“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,” she added.
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On a budget of $11.8 billion, the IRS collected $2.52 trillion in FY 2012. That translates to an average return-on-investment 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.”
The report said 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.”
The report identified 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.
National Treasury Employees Union president Colleen M. Kelley concurred with Olson's assessment. “Failing to fund the IRS adequately undercuts the ability of other federal agencies to perform their missions, hampers efforts to close the $400 billion annual tax gap and address the deficit,” Kelley said in a statement. “Taxpayers are already feeling the impacts of underfunding the IRS with fewer phone calls answered and difficulty getting face-to-face assistance. Overall, IRS staffing is down precipitously. The IRS carried out the 2012 tax-filing season, processing nearly 236 million tax returns, with 5,000 fewer employees than a year earlier. Even with decreased staffing, IRS employees are helping taxpayers deal with an increasingly complex Tax Code, but workers are stretched to the limit in trying to respond to questions, as the report demonstrates. This year, a delay in the start of the filing season will further strain the agency.”
Olson's report recommended 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.
Other Key IRS Problems
Federal law requires the National Taxpayer 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.
• 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 c
ould 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.