹³ Because virtual worlds were first developed as games, they are sometimes called "massive multiplayer online games" or "MMOGs."

¹⁴See http://www.worldofwarcraft.com/info/basics/guide.html (last visited May 12, 2008).

¹⁵See http://secondlife.com/whatis/ (last visited May 12, 2008).

¹⁶See, e.g., Chris Taylor, Google Moves into Virtual Worlds, by Combining Satellite Maps and 3-D Software, Google Earth Is Turning into a Virtual Online Playground, CNNMoney.com, at http://money.cnn.com/2006/05/11/technology/business2_futureboy_0511/ (Dec. 14, 2006); Tom Smith, Google's Virtual World Could Be Business Answer To Second Life, the Information Week, at http://www.informationweek.com/blog/main/archives/2007/09/googles_virtual. html (Sept. 25, 2007).

¹⁷ Linden Labs, the operator of Second Life, recently banned gambling and unlicensed banking activities. See, e.g., Eric Reuters, UPDATE 3 - Linden Bans Second Life Banks, Reuters Second Life News Center, at http://secondlife.reuters.com/stories/2008/01/08/breaking-linden-bans-second-life-banks/(Jan. 8, 2008).

¹⁸ For example, WoW's TOS provides:

¹⁹See, e.g., Joshua Fairfield, Virtual Property, Indiana Law No. 50, at http://ssrn.com/abstract=807966 (Oct. 2005); Erez Reuveni, On Virtual Worlds: Copyrights and Contract Law at the Dawn of the Virtual Age, 82 Ind. L.J. 261, 290-294 (2007) (discussing various arguments that could result in virtual property rights, notwithstanding the terms of the EULA or TOS). When Linden Labs exercised its right to deny a person access to virtual property, a court found the TOS arbitration clause to be unenforceable. See Bragg v. Linden Research, Inc., 487 F. Supp. 2d 593 (E.D. Pa. 2007).

²⁰See, e.g., http://www.mmopawn.com/sell-1.html (last visited Feb. 28, 2008). The actual price may depend on supply and demand conditions on the particular server hosting the part of the virtual world where the transaction will take place as well as the number of WoW gold pieces you are attempting to sell. An online chat on February 28, 2008, revealed that www.mmopawn.com would have paid $14 for 1,000 WoW gold pieces on the "Aegwynn US - A" server.

²¹See http://secondlife.com/whatis/economy-market.php (last visited Mar. 5, 2008).

²²See Edward Castronova, Virtual Worlds: A First-Hand Account of Market and Society on the Cyberian Frontier, CESifo Working Paper No. 618, 33, at http://papers.ssrn.com/abstract=294828 (Dec. 2001).

²³ Eli Shayotovich, Taxing Virtual Earnings - Seriously, at http://www.businessweek.com/print/innovate/content/may2006/id20060502_832540.htm (May 2, 2006).

²⁴See Daniel Terdiman, Big-shot Economist to Advise Teen Virtual World, CNET News.com, Sept. 17, 2007. See also http://acs.anshechung.com/ (last visited May 12, 2008).

²⁵ Robert D. Hof, My Virtual Life, Business Week, at http://www.businessweek.com/print/magazine/content/06_18/b3982001.htm?chan=g1 (May 1, 2006).

²⁶See www.secondlife.com; Second Life, Brand Promotion, at http://secondlifegrid.net/how/brand_promotion (last visited Mar. 10, 2008). See also, Tim Beyers, IRS to Tax Your Second Life? The Motley Fool, at http://www.fool.com/server/printarticle.aspx?file=/investing/high-growth/2006/10/16/irs-to-taxyour-second-life.aspx?terms=IRS%20to%20Tax%20Your%20Second%20Life (Oct. 16, 2006). H&R Block has started to offer tax advice in Second Life and is accepting Linden Dollars in exchange for a new tax preparation product. See H&R Block Launches First Virtual Tax Experience in Second Life, at http://www.hrblock.com/presscenter/articles/secondrelease.jsp (last visited Mar. 10, 2008). It is also paying "residents" in Linden Dollars for helping to market its product on their own virtual property. Id. Even the IRS has studied the utility of virtual worlds as a communication and training tool, concluding the IRS could use them to recruit new employees and provide taxpayer service, for example, through "Virtual Tax Days" where the IRS answers tax questions inside a virtual world. Wage and Investment, Strategy and Finance, Program Evaluation and Risk Analysis (PERA), Virtual Worlds, Project No. 7-03-16-2-024 (Apr. 2003).

²⁷ American Cancer Society, Second Life Relay for Life, at http://www.cancer.org/docroot/GI/content/GI_1_8_Second_Life_Relay.asp (last visited May 12, 2008) and Second Life, Philanthropy and Fundraising, at http://secondlifegrid.net/how/philanthropy_and_fundraising (last visited Mar. 10, 2008).

²⁸ The European Union subjects Second Life transactions between the operator and EU residents to VAT taxes. See Second Life, Value Added Tax, at http://secondlife.com/corporate/vat.php (last visited Mar. 10, 2008).

²⁹See, e.g., Morgan v. Comm'r, 309 U.S. 78, 80 (1940) ("State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed."). The EULA or TOS typically provides that a specific jurisdiction's laws will apply. For example, the Second Life TOS provides: "This Agreement and the relationship between you and Linden Lab shall be governed in all respects by the laws of the State of California without regard to conflict of law principles or the United Nations Convention on the International Sale of Goods." Second Life, TOS § 7.1, at http://secondlife.com/corporate/tos.php (last visited May 12, 2008).

³⁰See, e.g., Joshua Fairfield, Virtual Property, Indiana Law No. 50, at http://ssrn.com/abstract=807966 (Oct. 2005); Erez Reuveni, On Virtual Worlds: Copyrights and Contract Law at the Dawn of the Virtual Age, 82 Ind. L.J. 261, 290-294 (2007) (discussing various arguments that could result in virtual property rights, notwithstanding the terms of the EULA or TOS). As noted above, when Linden Labs exercised its right to deny a person access to virtual property, a court found the TOS arbitration clause to be unenforceable. See Bragg v. Linden Research, Inc., 487 F. Supp. 2d 593 (E.D. Pa. 2007).

³¹ At least for foreign persons, there is also a question about whether the person may be subject to tax in the United States, especially if the server is located in the United States. See generally, Richard L. Reinhold, Some Things That Multilateral Tax Treaties Might Usefully Do, 57 TAXL 661 (Spring 2004) (discussing the role of server location in determining if a corporation has a "permanent establishment" in the U.S.); Richard L. Doernberg, Electronic Commerce: Changing Income Tax Treaty Principles A Bit?, 89 Tax Notes 1625 (Dec. 18, 2000) (same). In addition, the location of the parties and the computer server may affect a state's authority to require the parties to an online-transaction to collect or pay sales or use tax. See, e.g., Paula K. Royalty, Tax Implications of Using Out-of-State Computer Servers, 1 Shidler L.J. Com. & Tech. 5 (Feb. 2, 2005).

³² IRC § 61 (defining gross income). Some taxpayers are not even aware that Internet transactions are subject to tax. The press surrounding the "Internet Tax Moratorium," which temporarily prohibits local governments from levying taxes on Internet connections may contribute to this misperception. See, e.g., Internet Tax Freedom Act Amendments Act of 2007, Pub. L. No. 110-108, 121 Stat. 1024 (Oct. 31, 2007).

³³Comm'r. v. Glenshaw Glass Co., 348 U.S. 426 (1955). Cottage Sav. Ass'n v. Comm'r, 499 U.S. 554 (1991) further clarified that the exchange of substantially similar mortgages gave rise to "realization" under IRC § 1001 of any gain or loss because the mortgages embodied "legally distinct entitlements." Thus, some may conclude that the exchange of one virtual item for another or for virtual currency triggers a "realization," which they may also conclude is taxable in the absence of a clearly applicable nonrecognition provision.

³⁴See, e.g., IRC § 74 (including in income prizes and awards); IRC § 83 (including in income property transferred in connection with the performance of services); Treas. Reg. § 1.61-14(a) (noting: "Illegal gains constitute gross income. Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession"); Rev. Rul. 80-52, 1980-1 C.B. 100 (noting members of a barter club had income from services in "the taxable year in which the [barter] credit units are credited to their accounts"); Cesarini v. U.S., 428 F.2d 812 (6th Cir. 1970) (holding that cash discovered inside a piano purchased at auction is gross income in the year of the discovery).

³⁵See, e.g., Rev. Rul. 80-52, 1980-1 C.B. 100.

³⁶See generally Treas. Reg. §§ 1.6045-1(a)(4); 1.6045-1(e), 1.6045-1(f); IRS Publication 525, Taxable and Nontaxable Income (2007). The barter exchange regulations notably tax the receipt of barter exchange credits or scrip at its face value (unless the Commissioner determines another value), even though pursuant to the regulations, "property does not include a credit or scrip." Treas. Reg. § 1.6045-1(f)(5)(iii).

³⁷ Notice 2000-6, 2000-1 C.B. 315 (providing a de minimis $1 exception).

³⁸See Dustin Stamper, Taxing Ones and Zeros: Can the IRS Ignore Virtual Economies?, 114 Tax Notes 149 (Jan. 15, 2007) (reporting that Professor Bryan Camp and Tim McDowel, executive director of the National Association of Trade Exchanges, both indicated that virtual world operators could be subject to the barter exchange reporting requirements).

³⁹ IRC §§ 6041(a), 6041(d); IRC § 6041A(a), 6041A(e); Instructions for Form 1099-MISC (2008) (box 7); Instructions to Form W-2 G (2008). Although "brokers" are subject to similar information reporting rules under IRC § 6045, Internet auction sites such as eBay contend they are not brokers. See, e.g., E-mail from Margaret M. Richardson to Eric Soloman and Michael Desmond (Apr. 16, 2007), reprinted as, Margaret M. Richardson, Individual Comments on Third-Party Information Reporting for Online Commerce, 2007 TNT 80-24 (Apr. 25, 2007).

⁴⁰See generally IRC §§ 3406(a)(1), 3406(h)(2), 1441(a), 1442(a).

⁴¹ For a detailed discussion of why certain income is not taxed, see generally, Lawrence Zenenak and Martin McMahon, Professors Look at Taxing Baseballs and Other Found Property, 84 Tax Notes 1299 (Aug. 30, 1999); Joseph M. Dodge, Accessions to Wealth, Realization of Gross Income, and Dominion and Control: Applying the "Claim of Right Doctrine" to Found Objects, Including Record-Setting Baseballs, 4 Fla. Tax. Rev. 685 (2000); Bryan T. Camp, The Play's the Thing: A Theory of Taxing Virtual Worlds, 59 Hastings L. J. 1 (Nov. 2007); Leandra Lederman, "Stranger than Fiction:" Taxing Virtual Worlds, 82 NYU L. Rev. 1620 (Mar. 2007).

⁴²See Morris v. Comm'r, 9 B.T.A. 1273, 1277-1278 (1928), acq., C.B. VII-2, 28 (1928); Tatum v. Comm'r, 46 T.C. 736, 739 (1966), aff'd, 400 F.2d 242 (5th Cir. 1968) (describing crops as representing an "unrealized appreciation" ); Strong v. Comm'r, 91 T.C. 627 (explaining the general rule). See also Rev. Rul. 56-496; 1956-2 C.B. 17; IRC § 631; Treas. Reg. § 1.631-1(d) and (e). Scholars have distinguished a farmer's harvest, a fisherman's catch, and a miner's diamonds, which a person sets out to obtain with the investment of labor or capital, from similar items that a taxpayer may find unexpectedly. See Joseph M. Dodge, Accessions to Wealth, Realization of Gross Income, and Dominion and Control: Applying the "Claim of Right Doctrine" to Found Objects, Including Record-Setting Baseballs, 4 Fla. Tax. Rev. 685, 696-697 (2000) (observing that no similar deferral applies to income from found items, which are generally taxable upon receipt).

⁴³See generally Burnet v. Logan, 283 U.S. 404, 51 S. Ct. 550 (1931).

⁴⁴See, e.g., Rev. Rul. 58-402, 1958-2 C.B. 15; In re Steen, 509 F.2d 1398, 1403-1405 (9th Cir. 1975); Treas. Reg. § 1.1001-1(g)(2).

⁴⁵See Treas. Reg. § 1.83-7.

⁴⁶See IRC § 83(a); Treas. Reg. § 1.83-1.

⁴⁷ The tax treatment of transactions on Second Life could differ from the treatment of transactions on other virtual worlds because according to the TOS Second Life Residents retain certain intellectual property rights to their virtual creations. Second Life, TOS § 3, at http://secondlife.com/corporate/tos.php (last visited May 12, 2008).

⁴⁸See Leandra Lederman, "Stranger than Fiction:" Taxing Virtual Worlds, 82 NYU L. Rev. 1620, 1654 (Mar. 2007).

⁴⁹See Rev. Proc. 77-29, 1977-2 C.B. 538 (suggesting that to properly substantiate gains and losses in "table games," which are typically played using chips, a taxpayer should record the gambling results at a given table rather than after each hand). See also Zarin v. Commissioner, 916 F.2d 110, 114 (3rd Cir. 1990) (holding, in part, that casino chips were not "property" in the hands of a gambler, but rather "nothing more than an accounting mechanism . . . designed to facilitate gambling in casinos where the use of actual money was forbidden"). But see PLR 200532025 (May 3, 2005) (concluding an online gaming site operator must report online credits to a taxpayer's gaming account, where the credits performed the same function as casino chips even if the taxpayer had not exchanged the credits for cash or property).

⁵⁰Compare Ann. 2002-18, 2002-1 C.B. 621 (declaring "[T]he IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel. . . . The relief provided by this announcement does not apply to travel or other promotional benefits that are converted to cash") with Dominic L. Daher, The Proposed Federal Taxation of Frequent Flyer Miles Received from Employers: Good Tax Policy But Bad Politics, 16 Akron Tax J. 1 (2001) (suggesting that the receipt of frequent flyer miles is taxable under current law and that the IRS's announcement was the result of political pressure).

⁵¹Compare IR-98-56 (Sept. 8, 1998) with Darren Heil, The Tax Implications of Catching Mark McGwire's 62nd Home Run Ball, 52 Tax. Law 871 (Summer 1999) (arguing that a taxpayer should be taxed even if he or she returns the ball because he or she exercises dominion and control over it and suggesting that because the IRS's press release was the product of political pressure it may not reflect the correct interpretation of existing law).

⁵²See, e.g., Heather M. Rothman, Tax Policy: As Congress Considers Online Game Taxes, Linden Lab Contends Law Already Clear, 210 DTR G-2 (Oct. 31, 2006).

⁵³ Commentators have pointed out a number of policy arguments for and against the taxation of in-world transactions. See, e.g., Bryan T. Camp, The Play's the Thing: A Theory of Taxing Virtual Worlds, 59 Hastings L. J. 1, 44-71 (Nov. 2007); Leandra Lederman, "Stranger than Fiction:" Taxing Virtual Worlds, 82 NYU L. Rev. 1620, 1641-1672 (Mar. 2007); Steven Chung, Real Taxation of Virtual Commerce: Has Second Life Crossed the Line?, Spring 2007 (unpublished manuscript, on file with Hastings LJ). However, our discussion is limited to administrative considerations.

⁵⁴ Second Life, Economic Statistics, at http://secondlife.com/whatis/economy_stats.php (last visited Mar. 10, 2008).

⁵⁵ Second Life, LindeX Market Data, at http://secondlife.com/whatis/economy-market.php (last visited Mar. 10, 2008).

⁵⁶ For example, there is no currency exchange for WoW gold. Different Internet vendors buy and sell WoW gold at different rates which are not always publicly disclosed. The value of WoW gold depends on the size of the transaction and its location (e.g., the server on which it is located).

⁵⁷ The greatest expense associated with a private letter ruling request is likely to be the cost of hiring a tax practitioner to submit the request. However, the IRS's fee for a private letter ruling is: $625 for taxpayers with gross income less than $250,000, $2,100 for those with gross income between $250,000 and $1 million, and $11,500 for those with gross income of $1 million or more. Rev. Proc. 2008-1, 2008-1 I.R.B. 1. For a discussion of the IRS's difficulty in evaluating the impact of potential user fees on its ability to achieve its mission, see National Taxpayer Advocate 2007 Annual Report to Congress 66 (Most Serious Problem, IRS User Fees: Taxpayer Service for Sale).

⁵⁸See Julian Dibbell, Play Money, or, How I Quit My Day Job and Made Millions Trading Virtual Loot, 303-311 (2006) (describing discussions with one IRS employee at a Taxpayer Assistance Center and his conclusion that in-game transactions involving virtual property are not taxable, and a follow up call to an IRS business assistance line where the IRS employee expressed the opinion that such transactions are taxable, but recommended that the taxpayer obtain a private letter ruling, for a fee, to get a more authoritative answer).

⁵⁹See generally David J. Mack, ITAX: An Analysis of the Laws and Policies Behind the Taxation of Property Transactions in a Virtual World, 60 Admin. L. Rev. 749, 759 (Summer 2008) (urging the IRS to issue guidance on the taxation of virtual transactions, in part, to avoid creating "a society of unintentional tax cheats").

⁶⁰ Imposing unreasonable recordkeeping burdens on taxpayers, as taxing in-world transactions might do, has long been thought to decrease voluntary compliance. See, e.g., Deborah H. Schenk, Simplification for Individual Taxpayers: Problems and Proposals, 45 Tax L. Rev. 121, 166-67 (1989).

⁶¹ Some commentators have suggested that from a tax policy perspective in-world transactions in Second Life should be subject to tax, but in-world transactions in other worlds should not. See, e.g., Leandra Lederman, "Stranger than Fiction:" Taxing Virtual Worlds, 82 NYU L. Rev. 1620, 1625 (Mar. 2007) (concluding "transactions in game worlds, such as WoW, should not be taxed unless the player engages in a real-market trade (a cash-out rule) . . . [and] that in intentionally commodified virtual worlds, such as Second Life, federal income tax law and policy counsel that in-world sales of virtual items be taxed"); and Steven Chung, Real Taxation of virtual Commerce: Has Second Life Crossed the Line? 14, 20 (Spring 2007) (unpublished manuscript, on file with Hastings LJ) (concluding that "imposing a taxable event at the in-world level would be fairer, would not create excess burdens and is not complex" but later clarifying "this article does not advocate taxing in-world transactions within Second Life").

⁶² SB/SE Examination Policy, Reporting Compliance, Internet Online Gaming an E-Business & Emerging Issues (DRAFT) Discussion Paper on the Compliance Impact of Internet Online Gaming (May 2007). As early as 2004, the IRS conducted a Compliance Initiative Project to address noncompliance by Internet auction sellers. SB/SE Reporting Compliance, Compliance Improvement Project, Internet Auction Sellers & Auction Brokers (Feb. 25, 2004). By contrast, according to SB/SE Compliance it "has not identified any known examinations involving Internet Online Gaming and the sale of virtual game items." SB/SE Examination Policy, Reporting Compliance, Internet Online Gaming an E-Business & Emerging Issues (DRAFT) Discussion Paper on the Compliance Impact of Internet Online Gaming 4 (May 2007).

⁶³ TIGTA also recently found that the IRS could improve the accountability of its guidance process. See TIGTA, Ref. No. 2008-10-075, The Published Guidance Program Needs Additional Controls to Minimize Risks and Increase Public Awareness (Mar. 4, 2008).

⁶⁴ Communications include: IRS, Retail Industry ATG - Chapter 3: Examination Techniques for Specific Industries (Electronic Business, Online Retail), at http://www.irs.gov/businesses/small/article/0,,id=141491,00.html (Aug. 2005); IRS, Online Auction Sellers, at http://www.irs.gov/businesses/small/industries/article/0,,id=163622,00.html (last visited Dec. 8, 2008); IRS, Bartering Income, at http://www.irs.gov/businesses/small/article/0,,id=187904,00.html (last visited Dec. 8, 2008); IRS, Electronic Business, at http://www.irs.gov/businesses/small/article/0,,id=108188,00.html (last visited Dec. 8, 2008); IRS, Tax Responsibilities of Bartering Participants, at http://www.irs.gov/businesses/small/article/0,,id=188095,00.html (last visited Dec. 8, 2008).

⁶⁵ Guidance includes: IRS, Tax Tip 2008-02, Gambling Winnings and Losses, at http://www.irs.gov/newsroom/article/0,,id=172190,00.html (last visited Dec. 8, 2008); IRS, Tax Topic 419, Gambling Income and Expenses, at http://www.irs.gov/taxtopics/tc419.html (last visited Dec. 8,. 2008); Transcript for Business or Hobby, at http://www.irs.gov/businesses/small/article/0,,id=187331,00.html; IRS Pub. 525, Taxable and Nontaxable Income, at http://www. irs.gov/pub/irs-pdf/p525.pdf (2007) (analogous to gambling, found property, prizes & awards, bartering, hobbies, etc.).

⁶⁶ For one of the most recent suggestions by a commentator regarding how the IRS could answer some of the difficult questions, see Theodore P. Seto, When is a Game Only a Game?: The Taxation of Virtual Worlds, Loyola-LA Legal Studies Paper No. 2008-24, at http://ssrn.com/abstract=1220923 (Aug., 12 2008).

⁶⁷ The South Korea and Swedish tax agencies have issued some guidance in this area. See, e.g., Flora Graham, Slapping a Tax on Playtime, BBC News, at http://news.bbc.co.uk/2/hi/technology/7746094.stm (Nov. 25, 2008). Although the Swedish pronouncement was not promulgated in English, it reportedly stated that "in-game transactions may incur liability for both value-added tax as well as income tax under Swedish law." Vili Lehdonvirta, Sweden Moves to Tax In-Game Transactions, Virtual Economy Research Network, at http://virtual-economy.org/blog/sweden_moves_tax_-game_transactions (Apr. 16, 2008).

Richard E. Byrd, Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

The IRS Restructuring and Reform Act of 1998 refocused the IRS mission from enforcement to a "greater emphasis on serving the public and meeting taxpayers' needs."¹ Current law provides for "simple and nontechnical" processes and procedures for examining, or auditing, taxpayers' returns.² The Internal Revenue Manual (IRM) and IRS publications provide opportunities for the IRS to meet taxpayer needs and preferences throughout the examination process.³ These needs and preferences may vary from choosing a method for conducting an examination (face-to-face versus correspondence) to requesting a telephone discussion of an audit issue with the examiner, and even include setting up a payment agreement for any taxes owed as a result of the audit. The IRS often fails to meet taxpayer needs and preferences due to limited resources or policy reasons. The resulting unsuitability of the process deviates from the IRS's commitment to provide "top quality" taxpayer service and can lead to taxpayer complaints and tax controversies.⁴

Because the IRS does not consistently meet taxpayer needs and preferences, the tax assessed sometimes reflects the taxpayer's inability to navigate the audit process rather than the amount truly owed. This is evidenced by the following disparities in audit and customer satisfaction results:

• Taxpayers audited in an office setting experience lower assessments and higher agreement rates;⁵

• Taxpayers audited by correspondence are more likely to be subject to repetitive audits;⁶ and

• Taxpayers who are able to discuss their correspondence audit by telephone with their tax examiner express very favorable comments.⁷

Analysis of Problem

The IRS audit program relies on one-on-one examination contact with a taxpayer and includes three types of examinations: correspondence examinations, examinations conducted in IRS offices, and field examinations typically held in a taxpayer's home or place of business.¹⁷ These examinations range from a mailed notice asking for clarification of a single tax return item to a full, face-to-face interview and review of the taxpayer's records.

The number of individual income tax returns examined has continuously increased since 2000.¹⁸ During fiscal year (FY) 2000, the IRS audited 617,765 such returns. By FY 2007, this figure more than doubled, with the IRS examining 1,384,563 individual returns. Examinations completed by correspondence accounted for 83 percent of all individual taxpayer audits,¹⁹ and IRS campus offices conducted slightly more than 71 percent of the correspondence examinations.²⁰

For FY 2009, the IRS plans to maintain the current level of correspondence examinations by initiating 1,122,554 individual audits.²⁵ Taxpayers contacted by the IRS regarding a math error notice, AUR, or SFR inquiry could still face an audit for the very year in question because the IRS does not consider these other programs to be examinations.²⁶

The General Accounting Office (GAO, now the Government Accountability Office) expressed concern about the suitability and volume of correspondence audits in a 1999 study.²⁷ The GAO found more than 50 percent of the taxpayers audited by correspondence did not respond to the IRS's letters. When asked why, the IRS indicated it had not studied the issue but speculated taxpayers may be overwhelmed or intimidated by the letters and may not be comfortable with responding; some may not understand the letters or know how to respond; and others may know they owe additional tax but hope their non-responsiveness discourages the IRS from trying to collect the tax.²⁸

More than 70 percent of the Earned Income Tax Credit (EITC) taxpayers surveyed for a TAS Research study indicated that, if given a choice, they would prefer to conduct their examinations in person, rather than through correspondence.²⁹ Perhaps most notably, more than 25 percent of the respondents indicated they were not even aware the IRS was auditing their returns.³⁰ The National Taxpayer Advocate is concerned about the suitability of these audits for correspondence examinations.³¹

This approach is similar to the National Taxpayer Advocate's view of taxation as a social contract between the government and its taxpayers, with attendant rights and responsibilities on each party to that contract.³⁶ Taxpayer behavior and motivations play a vital role in determining individual taxpayer compliance.³⁷ If the IRS fails to recognize this process, it risks turning compliant taxpayers into noncompliant ones.³⁸

According to the TIGTA report, easy phone access to the IRS helps resolve cases and issues. TAS-moderated practitioner focus groups showed that, while practitioners had difficulty contacting IRS auditors, they often successfully resolved outstanding issues after a telephone conversation with the auditor familiar with the case.⁴³ To address accessibility issues highlighted in the report and in customer satisfaction surveys, the IRS plans to switch to a universal call routing system that will automatically direct a call to the first available examination employee. While this change might meet the taxpayer's need to discuss a correspondence audit with an examiner, it does not address the taxpayer's preference and possible need to speak to someone familiar with his or her particular case.

A face-to-face audit may not be necessary if the IRS assigns the examination to one tax examiner with whom the taxpayer establishes a relationship. Through personalized, one-on-one communications, the examiner gains familiarity with the taxpayer's particular circumstances, while the taxpayer can share concerns and address any questions. Data compiled by the Pacific Consulting Group for SB/SE Correspondence Examination reflects very favorable results and comments from taxpayers who are able to contact their assigned correspondence examiner, make a personal connection, and discuss their case in detail.⁴⁴

Verbatim comments such as, "I was impressed by how friendly and courteous the IRS employees were. The representative I spoke with was very friendly and understanding of my circumstance. She was helpful and knowledgeable and understood that these matters can be confusing for the taxpayer such as myself," and, "The woman who handled my case was a delight to work with. Her grasp of the tax code was excellent. She treated me in a professional manner, but was very fair and pleasant,"⁴⁵ showcase positive interactions during correspondence examinations. Unfortunately, the ease of getting through to the right person, and the length of time to get through by phone, are still the areas with the most room for improvement in correspondence examination.⁴⁶

Taxpayers may need to request face-to-face meetings to resolve outstanding examination issues for a number of reasons, including language barriers, the inability to communicate clearly in writing, complexity of the tax law, and the volume of records required for verification.⁴⁷ For example, the state sales tax deduction, while very straightforward, could require numerous receipts for substantiation. Similarly, substantiating employee business expenses for an over-the-road truck driver may require the submission of a driver's log, which is not easily copied or duplicated.

The IRS is updating IRM 4.19.13.14, Transfers to Area Office Examination or Appeals Office, to provide examples of how to assist taxpayers who may request a transfer due to voluminous records.⁴⁸ While the IRM gives employees a method of sampling records, it does not offer examples of when to transfer a case to a local office. Examples of appropriate transfers would be useful for employees and would help promote consistent treatment of taxpayer cases.

IRS publications may lead taxpayers to believe that if they prefer to have a face-to-face meeting, all they have to do is ask. Publication 1, Your Rights as a Taxpayer,⁴⁹ informs taxpayers that they may "respond by mail or you can request a personal interview with an examiner." Similarly, Publication 556, Examination of Returns, Appeal Rights, and Claims for Refunds, goes on to state that "if your return can be examined more quickly and conveniently in another area, such as where your books and records are located, you can ask to have the case transferred to that area."⁵⁰ The public statements regarding the ability to have a face-to-face meeting simply do not agree with the internal processes in place to facilitate this request.

Whether the taxpayer's request is based on need or preference, the IRS rarely grants taxpayers a face-to-face meeting once a correspondence examination is underway. Complaints from taxpayers to TAS have revealed that even though IRS publications advertise taxpayers' right to a face-to-face conference, the IRS seldom honors taxpayer requests for in-person examinations.⁵¹ The IRS denies many such requests based on geographic inconvenience and the unavailability of premises for a face-to-face meeting. Further, the structure of the IRS makes it difficult to transfer a case from a campus correspondence exam unit to the field. This is because the Wage and Investment (W&I) Operating Division conducts most correspondence audits while Small Business/Self Employed (SB/SE) division employees handle office audits, and the examination inventory system does not facilitate easy transfers between divisions.

The IRS conducts slightly more than 71 percent of correspondence examinations at campus offices, which are often not located in the taxpayer's geographic area.⁵² Even if a campus is nearby, security measures prohibit walk-in traffic and face-to-face meetings.

TAS focus groups of practitioners expressed concern about problems with the practical application of correspondence audits. They indicated face-to-face audits were faster, cheaper, and provided a "better" result for the taxpayer.⁵³ While the definition of "better" is clearly subjective, the analysis of examination closures illustrated in Chart 1.14.1 below confirms that face-to-face audits produce a higher agreement rate.⁵⁴ This disparity jeopardizes the fairness and uniformity of tax administration. The use of various IRS examination processes should not influence the result of an audit.

 

CHART 1.14.1, Examination Closures

 

 

 

When the IRS electronically transfers an examination case from correspondence audit to a field office, it faces a shortage of personnel in the field to provide in-person assistance. As of the end of FY 2007, the IRS had only 1,060 Tax Compliance Officers to hold face-to-face meetings.⁵⁵ The IRS lacks the staffing to honor these requests and does not factor case transfers from correspondence audit into the field into its enterprise work plans.

In the case of self-employment tax audits, the correspondence exam function reviews income items reflected on Form 1040, Individual Income Tax Return, Line 21, Other Income, that appear to be subject to self-employment tax but were not included in the computation on the original return. The IRS issues a combo letter with a report proposing the assessment of self-employment tax on the pre-identified income items. Results for FY 2008 (through April) indicate that of the 5,519 self-employment combo letter audits initiated, the IRS closed 57 percent with no change to tax liability. Of the 3,954 child tax credit combo letter audits initiated, the IRS closed 45 percent with no change to liability.⁶¹ The results indicate the additional tax the IRS presumed to be "very likely" has not materialized. These cases can have a negative impact on tax morale based on "guilty until proven innocent" treatment. In addition, the combo letter does not adequately explain taxpayers' appeal rights, creating a possible abridgement of these rights in violation of the IRS Restructuring and Reform Act of 1998.⁶² TAS is pleased to report SB/SE and W&I have revisited its use of the Combo Letter in correspondence examinations and plans on limiting its use.⁶³ We encourage IRS to eliminate the use of combination letters in all situations.

To address these issues, SB/SE convened a Correspondence Examination Taxpayer Satisfaction Improvement Team in June 2008. The purpose of the team is to improve customer satisfaction results by better meeting the expectations, needs, and preferences of the taxpayer from the beginning of the correspondence examination process through final case closure. Using customer satisfaction data compiled by the Pacific Consulting Group, the team reviewed in depth the following four areas where taxpayer concerns and complaints showed the greatest room for improvement:

• Ease of getting through to the right person;

• Overall length of correspondence exam process;

• Providing consistent information about case; and

• Length of time to get through by phone.

• "Just a Phone Call Away from Great Customer Service" - an integrated approach for providing IRS employees with taxpayer comments, updated IRM guidance, and training regarding the importance of phone contact;

• "Exam Express" - an innovative program that will fast-track certain issues through the audit process;

• "First Read Improvements" - combining updated scanning technology and experienced tax examiners in the receipt and control process will improve the ability of correspondence examination functions to control, acknowledge, and address correspondence in a timely manner.

Conclusion

The importance of providing service from the taxpayer's perspective was highlighted in a July 9, 2008, e-mail communiqué from IRS Commissioner Douglas Shulman, stating,

IRS Comments

The IRS conducts well over a million correspondence examinations each year - examinations that focus on a limited number of specific, clear-cut issues that do not normally require a full-scale, face-to-face audit of the taxpayer's books and records. In comparison to other types of audits, correspondence examinations require fewer resources from either the IRS or taxpayers, are considerably less invasive for taxpayers, and effectively contribute to the tax administration objectives of fostering voluntary compliance and reducing the Tax Gap. Use of correspondence examinations is only one of the ways in which the IRS serves the public and meets taxpayer needs, as emphasized by the IRS Restructuring and Reform Act of 1998 (RRA 98).

Through various outreach activities, the IRS continually strives to increase taxpayer awareness of tax law requirements, taxpayer-related responsibilities, and taxpayer rights. Information on contacting the IRS and the examination process is available on IRS.gov and in IRS publications. While the IRS is responsive to taxpayer requests for face-to-face assistance, the IRS designs and manages its examination programs based on the audit streams most appropriate for the issues involved. In addition, the inherent nature of correspondence examinations generally makes face-to-face assistance unnecessary because these audits involve a limited number of issues and usually require the submission of fewer documents by taxpayers to substantiate the items reported on their returns.

The National Taxpayer Advocate notes that according to a TIGTA report, easy telephone access to the IRS helps resolve cases and issues. The National Taxpayer Advocate also refers to IRS use of the universal call routing system. In this regard, the IRS is moving forward with a vision for corporate inventory for much of its correspondence examination work that has the potential to dramatically improve telephone access while meeting taxpayer needs and preferences.

The W&I division has completely eliminated extension routing on all cases. Universal call routing now facilitates taxpayers' telephone interactions with the IRS by allowing them to talk to the next available examiner. Taxpayers no longer have a need to connect with the particular IRS employee assigned to their case since all return data, letters, reports, and work papers are now available to all W&I examiners. In addition, it should be noted that survey results confirm that most taxpayer calls regard case status, documents needed to resolve the audit, and routine questions about the tax issue that can be readily addressed by any examiner.⁷⁰

The IRS has also implemented the self-assign feature that allows any tax examiner that answers the toll free number to assign an unassigned case to him or herself and make the final determination on the case if the information provided by the taxpayer is sufficient. A Unified Work Request for programming has been submitted to expand this flexibility to cases in 90-day status as well. Other planned improvements include intelligent call routing, which will route calls to the most appropriate examiner based on the tax issues involved in the case. We are also moving forward with the correspondence imaging development project, which will eventually add taxpayer correspondence to the system, making the entire file, including taxpayer correspondence, available to any examiner at any site.

Telephone survey results reflect very favorable taxpayer feedback. For example, the W&I October 2008 survey reflects that 84 percent were satisfied with the time it took to reach IRS on the phone and 95 percent were satisfied with the length of time they spent with an examiner after they were connected. Further, 90 percent were satisfied with the ability of the examiner to make a decision on their case.

The National Taxpayer Advocate notes with approval the changes the IRS has made to reduce the use of combination or "combo" letters. We will also consider the National Taxpayer Advocate's suggestion to eliminate the use of that letter for other correspondence examination audit streams. However, the IRS disagrees with the National Taxpayer Advocate's allegation that use of these letters may abridge taxpayer rights in violation of RRA 98 by providing inadequate appeal rights. The combo letter, by definition, merges the initial contact letter and the 30-day letter into a single document that includes specific reference to the taxpayer's right to file an administrative appeal. The combo letter also includes a copy of Publication 3498-A, The Examination Process (Examinations by Mail). This publication discusses taxpayer rights, explains appeals procedures, and further outlines ways the IRS can assist taxpayers in the correspondence examination process in full conformance with RRA-98 requirements.

We are also pleased that the National Taxpayer Advocate endorses the work of the Correspondence Examination Taxpayer Satisfaction Improvement Team, which is considering the ease of contacting the right person at the IRS, overall length of the correspondence examination process, providing clear and consistent information, and length of time to get through by telephone. With regard to the National Taxpayer Advocate's proposal that the IRS implement the recommendations made by the Team, deliberations are still ongoing and when the team issues its final report, its recommendations will be forwarded to the Commissioner's Taxpayer Correspondence Taskgroup for consideration and approval.

The National Taxpayer Advocate also recommends that the IRS test the results of correspondence audits compared to face-to-face audits. The IRS is currently working to develop such a test. The National Taxpayer Advocate also notes, and we agree, that appropriate and consistent guidance specific to correspondence audits is vital. In this regard, the IRS works to continuously improve its guidance to correspondence examiners and telephone assistors.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends the IRS for significantly improving telephone access to meet taxpayer needs and preferences. We applaud the IRS for implementing the self-assign feature, which allows any examiner who answers the toll-free number through universal call routing to make the final determination on the taxpayer's case if the information provided by the taxpayer is sufficient. The National Taxpayer Advocate also supports the extension of this feature to all audit cases, including those where the IRS has issued the statutory notice of deficiency. We encourage the IRS to proceed with intelligent call routing and correspondence imaging, which will further enhance communications and better suit taxpayer needs and preferences during the examination process. The National Taxpayer Advocate appreciates the efforts of the Correspondence Examination Taxpayer Satisfaction Improvement Team to improve taxpayer service during the examination process, and is pleased with the IRS's agreement to test the results of correspondence audits compared to face-to-face audits for similar issues. Such testing will help the IRS to improve its guidance regarding correspondence examinations and "focus on the taxpayer's experience."⁷¹

We are pleased the IRS is planning to conduct the test comparing correspondence and office exam results with respect to similar cases. This study should show whether particular taxpayer populations (e.g., EITC taxpayers) are better able to understand what is required and bring in better information when conveyed in a face-to-face environment. If the test results confirm what TAS's survey results show, IRS should plan for and offer office examinations as an option in certain cases initially established as correspondence exams.

Although the National Taxpayer Advocate is pleased with the SB/SE and W&I plans to limit the use of the combo letter in some situations,⁷² she remains concerned about the use of the letter in all other situations because it potentially abridges taxpayer appeal rights. While the letter includes a copy of IRS Publication 3498-A, The Examination Process (Examinations by Mail) (Dec. 2006), both the publication and the letter fall short of adequately informing the taxpayers of their appeal rights as mandated in RRA 98 § 3465.⁷³ The National Taxpayer Advocate fundamentally disagrees with the joining of the 30-day timeframe to submit information with the 30-day timeframe to appeal. These two administrative processes should remain separate. Accordingly, the National Taxpayer Advocate urges the IRS to eliminate all and any use of combination letters in the examination process.

Recommendations

The National Taxpayer Advocate recommends that the IRS takes the following specific actions to meet taxpayer needs and preferences during the examination process:

² RRA 98, Pub. L. No. 105-206, Title III, Subtitle F, § 3503, 112 Stat. 771 (July 22, 1998).

³ For example, IRM 4.10.3.16.9 (Mar. 1, 2003) requires the IRS to honor a taxpayer's request for a face-to-face interview. Such needs and preferences may include face-to-face meetings, relief requests under repetitive audit procedures, or correspondence audit issue discussions via telephone with a tax examiner.

⁴ Taxpayers may use various avenues to express dissatisfaction with the examination process ranging from requests for TAS assistance and Audit Reconsiderations to protests to the Appeals function and U.S. Tax Court.

⁵ Automated Information Management System (AIMS) from the Compliance Data Warehouse (CDW), Individual Tax Returns for Tax Periods 2005-2008 (Sept. 2008). See also Chart 1.14.1, Examination Closures, infra.

⁶ For a detailed discussion on the frequency and likelihood of a Correspondence Examination, see Most Serious Problem, The IRS Correspondence Examination Program Promotes Premature Notices, Case Closures, and Assessments, infra.

⁷ Pacific Consulting Group, Compliance Center Examination (CC Exam) SB/SE National Report, January Through March 2008 10, 19 (July 2008).

⁸ IRC § 7602.

⁹ IRC § 7605(b); 26 C.F.R. § 301.7605-1(h).

¹⁰ The courts interpret the "one inspection" rule very narrowly, holding that a subsequent examination does not constitute a second inspection in many situations. See Application of Magnus, 299 F.2d 335 (2d Cir. 1962) (subsequent IRS third-party inquiry as a part of a continuing investigation "not a further examination"); Dahl v. Comm'r, T.C. Memo. 1974-190, aff'd, 526 F.2d 552 (9th Cir. 1975) (IRS reexamination of information contained in a prior audited return for the purpose of determining the correct tax liability for the year under examination not a second inspection); Estate of Maceo v. Comm'r, T.C. Memo. 1964-46 (IRS examination of new matters introduced by an amended tax return not a second examination when taxpayer failed to timely object); U.S. v. Kendrick, 518 F.2d 842 (7th Cir. 1975) (second examination applicable to a different type of tax); U.S. v. Omohundro, 619 F.2d 51 (10th Cir. 1980) (IRS subsequent examination of corporate records after examining the records of an individual taxpayer not a second examination); Spell v. U.S., 907 F.2d 36, 38 (4th Cir. 1990) (transfer of the case to Criminal Investigation (CI) for further investigation after completing a routine audit not a second inspection).

¹¹ IRM 4.19.3.30.7.1 (Nov. 8, 2005).

¹²See Curtis v. Comm'r, 84 T.C. 1349, 1350 (1985).

¹³See generally IRC § 6213(g).

¹⁴ The AUR program automatically matches the items reported on a tax return with information reported by third parties on information returns.

¹⁵ ASFR relies on data from information returns or prior year returns to prepare substitute returns and assessments for individuals who fail to file after the IRS sends them a notice.

¹⁶See IRM 1.2.13.1.1, Policy Statement 4-3(3) (Dec. 21, 1984). This policy statement specifically states that any inspection of the taxpayer's books of account, to the extent necessary to resolve a discrepancy between the taxpayer's return and a broad category of informational returns, will not be considered an inspection of books and records within the meaning of IRC § 7605(b). See also IRS Chief Counsel Advisory 200009045 (Mar. 3, 2000) (request for information to taxpayers in Coordinated Examination Program not an examination of taxpayer's books); Field Service Advice FSA 199916004 (Apr. 22, 1999) (IRS compliance with a request from a foreign country for tax information on a U.S. taxpayer pursuant to a tax treaty not a second examination).

¹⁷See Treas. Reg. §§ 601.105; 301.7605-1. See also Statistics of Income (SOI) Tax Stats - IRS Tax Compliance Activities, at http://www.irs.gov/taxstats/compliancestats/article/0,,id=117875,00.html (last visited Aug. 27, 2008).

¹⁸ Treasury Inspector General for Tax Administration (TIGTA), Ref. No. 2008-30-095, Trends in Compliance Activities Through Fiscal Year 2007 8 (Apr. 18, 2008).

¹⁹Id.

²⁰Id. at 7

²¹ IRM 4.10.3.16 (Mar. 1, 2003) and IRM 4.19.1.2.3 (Oct. 1, 2001).

²² General Accounting Office (GAO), GAO/GGD-99-48, IRS Audits - Weaknesses in Selecting and Conducting Correspondence Audits (Mar. 1999).

²³ Treas. Reg. § 601.105(b)(2)(ii).

²⁴See IRM 4.10.3.16.9 (Mar. 1, 2003).

²⁵ IRS Enterprise Plan Summary (June 19, 2008).

²⁶ IRM 1.2.13.1.1., Policy Statement 4-3(3) (Dec. 21, 1984). This policy statement specifically states any inspection of the taxpayer's books of account, to the extent necessary to resolve a discrepancy between the taxpayer's return and a broad category of informational returns will not be considered an inspection of books and records within the meaning of IRC 7605(b).

²⁷ GAO, GAO/GGD-99-48, IRS Audits - Weaknesses in Selecting and Conducting Correspondence Audits (Mar. 1999).

²⁸Id.

²⁹ National Taxpayer Advocate 2007 Annual Report to Congress vol. 2, 95. This study, conducted with W&I Research, indicated only about half of the respondents involved with Earned Income Credit audits said they clearly understood what they needed to do to comply with IRS requests for information.

³⁰ National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, 94-95, 103-104. See also The 2008 Tax Return Filing Season, IRS Operations, FY 2009 Budget Proposals, and the National Taxpayer Advocate's 2007 Annual Report to Congress, Hearing Before the Subcomm. on Oversight, H. Comm. on Ways and Means, 110th Cong. (Mar. 13, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate).

³¹ For a detailed discussion of the Correspondence Examination Process, see Most Serious Problem, The IRS Correspondence Examination Program Promotes Premature Notices, Case Closures, and Assessments, infra.

³² Tax morale is a broad concept, which encompasses internal motivations and perceptions (e.g., I am a law-abiding person). Feld and Frey define tax morale "as a complicated interaction between taxpayers and the government establishing a fair, reciprocal exchange that involves giving and taking of both parties." See Lars P. Feld & Bruno S. Frey, Tax Compliance as the Result of a Psychological Tax Contract: The Role of Incentives and Responsive Resolution, 2007 Law & Policy 102.

³³ Marjorie E. Kornhauser, Normative and Cognitive Aspects of Tax Compliance, Literature Review and Recommendations for the IRS Regarding Individual Taxpayers, 2007 National Taxpayer Advocate Annual Report to Congress vol. 2, 138.

³⁴ Lars P. Feld & Bruno S. Frey, Tax Compliance as the Result of a Psychological Tax Contract: The Role of Incentives and Responsive Resolution, 2007 Law & Policy 102.

³⁵ Example offered by Feld & Frey: "The tax officials can choose between these extremes in many different ways. For instance, when they detect an error in the tax declaration, they can suspect intent to cheat, and impose legal sanctions. Alternatively, the tax officials may give the taxpayers the benefit of the doubt, and inquire about the reason for the error. If the taxpayer in question indeed did not intend to cheat but simply made a mistake, he or she will most likely be offended by the disrespectful treatment of the tax authority. The feeling of being controlled in a negative way, and being suspected of tax cheating, tends to crowd out the intrinsic motivation to act as an honorable taxpayer and, as a consequence, tax morale will fall. In contrast, if the tax official makes an effort to locate the reason for the error by contracting the taxpayer in a courteous way, the taxpayer will appreciate this respectful treatment and tax morale will be upheld." Id.

³⁶ 2007 National Taxpayer Advocate Annual Report to Congress 478 (Key Legislative Recommendation, Taxpayer Bill of Rights and De Minimis "Apology" Payments). See also Hearing on the 2008 Tax Return Filing Season, IRS Operations, FY 2009 Budget Proposals, and The National Taxpayer Advocate's 2007 Annual Report to Congress, Hearing Before the Subcomm. on Oversight, H. Comm. on Ways and Means, 110th Cong. (Mar. 13, 2008) (testimony of Nina E. Olson, National Taxpayer Advocate).

³⁷ According to Joshua Rosenberg, in an ideal system (from the government perspective), "[people] would pay their taxes and feel good about it . . . [They] would feel about tax laws the same way they feel about criminal laws, contract laws, and property laws-- that they are an important part of government and are enacted for our benefit. [People] would believe that others pay their fair share, would expect them to do so, would be disturbed when they did not, and would do what they could to ensure that the tax laws were properly enforced and that the IRS had all the information it needed." Joshua D. Rosenberg, Narrowing the Tax Gap: Behavioral Options, 117 Tax Notes 517 (2007).

³⁸ National Taxpayer Advocate Keynote Address, American Bar Association Tax Section (May 5, 2006).

³⁹ National Taxpayer Advocate 2006 Annual Report to Congress, vol. 2, 3.

⁴⁰ IRS Oversight Board, Taxpayer Customer Service and Channel Preference Survey Special Report (Nov. 2006), 2006 Service Channels Survey, vii - viii.

⁴¹ National Taxpayer Advocate 2006 Annual Report to Congress, vol. 2, 6.

⁴² TIGTA, Ref. No. 2006-40-138, The Wage and Investment Division Automated Underreporter Telephone Operations Could Improve Service to Taxpayers 6 (Sept. 13, 2006).

⁴³ The National Taxpayer Advocate's Findings from the Earned Income Tax Credit (EITC) Examination and Document Requirements Focus Groups, IRS Tax Forums, June - September 2005 (Dec. 2005).

⁴⁴ Pacific Consulting Group, Compliance Center Examination (CC Exam) SB/SE National Report, January Through March 2008 10 (July 2008).

⁴⁵ Pacific Consulting Group, Compliance Center Examination (CC Exam) SB/SE National Report, 2007 Verbatim Customer Satisfaction Comments.

⁴⁶ Pacific Consulting Group, Compliance Center Examination (CC Exam) SB/SE National Report, January Through March 2008 (July 2008).

⁴⁷ National Taxpayer Advocate 2006 Annual Report to Congress 333.

⁴⁸ IRM 4.19.13.14 (clearance copy Aug. 2008).

⁴⁹ IRS Pub. 1, Your Rights as a Taxpayer (May 2005).

⁵⁰ IRS Pub. 556, Examination of Returns, Appeal Rights, and Claims for Refund (May 2008).

⁵¹ IRS Pub. 1, Your Rights as a Taxpayer (May 2005). See also I.R.M. 4.10.3.16.9 (Mar. 1, 2003) (providing that a taxpayer request for a face-to-face interview "should be honored.") See also Systemic Advocacy Project P0027246, created after TAS received numerous complaints from taxpayers regarding the failure of the IRS to honor requests for face-to-face examinations.

⁵² TIGTA, Ref. No. 2008-30-095, Trends in Compliance Activities Through Fiscal Year 2007 7 (Apr. 18, 2008).

⁵³ The National Taxpayer Advocate's Findings from the Correspondence Examination Focus Groups, IRS Tax Forums, June - September 2005 (Jan. 2006).

⁵⁴ Automated Information Management System (AIMS) from the Compliance Data Warehouse (CDW), Fiscal Years 2006 - 2008 (Sept. 2008).

⁵⁵ TIGTA, Ref. No. 2008-30-095, Trends in Compliance Activities Through Fiscal Year 2007 6 (Apr. 18, 2008).

⁵⁶ IRC § 7605(b).

⁵⁷ IRM 4.10.2.8.5 (Aug. 1, 2007).

⁵⁸ Systemic Advocacy Management Submission (SAMS) Issue No. 29054.

⁵⁹ The IRS began using the Combo Letter in March 1999. IRS, Electronic Publishing, at http://publish.no.irs.gov/catp.cgi?catnum=27226 (last visited Dec. 15, 2008).

⁶⁰ National Taxpayer Advocate 2007 Annual Report to Congress 292.

⁶¹ W&I response to TAS research request (June 30, 2008).

⁶² RRA 98; Pub. L. No. 105-206, Title III, Subtitle F, § 3465, 112 Stat. 767 (July 22, 1998). See also National Taxpayer Advocate 2007 Annual Report to Congress 292-300; National Taxpayer Advocate 2006 Annual Report to Congress 296-297; National Taxpayer Advocate 2004 Annual Report to Congress 177-179; National Taxpayer Advocate 2003 Annual Report to Congress 87-98; National Taxpayer Advocate 2002 Annual Report to Congress 57-61.

⁶³ SB/SE and W&I have submitted a Unified Work Request requesting a systemic change to move certain excise penalty cases, Self-Employment Tax cases, Alimony cases, and non-EITC DUPTIN cases from the Combination Letter program to an Initial Contact Letter.

⁶⁴ 2007 Taxpayer Assistance Blueprint, Phase II, at 53.

⁶⁵ National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, 95.

⁶⁶See Executive Order 13166, Improving Services for Persons with Limited English Proficiency (LEP), 65 FR 50121 (2000). See also Policy Statement P-22-3, IRM 22.31.1.1.2 (Apr. 1, 2006).

⁶⁷ W&I, Strategy & Program Plan FY 2008 - FY 2009 33.

⁶⁸ The Braille code, developed by Louis Braille (1809 - 1852), was first introduced in the United States in 1869 and was adopted as the Standard English Grade Two Braille code in 1932.

⁶⁹See 2006 National Taxpayer Advocate Annual Report to Congress 333 (Most Serious Problem, Limited English Proficient (LEP) Taxpayers: Language and Cultural Barriers to Tax Compliance).

⁷⁰ W&I October 2008 telephone survey results indicate that 70 percent of the taxpayers called for an explanation of the letter from the IRS while 11 percent wanted to let the IRS know they mailed records or wanted to provide other information.

⁷¹ IRS Commissioner Douglas Shulman, Remarks Before Tax Analysts Conference on Ten-Year Anniversary of the IRS Restructuring and Reform Act of 1998, at http://www.irs.gov/newsroom/article/0,,id=184857,00.html (last visited Dec. 11, 2008).

⁷² SB/SE and W&I have submitted a Unified Work Request requesting a systemic change to move certain excise penalty cases, Self-Employment Tax cases, Alimony cases, and non-EITC DUPTIN cases from the Combination Letter program to an Initial Contact Letter.

⁷³ RRA 98, Pub. L. No. 105-206, Title III, Subtitle F, § 3465, 112 Stat. 767 (July 22, 1998). Letter 566-B-EZ (SC), Simplified Service Center ICL/30 Day Combo Letter (Feb. 2005), does not contain clear, upfront direction to the taxpayers about the right and ability to appeal. The letter instructs the taxpayer in one paragraph that, "If you do not agree with all the changes listed on Form 4549-EZ, please send us the following information by [date]: A letter telling us what item(s) you disagree with an why, and; Clear photocopies of the records, information, and/or supporting documents, listed on the enclosed Form(s)." It is not until the second page that the letter finally informs the taxpayers about the right to appeal, referring to explanations in the publication: "After we review what you've sent us, we will contact you with the result. If you still disagree with our findings, you have the right to file an administrative appeal as explained in the enclosed Publication 3498-A, The Examination Process (Examinations by Mail)." See id.

Richard E. Byrd Jr., Commissioner, Wage and Investment Division

Chris Wagner, Commissioner, Small Business/Self-Employed Division

Definition of Problem

The correspondence examination program plays a vital role in the IRS mission of promoting voluntary compliance with the tax law. Correspondence audits focus on a limited number of specific, clear-cut issues that would not normally require a face-to-face examination.¹ These audits, conducted exclusively by mail, should help the IRS leverage its compliance resources, increase audit coverage, and minimize taxpayer burden.² Instead, the program as currently designed experiences problems that increase taxpayer burden. These problems include the mishandling of taxpayer correspondence (receipt, control, and response); a lack of one-on-one contact with taxpayers in resolving their inquiries and disputes; and inconsistent, sometimes ignored policies and procedures that cause premature and incorrect assessments of tax, penalties, and interest. Among the problems that limit the IRS's ability to operate an effective correspondence examination program are:

• An automated process that curtails examinations and leads to premature notices, case closures, and assessments;

• A lack of one-on-one contact with taxpayers, which results in premature enforcement actions;

• A focus on closing cases rather than helping taxpayers to resolve their problems; and

• A dramatic increase in the amount of overage discretionary correspondence mail.³

Analysis of Problem

The correspondence examination program has grown dramatically in recent years. In FY 2007, the IRS examined 1,144,596 Forms 1040 through correspondence,⁹ an increase of 160 percent over the 439,734 Forms 1040 examined by correspondence in FY 2000.¹⁰ The following chart illustrates the growth in correspondence examinations since FY 2000, in contrast to face-to-face examinations, which grew less than 35 percent over the same period (from 178,031 returns in FY 2000 to 239,967 in FY 2007).¹¹ In addition to routine correspondence audits, such as Earned Income Tax Credit, (EITC), the program also includes audits of non-filers, return preparers, high-income taxpayers,¹² and other types of inventory at the discretion of local managers.¹³ The IRS contends correspondence audits increase voluntary compliance and reduce taxpayer burden.¹⁴

 

CHART 1.15.1, Growth in Correspondence Vs.

 

Face-To-Face Examinations

 

 

 

Chart 1.15.1 above contrasts the growth in correspondence examinations and face-to-face audits for each year from FY 2000 through FY 2007.

This upward trend may be a cause for concern in view of an earlier General Accounting Office (GAO, now the Government Accountability Office) study that reported over 50 percent of taxpayers examined by correspondence failed to respond to the IRS's letters.¹⁶ Since the IRS routinely issues Statutory Notices of Deficiency in all of its no-reply audits, this statistic implies that half of all taxpayers examined by correspondence receive deficiency notices automatically.¹⁷ Moreover, the Treasury Inspector General for Tax Administration (TIGTA) recently reported that correspondence examinations may do little to improve compliance because they are less comprehensive than face-to-face audits.¹⁸

The Large and Mid-Size Business Division (LMSB) employs revenue agents, who conduct audits at the taxpayer's place of business. Most LMSB taxpayers are high-asset corporations, whose returns involve large-dollar, complex tax issues, requiring an extensive review of their books and records.²⁰ Similarly, the Small Business/Self-Employed Division (SB/SE) employs revenue agents who conduct audits at the taxpayer's place of business. SB/SE field audits generally include smaller corporations, partnerships, and the larger sole proprietorships.²¹ SB/SE tax compliance officers, in contrast, conduct their audits in an office setting, where individual taxpayers typically bring their records for inspection.²² At the end of FY 2007, the IRS had 10,121 revenue agents and 1,060 tax compliance officers on staff.²³

Taxpayers who disagree with any of the proposed adjustments may request an informal conference with a supervisor. If this discussion does not resolve the taxpayer's concerns, he or she may request an independent review by the Appeals function, generally within 30 days. Those who are not satisfied after conferring with Appeals may take their cases to the U.S. Tax Court. In these situations, taxpayers must petition the court within 90 days from the date the IRS mails the Statutory Notice of Deficiency (90-day letter).²⁵ If taxpayers do not respond to (or "default") the 30-day letter,²⁶ the IRS issues a Statutory Notice of Deficiency. During the ensuing 90-day period, taxpayers are free to discuss their cases with the IRS. However, such discussions will not serve to extend the 90-day period to petition the court.

In 1999, the IRS began using a combination or combo letter, replacing two distinct letters that the IRS previously issued at different times in the audit process, effectively merging the initial contact letter and the 30-day letter into a single document. The combo letter currently comprises the initial contact letter, document request, and audit report (30-day Letter).²⁸ The National Taxpayer Advocate has repeatedly voiced concerns that the combo letter in correspondence examinations is confusing to taxpayers and frequently results in either preemptive "protective" appeals and court petitions, or defaults where the tax is assessed after the IRS does not receive a response.²⁹ The letter also tells taxpayers they must first provide relevant information to the contact person named in the letter before Appeals will hear their cases. This instruction may result in taxpayers not requesting an appeal because they fear reprisal from the examiner and a worse result.

The combo letter not only combines two separate stages of the audit, thus truncating the audit process, but also conflates the examiner's document requests and preliminary audit findings with the final audit report and Appeals notification. For many taxpayers, 30 days is simply not enough time to produce the myriad of documents requested by tax examiners, such as birth certificates, marriage licenses, Social Security cards, and school records, and may result in a hardship.³⁰ Moreover, without timely notification of whether tax examiners have received, reviewed, and accepted the taxpayers' information, the 30-day period may lapse without taxpayers knowing if they should provide different documents or request an appeal.³¹ In its efforts to streamline the correspondence audit process by using the batch processing system, the IRS may inadvertently prompt numerous taxpayers to file protective appeals requests or court petitions. It can be confusing to taxpayers when in one communiqué the IRS proposes adjustments, asks for additional documentation, and offers Appeal rights that should be exercised within the same 30-day period.³² The combo letter causes unnecessary burden and frustration for taxpayers, and results in costly downstream re-work for the IRS.³³

Once the IRS engages the batch system, cases move through the examination process automatically. Each step in the process has a pre-established period programmed into the system. Files are not created or examiners assigned to the cases until the IRS receives and controls a taxpayer's correspondence.³⁵ If a taxpayer fails to furnish the requested documentation precisely within the prescribed period, the case automatically moves to the next phase in the process.

The issuance of premature 90-day letters has been attributed to the inflexibility of this process.³⁶ Because the batch system automatically processes a case from its creation through the issuance of a Statutory Notice of Deficiency and subsequent closing, the IRS has effectively eliminated the need for human involvement in every case in which a taxpayer does not reply in a timely fashion.³⁷ If a taxpayer does respond, the tax examiner considers that response and reintroduces the case back into the batch system for automated closing.³⁸

The automated batch system enables the IRS to process correspondence examinations with little or no involvement by tax examiners until taxpayers reply to notices. However, the automated nature of the process can contribute to premature notices, case closures, and assessments, because it is geared primarily toward closing cases or moving them along, and may not provide taxpayers sufficient time or assistance to respond to IRS requests for information.

The automated process limits the ability of taxpayers to engage in a meaningful dialogue with tax examiners, to ask questions about the process and the issues, and to resolve problems that invariably arise during the course of an examination.

The National Taxpayer Advocate recently reported that a review of the correspondence examination process W&I conducted at one campus found that 9.52 percent (or 3,086) of the 32,422 cases it reviewed were prematurely forwarded for issuance of a Statutory Notice of Deficiency.³⁹ In her 2007 Annual Report to Congress, the National Taxpayer Advocate once again encouraged the IRS to allow more time to associate and consider taxpayer documentation before issuing a notice of deficiency.⁴⁰

In 2008, IRS campus analysts identified a problem with a computer program that affects the suspense period for taxpayer responses. The IRS had lost the ability to stop issuing notices when cases were forwarded to the National Print Site for the printing of 90-day letters.⁴¹ The IRS had not updated the programming to account for the time between the requests to generate the notice and the notice being sent. While W&I indicated the problem has not caused any premature deficiency notices, the division admitted it does make it difficult to stop a statutory notice even when mail is received timely.⁴²

Tax practitioners have commented that the IRS frequently requests additional information prior to reviewing all relevant case information. In addition, the sheer volume of the documentation requested is often overwhelming. Moreover, practitioners continue to express concern about the IRS's failure to acknowledge receipt of correspondence, explaining that these circumstances make for an inefficient and frustrating examination process. This lack of acknowledgement also leads to more phone calls to the IRS to check on the status of documents.⁴⁵

A recent W&I FY 2008 Compliance Report underscores the National Taxpayer Advocate's growing concern, revealing that during the one-year period ending June 30, 2008, the IRS experienced a 242 percent increase in its overage discretionary correspondence examination mail.⁴⁶

Conversely, revenue agents and tax compliance officers conducting face-to-face examinations must actually locate taxpayers to make their initial contacts. If the initial contact letter is returned, field and office auditors must try to find a more current address.⁴⁹ Auditors who cannot reach taxpayers by telephone or letter follow the same requirements as a tax examiner and use the Social Security numbers for the account on IDRS to search for a new address on information documents. However, they also must perform additional research such as employing an asset locator service, issuing a postal tracer, contacting the taxpayer's employer, internet research, and querying the Currency Banking Retrieval System (CBRS). If the examiners still cannot locate the taxpayers, they must confer with their managers to decide whether the examination should continue.⁵⁰ The disparity in these two processes increases the likelihood of inaccurate default assessments in correspondence examinations, which harm taxpayers and generate costly downstream work such as audit reconsiderations and TAS involvement.

The impact of this approach on taxpayers is significant, and was clearly stated in a letter to Acting Commissioner Linda Stiff, dated November 28, 2007, in which the President of the National Association of Enrolled Agents (NAEA) voiced growing concerns about a disturbing trend in IRS enforcement efforts.⁵¹ The IRS in the situations described issued a quick succession of notices without allowing adequate time to review and act on taxpayers' responses to requests for information, which culminated in premature deficiency notices. The National Taxpayer Advocate has repeatedly urged the IRS to allow more time to associate and consider taxpayer documentation before proceeding with enforcement. Although the IRS has acknowledged that it issues notices prematurely, it insists such occurrences are isolated.⁵²

At the heart of these problems lie the government's burgeoning tax gap and the IRS's Strategic Plan, operational priorities, and performance measures. The Strategic Plan calls for the reduction of audit cycle time as a key component in improving audits and audit coverage.⁵³ This strategy drives IRS managers to focus too heavily on closing cases and reducing examination cycle time, without considering existing, well-defined quality standards and a highly publicized commitment to customer service.

In one instance, W&I reported accomplishments indicating it achieved a discretionary closure rate 25 percent higher than its year-to-date plan.⁵⁴ In the same report, W&I also reported that its discretionary cycle time was down by 14.2 percent.⁵⁵ Yet, in a separate report, W&I disclosed a disturbing 242 percent increase in its overage discretionary correspondence mail.⁵⁶ This disparity demonstrates that the focus on shortened cycle time may translate into the IRS not properly considering taxpayer correspondence and issuing incorrect and premature notices of deficiency.

These safeguards and procedures do little good unless IRS employees and managers adhere to them consistently. For example, IRM provisions direct tax examiners to call taxpayers if they need additional information to evaluate correspondence and less than 15 days remain until default.⁵⁸ However, TIGTA reported tax examiners rarely attempted to contact taxpayers by phone when they needed additional information to complete the audits, even though taxpayers provided their phone numbers for this purpose.⁵⁹ Failure to follow the procedure and contact taxpayers by telephone to resolve correspondence examinations creates needless re-work and taxes the IRS's already limited resources. In response to a recent TAS inquiry, W&I and SB/SE indicated they encourage tax examiners to contact taxpayers by telephone, as provided in the IRM, and noted SB/SE added this procedure to its Operating Guidelines in FY 2007.⁶⁰

Conclusion

The IRS should consider taking the following actions to improve the correspondence examination program: implement processes and procedures to associate and consider taxpayer correspondence timely; move forward with systemic restrictions to limit the reduction of suspense periods in the batch processing system; issue a Servicewide Electronic Research Program (SERP) Alert covering IRM 4.19.3.1, Outgoing Calls, to emphasize the importance of effective use of the telephone in resolving correspondence examinations; eliminate the use of the Examination Procedural Job Aid, and follow the guidance in IRM 4.19.19, Telephone Contacts; align the procedures used by tax examiners in locating taxpayers and handling undeliverable mail in IRM 4.19.13, Liability Determination -- General Development and Resolution, with the procedures used by tax compliance officers in IRM 4.10.2, Examination of Returns -- Pre-contact Responsibility; and stop using the combo letter in all correspondence examinations, and revert to the pre-1999 examination procedure of issuing a preliminary audit report, followed by a traditional 30-day letter, at a later stage in the audit.

IRS Comments

As acknowledged by the National Taxpayer Advocate, correspondence examinations play a vital role in promoting voluntary compliance with the tax law and in closing the Tax Gap. During FY 2008, the IRS examined 1.1 million returns and assessed over $6.7 billion through its correspondence examination programs. These programs include EITC and non-EITC programs, such as Schedule A tax issues, non-filers, premature IRA distribution, education credits, and child tax credit. The examination of these issues through correspondence, rather than through a field or office audit, requires fewer resources from either the IRS or taxpayers, and are considerably less invasive for taxpayers.

We do not agree that the automated correspondence examination process leads to premature assessments. Most EITC and some discretionary audits use an automated batch processing system. This is an excellent system that prevents, rather than causes, premature notices. Cases cannot move through the system until programmed timeframes have expired. When taxpayer correspondence is received and entered on the system, all actions cease until an examiner considers this correspondence. In this regard, the National Taxpayer Advocate cites a November 28, 2007, letter from the National Association of Enrolled Agents as an example of a situation culminating in premature issuance of deficiency notices. The letter from NAEA voiced concerns regarding the timing of IRS notices and indicated the IRS was issuing subsequent follow-up notices too rapidly. The IRS works with the NAEA and others in the practitioner community to solicit feedback and identify improvement opportunities. In this case, the IRS promptly reviewed and adjusted the suspense dates for printing these notices, which served to address the NAEA's concern. The National Taxpayer Advocate's report also states that 9.52 percent of cases at one campus had premature statutory notices issued. This was caused by a clerical error in calculating the suspension period in which the statutory notices were issued an average of three days earlier than the designated suspension period. Immediate actions were taken to correct this error.

We also do not agree with the National Taxpayer Advocate's contention that an increase in overage correspondence contributes to premature notices and assessments. While the IRS makes every effort to track and timely consider all taxpayer correspondence, from time to time heavy volumes prevent us from doing so. However, as noted above, once mail is received and entered into the system, all notices stop, except systemic interim letters, until the mail is considered. This applies to all mail, including overage. Further, in her report, the National Taxpayer Advocate repeatedly cites an overage mail percentage increase for W&I Discretionary Exam of 242 percent from 2007 to 2008. This figure is not presented in context and actually represents the difference from a June 2007 overage percentage of 11 percent compared to a June 2008 overage percentage of 17 percent.⁶¹ By the end of FY 2008, the overage percentage was reduced to less than eight percent.

The National Taxpayer Advocate's report also states that the IRS focuses on closing cases rather than helping taxpayers to resolve their problems. While we disagree with the statement, we agree we need to continually focus on helping taxpayers understand and resolve their tax issues. It is our intent to conduct a correspondence examination program that promotes the IRS mission and we realize that responding to the needs of taxpayers in this process is vital. In this regard, the IRS created a Taxpayer Communication Task Group to evaluate all IRS notices and explore communications improvement opportunities. In addition, the IRS works very closely with the tax practitioner community to identify specific opportunities for improvement in the correspondence examination program. Based on practitioner focus group feedback, we have initiated or planned changes such as the issuance of letters to acknowledge receipt of taxpayer correspondence and implementation of uniform and adequate notice suspense timeframes. We are also working with the National Taxpayer Advocate to address her concerns with the combination, or "combo" letter. Use of this letter is being eliminated for all but a few programs, such as Criminal Investigation referrals and non-filer cases, where the chance of the returns being adjusted are highly likely. These changes will be implemented during 2010.

With regard to telephone contacts, the IRS is taking actions to move toward a vision for corporate inventory for much of this work. The W&I Division has implemented a self assign feature that allows a taxpayer to provide information to any tax examiner that answers our toll free number on an unassigned case. If the information the taxpayer provides is sufficient, the examiner can immediately assign the case to himself or herself and make the final determination on the case. A Unified Work Request for a programming change has also been submitted to expand this flexibility to cases in 90-day status. In addition, W&I has completely eliminated extension routing on all cases. Universal call routing now facilitates taxpayers' telephone interactions with the IRS by allowing them to talk to the next available examiner on any case. This process eliminates the need for the taxpayer to connect with the particular IRS employee assigned to his or her case, since all return data, letters, reports, and work papers are available to all examiners. In addition, an October 2008 telephone survey reflects that 70 percent of taxpayers called for an explanation of the letter from the IRS and another 11 percent called to inform the IRS that they mailed records or wanted to provide other information; issues that can easily be addressed by any examiner.

The IRS has received very favorable feedback from taxpayers regarding these changes to our telephone operations. For example, the W&I October 2008 telephone survey indicates 84 percent of taxpayers were satisfied with the time it took to reach a tax examiner on the phone and 95 percent were satisfied with the length of time they spent with the examiner after they were connected. Further, 90 percent were satisfied with the ability of the examiner to make a decision on their case. Other planned improvements include intelligent call routing, which will route calls to the most appropriate examiner based on the tax issues involved in the case. We are also moving forward with the correspondence imaging development project which will electronically add taxpayer correspondence to our frontline employees' desktops. This will allow for faster responses to taxpayer mail and reduce overage inventory.

The National Taxpayer Advocate recommends that the IRS move forward with systemic restrictions to limit reduction of suspense periods in the batch processing system. The IRS has already submitted a Uniform Work Request to program RGS/CEAS to automatically populate the suspense period whenever a case is updated into a new letter status. In addition, system changes have already been made to standardize the suspense periods for cases in Status 22. Cases are updated to Status 22 when the 30-day letter is issued to the taxpayer. The 30-day letter includes an audit report with proposed adjustments which is issued prior to the statutory notice.

The National Taxpayer Advocate recommends that the IRS issue a SERP Alert covering IRM 4.19.3.1 to emphasize the importance of effective use of the telephone. While we agree our employees should follow this IRM, we do not believe issuance of a SERP alert is the most effective way to ensure these provisions are being adhered to. Rather, we plan to address this area by evaluating the case reviews included in an ongoing study. The results will allow us to provide site-specific feedback for managers and employees regarding their performance in this area.

The National Taxpayer Advocate recommends that the IRS eliminate use of the Examination Procedural Job Aid and follow the guidance in IRM 4.19.19, Telephone Contacts. Correspondence examination telephone assistors are already required to follow IRM 4.19.19, which provides technical guidance that is not superseded by any locally generated procedural job aids. However, we will ensure that any such job aids do not contain instructions to staff that are inconsistent with the IRM. Further, W&I Examination has a Toll-Free Telephone Assistance Guide in SERP which contains hyperlinks to various IRM and other references for quick access to guidance for examiners to assist in the handling of taxpayer telephone calls.

The National Taxpayer Advocate recommends the that IRS align the procedures used by tax examiners in locating taxpayers and handling undeliverable mail in IRM 4.19.13 with the procedures used by tax compliance officers in IRM 4.10.2. During notice generation at the campus level, the address is systemically referenced against the most current IRS Master File address data for the taxpayer. In addition, when the notice is received at the National Print Site for mailing, another check is performed on the address to determine if it is a valid postal address prior to the mail-out. These procedures are fully consistent with the law and we believe they ensure that a majority of all correspondence reaches its intended recipient. IRS data indicates that currently only about six percent of correspondence examination notices are undelivered.⁶² Further, much of the guidance in IRM 4.10.2 that applies to more complex office and field examinations, such use of third party contacts, postal tracer services, etc., are impractical in the campus correspondence examination environment.

Finally, the National Taxpayer Advocate recommends that the IRS stop using the combo letter in all correspondence examinations. As noted above, Uniform Work Requests for programming that will eliminate use of the combo letter in all but a few situations are in the implementation process. The IRS will also evaluate discontinuing the use of these letters for the remaining cases.

Taxpayer Advocate Service Comments

The National Taxpayer Advocate commends the IRS for its commitment to improving the correspondence examination program, for its innovation in the development of new customer service delivery systems, and for its willingness to work collaboratively with TAS and the practitioner community to improve customer service while seeking ways to reduce costs and burdens faced by taxpayers in complying with the law. The IRS's proactive approach to addressing the concerns of the NAEA, and its willingness to rethink its position on the use the combo letter are good examples of this commitment. The creation of a Taxpayer Communications Task Group, along with the aggressive use of focus groups, customer surveys, and national phone forums all serve to enhance the notice improvement process and improve communications with taxpayers. The advent of Universal Call Routing holds the promise of transforming IRS call sites into world class operation centers. Despite these system enhancements and service improvements, the National Taxpayer Advocate remains concerned that the unregulated growth in correspondence examinations is undermining the agency's ability carry out its mission and is burdening taxpayers.

The IRS's reliance on a rigid automated system for conducting examinations eliminates flexibility, a crucial element of the exam process. Adhering to the expiration of automated timeframes to move cases through the process could prematurely push cases forward, because taxpayers may not have sufficient time or assistance to respond to IRS requests for information. The automated process limits the ability of taxpayers to engage in a meaningful dialogue with tax examiners, to ask questions about the process and the issues, and to resolve problems that invariably arise during the course of an examination. While the National Taxpayer Advocate is pleased the IRS is communicating with stakeholders, such as the NAEA, the examples these stakeholders share continue to illustrate the type of problems that can arise when relying on an automated system to conduct examinations.⁶³

The National Taxpayer Advocate applauds the IRS's efforts to improve the control and tracking of unassociated correspondence and understands the challenges heavy volumes of mail can create. It is important to note the batch system cannot be effective unless correspondence is properly controlled and recorded upon receipt. Additionally, it is unacceptable for the IRS to send 2.9 million "interim" letters advising taxpayers to expect delays of 30 days or more in processing their correspondence, which is over and above the IRS's acceptable 30-day initial processing period.⁶⁴ These correspondence delays create additional follow-up contacts from concerned taxpayers, such as duplicate return filings, duplicate correspondence, calls to the IRS's toll-free line, and TAS referrals: all of which result in unnecessary rework for IRS employees.⁶⁵ In regard to the 241 percent figure, this number accurately represents the challenges the IRS is experiencing in addressing taxpayer correspondence in a timely fashion as compared to the increase in discretionary examinations in 2007 to 2008. No matter what percentage may be used, it is clear overage mail remains an issue.⁶⁶

The National Taxpayer Advocate acknowledges that the IRS is often under extraordinary pressure to do a number of tasks, including conducting examinations. However, in the past several years, the IRS has shifted from assisting taxpayers in understanding their tax obligations and resolving audit problems to closing cases and reducing examination cycle time. The IRS relies too heavily on moving cases along through an automated system, rather than considering all taxpayer correspondence and making sure the taxpayer understands his or her obligations. This approach may cause faulty tax assessments, premature enforcement actions, or unnecessary burden and anxiety to the affected taxpayers.

The National Taxpayer Advocate supports the IRS's plans to conduct case reviews as part of an ongoing study to promote the effective use of the telephone in resolving correspondence examinations. Particular emphasis should be placed on adherence to IRM 4.19.13.9.1, which requires examiners to make telephone contact with taxpayers to resolve issues and clarify information needed before issuing a request for additional information. The National Taxpayer Advocate also urges the IRS to consider issuing a SERP alert to emphasize the importance of telephone contact, to mandate its use, and to stress the importance of adherence to IRS policy. A separate alert will reinforce and direct employees' attention to the IRM instruction. The IRS should also develop training materials for tax examiners covering telephone examination techniques.

The National Taxpayer Advocate disputes the IRS contention that merely satisfying the letter of the law represents an adequate attempt to contact taxpayers for the purpose of conducting examinations, especially in view of the high default rates and future downstream rework generated by audit reconsiderations. Moreover, the IRS has not presented data to support its contention that the use of postal tracers and third party contacts, typically used to contact taxpayers in office and field audits, is impractical for use in the context of correspondence examinations. The National Taxpayer Advocate believes the IRS should make a greater effort to locate and contact taxpayers before issuing a statutory notice of deficiency on "no reply" cases.

The National Taxpayer Advocate has long advocated for the IRS to stop using the combo letter in all correspondence examinations, and is pleased to report the IRS has agreed to eliminate the combo letter in all but a few examination programs, e.g., non-filers and criminal investigations referrals that have high potential for audit adjustments, beginning in 2010. While the National Taxpayer Advocate would urge this action without delay, she commends the IRS for its willingness to consider the complete elimination of the combo letter and looks forward to working with the IRS in exploring this possibility.

Recommendations

The National Taxpayer Advocate recommends the IRS take the following actions to improve the correspondence examination process:

² For a detailed discussion of the suitability issues relating to correspondence audits, see Most Serious Problem, Suitability of the Examination Process, supra.

³ Wage and Investment Division (W&I), Compliance Measures (June 2008). Correspondence examinations do not include related compliance programs (e.g., Automated Underreported (AUR), Substitute-for-Return, (SFR), CP 2000, or Math Error programs). The discretionary correspondence examination mail figures are exclusive of any of the other compliance programs and reflect a 242 percent increase in overage correspondence.

⁴ National Taxpayer Advocate 2007 Annual Report to Congress, vol. 2, 107.

⁵ Treasury Inspector General for Tax Administration (TIGTA), Ref. No.2008-30-095, Trends in Compliance Activities Through Fiscal Year 2007 35, 45 (Apr. 18, 2008).

⁶ IRS Pub. 556, Examination of Returns, Appeals Rights, and Claims for Refund, 3 (Rev. May 2008).

⁷ TIGTA, Ref. No.2008-30-095, Trends in Compliance Activities Through Fiscal Year 2007, 7 (Apr. 18, 2008).

⁸Id. at 8.

⁹Id. at 35.

¹⁰Id.

¹¹Id.

¹² IRM 4.19.13.1 (Jan. 1, 2007). In FY 2007, the IRS changed the definition of high-income nonfilers from greater than $100,000 in income to greater than $200,000 in income; TIGTA, Ref. No. 2006-30-105, While Examinations of High-Income Taxpayers Have Increased, the Impact on Compliance May Be Limited (July 2006), 6. See also National Taxpayer Advocate 2006 Annual Report to Congress 292.

¹³ IRM 4.10.3.16.9 (Mar. 3, 2003); IRS, Strategic Plan, 2005-2009, 19; Tax Fairness: Policy and Enforcement: Hearing Before the Subcomm. on Financial Services and General Government, H. Comm. on Appropriations, 110th Cong. (Mar. 5, 2007) (statement of Nina E. Olson, National Taxpayer Advocate).