National Taxpayer Advocate Nina Olson told Congress in her annual report that the Internal Revenue Service is not doing enough to assists victims of tax-related identity theft and tax return preparer fraud.
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The number of tax-related identity theft incidents has increased substantially in recent years, Olson noted. Within the Taxpayer Advocate Service, which Olson leads, identity theft case receipts increased by more than 650 percent from fiscal year 2008 to FY 2012. At the end of FY 2012, the IRS had nearly 650,000 identity-theft cases in its inventory.
The problem has grown worse as organized criminals have found ways to steal the Social Security numbers 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.
The report acknowledged that 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 labyrinthine procedures and drawn-out timeframes for problem resolution. 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 found that 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.
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.”
The report also criticized 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 said the taxpayer-victim is legally entitled to receive the refund, and the IRS has no legal basis for withholding it.
The National Taxpayer Advocate’s annual report also identified the need for tax reform as the overriding priority in tax administration and the most serious problem facing taxpayers. The report recommended 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.”
The report noted 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 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 stated. “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.
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 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.
The report recommended 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.”
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 of Congress 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 and Budget
In the report, Olson also expressed concern that the IRS is not adequately funded to serve taxpayers and collect taxes.
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 noted.
“The IRS is materially different from other discretionary programs in that it serves as the de facto Accounts Receivable Department of the federal government,” she said. “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.”