National Taxpayer Advocate Nina E. Olson told Congress that proposed budget cuts for the Internal Revenue Service could reduce taxpayer service and compliance.

Nina Olson

Olson released her mid-year report to Congress on Wednesday and also testified before the Senate Finance Committee on Tuesday during a hearing on Tax Code complexity and the impact on the $345 billion tax gap (see Congress Finds Tax Code Complexity Contributes to Tax Gap).

On the funding side, the IRS’s appropriations in fiscal year 2011 were reduced by 0.2 percent in nominal dollars and by more when increased costs are taken into account as compared with the previous year. The funding level for fiscal 2012 remains uncertain as House Republicans push for reducing the IRS budget.

“In recent years, the IRS has been given more and more tasks, but it is not receiving the resources it needs to fulfill these tasks without cutting corners,” the report said. “And when the IRS cuts corners, taxpayers can be harmed and revenue collection may suffer.”

The last few years have been particularly challenging for taxpayers and the IRS, as the recently enacted Economic Stimulus Payments, First-Time Homebuyer Credit, and Making Work Pay Credit, among other tax benefits, have proven complex to claim or substantiate and have led to a significant increase in taxpayer inquiries and problems, the report noted.

The National Taxpayer Advocate has previously suggested that the IRS generally be exempt from budget caps or reductions. She has noted that the “tax gap” (i.e., the amount of tax due but not paid voluntarily and timely) is estimated to be about $345 billion a year. “As the de facto ‘Accounts Receivable Department’ of the federal government, the IRS collects well over 90 percent of all federal revenue,” the report noted. On a budget of about $12.1 billion, the IRS collected $2.35 trillion in fiscal year 2010, or about $194 in federal revenue for each dollar it spent.

“Despite differing views about the appropriate level of taxation, there is widespread agreement that taxes that are due and owing under the law should be collected,” aid the report. “Spending cuts mean the IRS will not have the resources to ensure that all taxpayers pay their fair share, thereby effectively forcing compliant taxpayers to pay more to subsidize noncompliance by others. Moreover, the IRS will not have the ability to meet the service needs of the taxpayers who are paying our nation’s bills.”

The IRS’s ability to respond to taxpayer phone calls and correspondence has declined, the report found. Comparing fiscal 2010 with FY 2004, the percentage of phone calls the IRS answered from taxpayers seeking to reach a telephone assistor declined from 87 percent to 74 percent, and the percentage of unanswered correspondence classified as “overage” at year’s end increased by 135 percent.

The report also expresses concern about the ability of the Taxpayer Advocate Service itself to meet taxpayer needs.

“Congress created TAS largely to serve as the IRS’s ‘safety net’ for taxpayers who are experiencing significant hardships,” the report said. “In practice, TAS is often a taxpayer’s last resort for resolving a tax problem.”

TAS’s case receipts have risen from about 169,000 in fiscal 2004 to about 299,000 in fiscal 2010, an increase of 77 percent. The report expressed concern that if TAS does not receive sufficient resources to handle its growing workload, it will have no choice but to decline to accept certain categories of cases, leaving taxpayers to fend for themselves.

In fiscal 2012, TAS will continue to study the adequacy of the resources available to the IRS to enable it to fulfill its tax collection and taxpayer service responsibilities, and will continue to advocate for a reasonable balance between the IRS’s responsibilities and its resources.

The report also covered other areas, including collection practices at the IRS. The National Taxpayer Advocate has expressed concern about IRS collection practices in prior reports and has, in particular, made recommendations to reduce the harm that unproductive liens can inflict on taxpayers. The latest report praises several recent changes the IRS has announced, including making lien withdrawals available to taxpayers in a wider range of cases.

However, the report expressed continuing concern about the IRS’s practice of automatically filing tax liens based on a dollar threshold instead of basing lien-filing decisions on an analysis of the taxpayer’s financial situation. The National Taxpayer Advocate believes that such an analysis “should balance the need to protect the government’s interests in the taxpayer’s assets with a corresponding concern for the financial harm the lien will create for that taxpayer.”

In cases where the IRS has determined a taxpayer is suffering an economic hardship or possesses no significant assets, the filing of a lien is unlikely to further tax collection but will further damage a taxpayer’s credit rating, thus harming the taxpayer, increasing the taxpayer’s cost of living, and reducing the chance the taxpayer will be able to obtain a job and pay off the tax debt.

In fiscal year 2012, TAS will work with the IRS to fully evaluate the results of its limited changes to the lien-filing process and identify additional opportunities for improvement. In addition, TAS is conducting its own study of the impact of lien filings on future tax compliance and will refine its recommendations based on the study results.

Additional areas on which the National Taxpayer Advocate intends to focus in the coming year include the

•  Taxpayer Impact of Possible Government Shutdown. As part of the federal government’s preparations for the possibility of a government shutdown earlier this year, the IRS revised its contingency plan to identify the limited functions it could perform. The plan identified excepted activities relating to the protection of government property, but it made no allowance for the protection of taxpayers’ lives or property, including the processing of paper tax returns and related refunds. The National Taxpayer Advocate believes the permissible activities defined in the Anti-Deficiency Act should be clarified to provide protection for taxpayers’ lives and property, and will address this issue in her 2011 Annual Report to Congress.

• Tax Reform and Tax Complexity. The National Taxpayer Advocate will continue to engage the taxpaying public in a dialogue about fundamental tax simplification. To help advance this process, TAS has established an electronic suggestion box to solicit comments from taxpayers regarding which tax breaks they would be willing to give up to achieve a simpler tax system and which tax provisions they consider to be particularly unfair. To date, TAS has received some 1,500 comments. A selection of these comments is posted at http://www.taxpayeradvocate.irs.gov/2012-Objectives-Report.

• Earned Income Tax Credit Improvements. The EITC is often criticized for the relatively high level of “improper payments” associated with the credit. While some overclaims result from purposeful false claims, considerable noncompliance results from the difficulty taxpayers face in substantiating their claims to the satisfaction of the IRS, notably by proving that a qualified child lived with the taxpayer for more than half the year and bears the requisite familial relationship. In FY 2012, TAS will review proposals and apply previous research findings to help reduce EITC noncompliance.

• Tax-Related Identity Theft. Despite significant IRS efforts to reduce tax-related identity-theft problems, the IRS continues to experience difficulties in expeditiously resolving these cases and TAS’s identity theft-related cases continue to increase. TAS will continue to work with the IRS to mitigate identity theft problems, improve identity theft case processing, and follow up on the National Taxpayer Advocate’s previous recommendations in this area.

•  Innocent Spouse Relief. The Tax Code currently contains “innocent spouse” rules designed to shield individuals from responsibility for joint tax liabilities generally attributable to their spouse (or former spouse) in appropriate cases. However, equitable relief for otherwise eligible taxpayers is barred if an “innocent spouse” request is not filed within two years from the date of the first IRS collection action. For reasons detailed in prior National Taxpayer Advocate reports, this “two-year rule” can lead to harsh results. TAS looks forward to working with the IRS to improve the rules. TAS is also partnering with a domestic violence coalition to provide training for TAS and IRS public contact employees about assisting and working with taxpayers who are victims of domestic violence and abuse.