As IRS Tax Filing Season Begins, There's Bad News For Honest Taxpayers

Janet Novack writes about tax and retirement policy and planning for Forbes and says:  With this year’s tax filing season set to begin in a week, there are ominous signs for honest folks who want to complete their 1040s and pay what they owe (not more or less) with a minimum of hassle.  Customer service at the Internal Revenue Service is dismal and deteriorating. (Only 68% of telephone callers who wanted to talk to a human at the IRS last tax filing season reached one, and then only after an average 17 minute wait.)  The epidemic of identity theft refund fraud hasn’t yet been contained.  Hope for a major reform that might simplify the tax code is waning. And last Friday a federal judge issued a permanent injunction blocking an IRS plan to regulate and enforce some minimum competency and continuing education requirements on hundreds of thousands of currently unregulated paid tax preparers.

“If the injunction stands, the taxpayers of the United States will be grievously harmed,” IRS National Taxpayer Advocate Nina E. Olson told Forbes. “The practical effect of not having some kind of consumer protection for taxpayers going to return preparers is enormous. And I say that seeing all the return preparer fraud, and the return preparer negligence, and the return preparer inadvertent mistakes that happen.” (Olson’s Congressionally created office acts as a watchdog for taxpayer rights, making policy recommendations and helping individual taxpayers deal with the IRS; it logged nearly 220,000 cases last year.)

In an interview Tuesday, Olson painted a depressing picture of how a variety of trends are coming together to create problems for taxpayers. “It’s this endless loop,’’ she said.  “You’ve got a complex tax law. People need to call to ask questions about things. And then they can’t get through and then they make mistakes, or they go to unscrupulous preparers, or preparers who aren’t educated, who make mistakes, and then you’re in this enforcement cycle.”

In the enforcement cycle, she adds, ordinary taxpayers get computer generated IRS letters demanding more money or documentation. When they call the IRS with questions related to these notices, they end up on hold. Then they mail their letters to the IRS explaining why they think the IRS’ proposed bill is wrong  or providing the requested documentation, and encounter yet another problem— the IRS is falling further behind on answering taxpayer correspondence.  According to Olson’s recent 2012 Annual Report To Congress, at the end of fiscal 2012, on Sept. 30^th, the IRS had more than a million pieces of correspondence from taxpayers waiting to be answered (up 188% from the inventory at the end of 2004), with nearly half of those letters more than 45 days old (up 316 percent from 2004.)

No, IRS workers aren’t suddenly slacking off.  In a statement last week, the IRS blamed a decline in some performance measures, including a drop in audit coverage and collections, on an 8% decline in its workforce since 2010, plus a doubling of the staff it has assigned to fight identity theft refund fraud. That’s where a fraudster (in some cases, a crooked tax preparer) uses stolen Social Security numbers to electronically file bogus returns seeking refunds. The IRS has gotten much better at screening for and preventing the payment of such fraudulent claims, Olson says, but the epidemic isn’t yet contained and the honest folks whose identities have been hijacked end up going through a lot of grief and waiting six months or more for their refunds. At the end of fiscal 2012,  the IRS had almost 650,000 identity theft cases in its inventory, Olson reports.

Now if you’ve never had your Social Security number stolen, and you’ve never gotten a letter from the IRS ‘demanding more money or documentation, you may not know what Olson is talking about. Nearly 60% of taxpayers pay a pro and the majority of those pros are, no doubt, competent and honest.  As for do-it-yourselfers, the IRS’ web site is pretty useful and tax software like Intuit’s TurboTax and H &R Block’s AtHome mask a lot of the tax code’s insane complexity. (That’s provided you don’t try to understand the calculations on your IRS Form 6251, Alternative Minimum Tax.)

But what if you have a question you want to ask a real human being? According to a recent report from Congress’ Government Accountability Office, the IRS had the “full time equivalent” of  about 13,500 customer service representatives answering taxpayer calls and mail in 2011 and 2012, down from 15,000 in 2010. So even though the IRS has added more automated features to handle some calls, the average wait for a human grew to 17 minutes last year, from 9.5 minutes in 2010 and just 4.6 minutes in 2007,  when 81% of callers got through to a human, before either becoming discouraged and hanging up or being cut off. (For the IRS, 81% is considered good service.)

These days, even the most knowledgeable taxpayers can find dealing with the IRS a pain. Just read the account here from Forbes Associate Editor and tax maven Ashlea Ebeling who got a computer generated Automated Under Reporter (CP 2000) notice demanding $3,242 in additional 2010 tax last year, spent  20 minutes on hold before giving up on speaking to a person at the IRS, wrote a letter explaining why the agency was wrong, and then waited two months for an IRS reply acknowledging she owed no extra tax on her CPA-prepared return. (Unlike most taxpayers, she wasn’t intimidated by the letter and knew enough to challenge it herself, so she didn’t have to pay her CPA extra to resolve the issue.) Think this can’t happen to you? It’s not that unusual. The IRS sends out nearly five million AUR notices, plus five million “math error” notices annually. In addition, 1.4 million individual returns were examined in FY 2012, with 1.1 million of those done in “correspondence” audits, in which taxpayers are asked to send in documentation to substantiate some item, such as their charitable deductions. (For context, about 140 million individual tax returns are filed each year.)

In Ebeling’s case, the IRS challenged numbers related to dependent care benefits and distributions from her Health Savings Account, illustrating yet another reason honest taxpayers’ hassles with the IRS are growing. Over the last two decades, Olson points out, Congress has been using the tax code to deliver ever more social welfare benefits. So there are dozens of different tax breaks—and in some cases big refundable tax credits– for the working poor, kids, child care, adoption, college tuition, retirement savings, high deductible health plans, and even green remodeling. The refundable credits are a magnet for fraud. Plus, most of these breaks  have tricky eligibility rules and substantiation requirements, leading to confusion and honest mistakes— by both taxpayers and the IRS.

Here’s just one example, from Olson’s latest report, of the strains on the tax system. Congress created the adoption credit on a temporary basis in 1997 and  then kept renewing and increasing it. In 2010, as part of ObamaCare, Congress made it into a fully refundable $13,170 credit for 2010 and 2011—meaning a stipend adoptive parents could receive even if they hadn’t paid any income taxes.  (The fiscal cliff tax deal made the adoption credit permanent, at a maximum of $12,650 for 2012 and $12,970 for 2013, but eliminated refundability.) 

Understandably, with $13,170 checks being written by the Treasury, the IRS wanted to be vigilant. It audited 69% of the 2011 tax returns seeking the adoption credit, forcing taxpayers to wait months for their refunds. Many of the audited taxpayers had missing or potentially invalid paperwork.  Yet when all was said and the done, the IRS disallowed only $11 million of $668 million in 2011 adoption credit claims, Olson reports.  A lot of grief for parents and the IRS.

Now here’s where the unregulated tax preparers come in: After the expansion of the refundable earned income tax credit in the 1990s, Olson notes, folks who knew nothing about the tax law (and in some cases were happy to break the law) started hanging out their shingles as preparers and using tax software to process returns seeking EITC refunds. Yet because of all the complications surrounding the EITC and other tax benefits,  tax preparers really need to know  the tax law, just as the IRS must be able to promptly answer its phones and explain that law.  Sounds sort of obvious.