WASHINGTON
— National Taxpayer Advocate Nina E. Olson today released her 2012 annual
report to Congress, identifying the need for tax reform as the overriding
priority in tax administration. The Advocate also expressed concern that the
Internal Revenue Service is not adequately funded to serve taxpayers and
collect tax, and identified ways in which this chronic underfunding harms
taxpayers and the public fisc. She also found that the IRS is not doing enough
to assist victims of tax-related identity theft and return preparer fraud.
TAX REFORM
The National Taxpayer Advocate’s annual report designates the complexity of the tax code as the #1 most serious problem facing taxpayers and recommends that Congress take significant steps to simplify it. “The existing tax code makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns,” Olson wrote. “It obscures comprehension, leaving many taxpayers unaware how their taxes are computed and what rate of tax they pay; it facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud; and it undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply.”
Compliance Burdens. The report states that the tax code
imposes a “significant, even unconscionable, burden on taxpayers.” Since 2001,
Congress has made nearly 5,000 changes to the tax code, an average of more than
one a day, and the number of words in the code appears to have reached nearly
four million.
An analysis of IRS data by the Taxpayer Advocate Service (TAS) shows that
individuals and businesses spend about 6.1 billion hours a year complying with
tax-filing requirements. “If tax compliance were an industry, it would be one
of the largest in the United States,” the report says. “To consume 6.1 billion
hours, the ‘tax industry’ requires the equivalent of more than three million
full-time workers.”
Individual taxpayers find return preparation so overwhelming that few do it on
their own. Nearly 60 percent of taxpayers hire paid preparers, and another 30
percent rely on commercial software, with leading software packages costing $50
or more. In other words, taxpayers must spend money just to figure out how much
money they owe.
Magnitude of “Tax Expenditures.” To reduce taxpayer
burden and enhance public confidence in the integrity of the tax system, the
report urges Congress to greatly simplify the tax code. In general, this means
Congress should reassess the need for existing income exclusions, exemptions,
deductions and credits (generally known as “tax expenditures”). For fiscal year
(FY) 2013, the Joint Committee on Taxation has projected that tax expenditures
will come to about $1.09 trillion, while individual income tax revenue is
projected to be about $1.36 trillion. To put these numbers in perspective, if
Congress were to eliminate all tax expenditures, straight math indicates it
could cut individual income tax rates by 44 percent and still generate the same
amount of revenue it collects under current rules.
Tax Policy Decisions and Revenue Decisions Should Be Made Separately
and Then Married Up. The report recommends that Congress approach
tax reform in a manner similar to zero-based budgeting. The starting assumption
would be that all tax expenditures would be eliminated. A tax break would be
retained only if a compelling case can be made that the benefits of that break
outweigh the complexity burden it creates. “In performing this analysis,” Olson
said in releasing the report, “we should look at each provision in the code and
ask questions like: ‘Does this government incentive make sense?’; ‘If it does,
is it better administered through the tax code or as a direct spending
program?’; ‘However well intentioned, is it doing what it was intended to do?’;
and ‘If yes, can it be administered without imposing unreasonable burdens on
taxpayers or the IRS?’. At the same time, Congress can separately consider how
much revenue it wants to raise, and it can then marry up our optimally designed
tax system with our revenue needs by setting tax rates accordingly.”
Recommendations. The report recommends that Members of
Congress take several steps, including:
1) Lay the groundwork for tax reform by holding meetings with constituents to discuss the complexity of the existing tax code and the trade-offs between tax rates and tax breaks that tax reform will require.
2) Apply a “zero-based budgeting” approach to comprehensive tax reform that starts out with the assumption that all tax benefits will be eliminated and then adds a benefit back only if Members conclude that, on balance, the public policy benefits of providing that benefit through the tax code outweigh the complexity it imposes on taxpayers.
IRS
FUNDING
The IRS budget has been reduced in each of the last two fiscal years, and
appears likely to face further cuts in coming years. Although these cuts
reflect across-the-board reductions in federal discretionary spending,
underfunding the IRS makes no sense, Olson said. “The IRS is materially
different from other discretionary programs in that it serves as the de facto
Accounts Receivable Department of the federal government. Each dollar
appropriated for the IRS generates substantially more than one dollar in
additional revenue. It is therefore ironic and counterproductive that concerns
about the deficit are leading to cuts in the IRS budget, when those cuts are
making the deficit larger.”
Olson added: “The plain truth is that the IRS’s mission trumps all other agencies’ missions, because without an effective revenue collector, you can’t fund those other agencies.”
Olson added: “The plain truth is that the IRS’s mission trumps all other agencies’ missions, because without an effective revenue collector, you can’t fund those other agencies.”
IRS Funding Decisions Fail to Take Into Account “Return on
Investment.” On a budget of $11.8 billion, the IRS collected $2.52
trillion in FY 2012. That translates to an average return-on-investment (ROI)
of about 214:1. Yet the appropriations process treats the IRS like any other
discretionary spending program, with no explicit recognition that each dollar
appropriated for the IRS generates substantially more than one dollar in
additional revenue. Last year, the IRS Commissioner estimated in a letter to
Congress that proposed reductions in the IRS budget would cause tax collections
to fall seven times as much.
“No business would fail to fund a unit that, on average, brought in $7 for
every dollar spent. Shareholders would rebel and bring lawsuits, or at least
oust the management or board of directors,” Olson wrote in her preface to the
report. “Yet this is precisely what we are doing with the IRS budget.”
Lack of Funding Hampers Taxpayer Service. The report
says that lack of funding is also preventing the IRS from meeting taxpayer
needs. Since FY 2004, when taxpayer service levels peaked, the IRS’s performance
in handling telephone calls and correspondence has been declining. In FY 2004,
the IRS answered 87 percent of all calls seeking to reach a live telephone
assister, and the average wait time was just over 2½ minutes. In FY 2012, the
IRS answered just 68 percent of its calls, and those who got through spent an
average of nearly 17 minutes waiting on hold. In FY 2012, the IRS received over
10 million letters in response to proposed tax adjustments, and at the end of
the year, 48 percent of all taxpayer correspondence in its inventory had not
been processed within established timeframes – up dramatically from 12 percent
in FY 2004.
“Congress has enacted laws that now require more than 140 million individuals
to file income tax returns,” Olson said. “When taxpayers are attempting to
comply with laws that require them to turn over a significant portion of their
incomes to pay our nation’s bills, they have a right to expect that their
government will do a better job of taking their telephone calls and answering their
letters.”
Lack of Funding Impairs Taxpayer Rights and Increases Taxpayer
Burden. The report identifies numerous areas where lack of funding
is causing taxpayer problems. “Nowhere is this more apparent than in the IRS’s
increasing use of automated enforcement procedures,” Olson said. “To conserve
resources, the IRS has largely automated its correspondence audits and its
issuance of liens and levies. It typically moves forward with tax assessments
without first talking to taxpayers to give them a chance to substantiate their
return positions, and it proceeds with liens and levies before having a
conversation to find out whether a tax delinquency is due to financial
hardship, which would suggest that an installment agreement or
offer-in-compromise should be considered.” The report notes that the IRS’s
limited resources to conduct outreach and education to taxpayers (particularly
small businesses) and to enforce the laws also contribute to its inability to
close the annual tax gap, which was most recently estimated at nearly $400
billion in 2006. The report points out that noncompliance violates the rights
of compliant taxpayers, who indirectly pay more tax to make up the shortfall.
Based on Census Bureau data, the average household effectively paid an extra $3,300
in tax in 2006 to subsidize noncompliance by others.
Recommendations. The report recommends that Congress:
1) Consider revising the budget rules so that the IRS is “fenced off” from otherwise applicable spending ceilings and is funded at a level designed to maximize tax compliance, particularly voluntary compliance, with due regard for protecting taxpayer rights and minimizing taxpayer burden.
2) Keep in mind in allocating IRS resources that tax compliance requires an appropriate balance between high quality taxpayer service and effective tax-law enforcement, and funding should be provided in a manner that allows the IRS to maintain such a balance.
TAX-RELATED
IDENTITY THEFT
The number of tax-related identity theft incidents has increased substantially
in recent years. Within TAS, identity theft case receipts increased by more
than 650 percent from FY 2008 to FY 2012. At the end of FY 2012, the IRS had
almost 650,000 identity-theft cases in its inventory servicewide. The problem
has grown worse as organized criminal actors have found ways to steal the
Social Security numbers (SSNs) of taxpayers, file tax returns using those
taxpayers’ names and SSNs, and obtain fraudulent tax refunds. Then, when the
real taxpayer files a return claiming the refund, that return is rejected. The
impact on victims is significant. More than 75 percent of taxpayers filing
returns are due refunds, which average some $3,000 and are not paid until the
IRS fully resolves a case.
IRS Commitments. In 2008, the IRS Commissioner testified
about identity theft before a Senate Finance Committee hearing. He stated: “My
overall goal as the IRS Commissioner is that when a taxpayer [who is an
identity theft victim] contacts us with an issue or concern, we have in place a
seamless process that gets the issue resolved promptly.” Later that year, the
IRS established an “Identity Protection Specialized Unit” (or “IPSU”), which
was designed to provide centralized assistance to victims of identity theft.
The National Taxpayer Advocate supported the commitment to centralized and
prompt victim assistance.
IRS Performance. The report says the IRS has created
numerous task forces and other teams in recent years in an attempt to improve
its identity theft processes, yet victims still face the same “labyrinth of
procedures and drawn-out timeframes for resolution” that they faced five years
ago. The IRS is instructing its employees to advise identity theft victims that
it will take 180 days – half a year – to resolve their cases. Complicated cases
inevitably will take longer. Thus, the IRS’s procedural changes are not
providing faster relief.
The report also says the IRS has decided to reverse course and decentralize
victim assistance. It recently created specialized units within each of 21
individual functions to work on identity theft cases, apparently under the
belief that most identity theft cases involve a single issue that the relevant
specialized unit can work most efficiently. The report expresses concern about
this backtracking from a centralized approach.
One-Stop Shopping Needed. TAS itself handled nearly
55,000 identity theft cases in FY 2012, most of which involved multiple issues
that required actions by multiple units. The report expresses concern that
creation of 21 specialized units will erode the centralized role of the IPSU,
require taxpayers to speak with multiple functions, increase the time it takes
to resolve cases, and heighten the risk that some issues may not be addressed.
“Taxpayers need ‘one-stop shopping’ – a single point of contact they can work
with to resolve all issues in their cases – and the IRS needs a ‘traffic cop’
to make sure that all units complete their actions and that parts of cases do
not fall through the cracks,” Olson said. “And six months is an unacceptable
period of time to expect taxpayer-victims to wait. The IRS must do more to
provide the prompt and seamless assistance to identity theft victims that
Commissioner Shulman promised.”
OTHER KEY ISSUES ADDRESSED
Federal law requires the Advocate’s Annual Report to Congress to identify at
least 20 of the “most serious problems” encountered by taxpayers and make
administrative and legislative recommendations to mitigate those problems.
Overall, this year’s report identifies 23 problems, provides updates on six
previously identified problems, makes dozens of recommendations for
administrative change, makes seven recommendations for legislative change, and
analyzes the 10 tax issues most frequently litigated in the federal courts.
Among the “most serious problems" addressed are the following:
- The IRS’s failure to provide tax refunds to victims of preparer fraud. When a taxpayer is victimized by a preparer who receives a fraudulent refund by paper check, the IRS will issue a replacement refund to the taxpayer. However, the IRS will not issue a replacement refund when a taxpayer is victimized by a preparer who receives the fraudulent refund by altering the bank routing number on a direct-deposit request, even though the IRS has received legal advice that it may do so. Olson says the taxpayer-victim is legally entitled to receive the refund, and the IRS has no legal basis for withholding it.
- The IRS’s extraordinarily high audit rate of taxpayers who claim the adoption tax credit. Congress created the adoption tax credit to help low and middle income families afford the costs of an adoption, which are estimated to run as high as $40,000. Yet the IRS, partly using income-based rules, selected 69 percent of tax returns claiming the credit during the 2012 filing season for audit, compared with one percent of returns overall. These audits imposed significant burden on the affected taxpayers for several reasons, most notably because the median refund claim constituted nearly one-quarter of the taxpayers’ adjusted gross income for the year, and the audits on average took over four months. Despite the burden, the payoff was relatively small. The IRS denied only about 10 percent of the amounts claimed in tax year 2010, and as of mid-November had denied only about 1.5 percent of the amounts claimed in tax year 2011. The excessive focus on returns claiming the adoption credit burdened many taxpayers and could have the effect of negating Congress’s intent to encourage adoptions, the report says.
- The IRS’s Offshore Voluntary Disclosure programs and their failure to distinguish adequately between “bad actors” and “benign actors.” The IRS has sought to increase enforcement of Foreign Bank and Financial Accounts (FBAR) reporting requirements in recent years and has offered a series of voluntary disclosure programs designed to settle with taxpayers who had failed to file required FBAR forms. However, the report says, the programs generally applied a “one-size-fits-all” approach that required the payment of significant penalties and did not distinguish between “bad actors” and “benign actors.” By generally requiring taxpayers who make voluntary disclosures to “opt out” of the disclosure program and submit to comprehensive audits in order to avoid draconian penalties, the report argues that the program has caused excessive burden and fear for taxpayers who had reasonable cause for not filing FBAR forms or whose failure to file was inadvertent.
Research
Study on Factors Influencing Voluntary Tax Compliance by Small Businesses.
Volume 2 of the report contains
six research studies, including preliminary results of a survey of sole
proprietors that TAS commissioned to better understand factors that may affect
income tax reporting compliance. The Advocate’s office undertook the study
because the IRS has estimated that only 43 percent of sole proprietor income is
reported on tax returns, representing the largest portion of the tax gap (i.e.,
tax that is owed but is not timely and voluntarily paid). Developing a more
complete picture of the attitudes of this category of taxpayers therefore could
assist the IRS in improving tax compliance. Based on IRS computer scoring of
the likely compliance level of tax returns, the Advocate’s office selected a
sample of the most compliant and the least compliant returns and commissioned
an anonymous survey of certain groups of these taxpayers to determine
attitudinal and other differences. Among the preliminary findings:
- Respondents in the high-compliance group expressed more trust in government and the IRS.
- Respondents from low-compliance communities were suspicious of the tax system and its fairness.
- Respondents in the high-compliance group were more likely to use return preparers.
- Taxpayers in the low-compliance groups expressed less trust in tax preparers and were less likely to use them or follow their advice.
- Low-compliance taxpayers tended to be clustered in certain communities.
* * * * *
Please visit www.taxpayeradvocate.irs.gov/2012AnnualReport for more
information about this report, including an Executive Summary, downloadable
infographics on the Most Serious Problems, and videos of the National Taxpayer
Advocate discussing key issues.
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