Struggling taxpayers hurt by IRS collection practices

National Taxpayer Advocate Nina E. Olson found that IRS collection practices are harming financially struggling taxpayers without producing significant revenue gains according to her annual report to Congress released Wednesday.

Olson also concluded that increased demands on the IRS have eroded the agency's ability to meet taxpayer service needs. But she did pat the IRS on the back for its success in implementing significant legislative changes designed to stimulate the economy in the middle of the filing season.

How is the IRS harming taxpayers? She says IRS lien filing policies creates serious problems for taxpayers. Over the past decade, the IRS increased its lien filings by nearly 475% – from about 168,000 in FY 1999 to nearly 966,000 in FY 2009, yet overall inflation-adjusted collection revenue declined by 7.4% during this period.
The IRS uses automated systems to file liens against taxpayers, even when the taxpayer possesses minimal or no property and the lien will do little more than damage the taxpayer's financial viability and access to credit. Her study found no obvious causal relationship between the number of lien notices filed and the amount of overall revenue collected.

She also found that IRS procedures for determining a taxpayer's ability to pay outstanding tax liabilities may be driving some taxpayers into long-term noncompliance because the IRS fails to consider other debts such as credit card balances, school loans, and actual hospital or medical bills. Other tax systems, including Sweden's, consider the taxpayer's overall financial picture during the collections process.

"Any taxpayer with these debts will tell you that these creditors don't go away," Olson wrote in the report. "Taxpayers are placed in the intolerable position of agreeing to pay the IRS more than they can actually afford (given their other debts) and then defaulting on the IRS payment arrangements when they channel payments to unsecured creditors in order to get some peace. Thus, the IRS itself fosters noncompliance by its failure to take a holistic approach to the taxpayer's debt situation."

Olson recommends that Congress require the IRS, before imposing a lien, make a determination that the benefits of filing the lien outweigh the harm to the taxpayer and will not jeopardize the taxpayer's ability to comply with future tax obligations.

Federal law requires the National Taxpayer Advocate, an office within the IRS, to submit an annual report to Congress each year identifying at least 20 of the most serious problems encountered by taxpayers and to make administrative and legislative recommendations to mitigate those problems.

Overall, this year's report identifies 21 problems, provides updates on two previously identified issues, makes dozens of recommendations for administrative change, proposes 11 recommendations for legislative change, and analyzes the 10 tax issues most frequently litigated in the federal courts during the past fiscal year.

Telephone service another problem

Olson's report found that the IRS's ability to answer phones is declining and creating serious problems for taxpayers. She noted that the IRS set a target for FY 2010 of answering 71% of calls from taxpayers seeking to speak with a customer service representative about account questions, down from 83% in FY 2007.

"In other words, the IRS is planning to be unable to answer about three of every 10 calls it receives," Olson wrote, adding that the IRS expects those who get through will have to wait an average of 12 minutes.

The report states that this projected level of service is barely above the level of 69% notched in 1998, when Congress passed the landmark IRS Restructuring and Reform Act due in large part to concerns about inadequate taxpayer service. "This level of service is unacceptable," Olson wrote.

Preparer regulation praised

Olson praises the IRS for moving ahead with plans to regulate federal income tax preparers. She called the plan, which the IRS issued earlier this week, a "significant, far-reaching initiative."

Under current law, anyone may prepare a tax return for compensation, with no training, licensing, or oversight required. While attorneys, CPAs, and Enrolled Agents must pass difficult examinations to practice, others (known as "unenrolled preparers") are not required to do so. To protect taxpayers and improve tax compliance, Olson has proposed since 2002 that unenrolled preparers be required to register with the IRS, pass an examination, and complete periodic continuing education courses.

The IRS plan announced this week would impose these requirements on return preparers who sign tax returns but not on preparers who meet with taxpayers and prepare their returns if someone else signs them.

To minimize cost and burden, a return preparation business may decide to employ one "signing" preparer who is certified under the new IRS rules and an unlimited number of "nonsigning" preparers. The nonsigning preparers would not have to register, pass an exam, or take continuing education courses, and the signing preparer would be unable to thoroughly review every return he signs (in part because the interview with the taxpayer is central to accurate preparation of the return).

Olson noted that the burden of the new rules themselves may cause more return preparation businesses to employ nonsigning preparers.

"We are concerned that excluding nonsigning preparers could create an exception that swallows the rule," the report states. The report notes that not all nonsigning preparers need to be covered to protect taxpayers and recommends that the IRS consider extending the new rules to apply to all unenrolled nonsigning preparers.

Rethink paying first policy

Olson thinks the IRS should rethink its pay refunds first, verify returns later approach, but I doubt many taxpayers would agree with her. Most want their money as quickly as possible. The problem is that under current procedures, the IRS processes income tax returns before it processes most information returns, including Forms W-2, Wage and Tax Statement, and Forms 1099, which report interest, dividends, and other payments.

"This sequence makes little logical sense," the report states. This sequence leads to millions of cases where taxpayers inadvertently make overclaims that the IRS does not identify until months later. Taxpayers are exposed not only to a tax liability but to penalties and interest charges as well.

Also the government takes loses in tax revenue because there is a greater chance of fraud. The IRS is then required to devote resources to recovering refunds that should not have been paid and that it often cannot recover.

The report recommends that Congress direct the Treasury Department to prepare a report identifying the administrative and legislative steps required to allow the IRS to receive and process information reporting documents before it processes tax returns. It recommends setting a goal of making these changes within six years.

Lita Epstein has written 25 books including The Complete Idiot's Guide to Tax Breaks and Deductions and The Complete idiot's Guide to Personal Bankruptcy.

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