The Internal Revenue Service Oversight Board issued a warning to Congress that the IRS is operating in a high-risk environment with budget constraints leading to lower staffing levels and reduce customer service for taxpayers.

In its annual report to Congress, the IRS Oversight Board praised the IRS for the progress it has achieved over the past fiscal year in making the nation’s tax system more efficient and effective, but cautioned that further budget cuts could potentially erode the agency's ability to collect revenue to fund essential government programs.

The report also called for continued progress in the fight against tax refund fraud and said the IRS needs to stay focused on its key mission and strategic goals despite its expanded duties.

The IRS Oversight Board took note of milestones achieved by the IRS in fiscal 2012 in a number of key areas, such as technology, enforcement and issue resolution. Most notable was the successful launch of the Customer Account Data Engine 2, or CADE 2, in January 2012, allowing the IRS to migrate from a weekly to a daily processing cycle for individual taxpayer accounts.

"The successful standup of CADE 2 and the releases to follow hold the potential for providing substantial benefits to taxpayers and the IRS," said board chairman Paul Cherecwich, Jr. in a statement. "Moreover, CADE 2's importance to our tax system should not only be seen through the lens of better customer service, such as faster processing of many refunds and up-to-date taxpayer account information. This new relational database also paves the way toward real-time data analytics that can help the IRS better detect trends and patterns in non-compliance and better focus its resources to combat them."

The board's report also highlighted a number of other IRS programs that turned in solid results in fiscal 2012. The individual electronic filing program crossed the 80 percent threshold in 2012, achieving the e-file goal originally set in the IRS Restructuring and Reform Act of 1998.

In addition, the IRS announced in June 2012 that it had collected more than $5 billion in back taxes, penalties, and interest from the three Offshore Voluntary Disclosure Programs. The Oversight Board also praised the IRS for challenging the assumption that there must be an adversarial relationship between large corporate taxpayers and the IRS. To this end, the IRS has bundled together a suite of issue resolution programs that continued to gain popularity in FY2012 and saved both taxpayers and the IRS time and money.

However, the IRS Oversight Board expressed its continued concern over IRS resources. The IRS’s FY2012 enacted budget was $330 million less than the FY2011 level. To deal with these budget constraints, the IRS offered buyouts to thousands of its employees and sought efficiencies wherever it could, such as closing 43 of its smaller offices. According to the board's report, the IRS and taxpayers are already feeling the effects of these budget cuts.

Last year, the IRS had to set the telephone assistor level of service below what the board deemed an acceptable level because it did not have the resources to hire more customer service representatives.

“In spite of a more than $4-to-$1 return on investment, the IRS remains a target for further budget cuts,” said Cherecwich. “The board has repeatedly expressed its concern about the impact of any additional budget cuts on IRS service and compliance levels. If this trend continues, it could compromise the IRS’s ability to collect the taxes due with serious repercussions for our nation, the economy, and the integrity of our tax system.”

Other areas of risk identified in the board's annual report included the ability of taxpayers, tax practitioners and IRS employees to communicate, resolve issues, and conduct more business electronically; better strategies for identifying and stopping tax refund fraud; the IRS's expanded portfolio of duties that go beyond its core mission; the potential for large-scale retirements and the subsequent loss of institutional knowledge; and the expiration of the streamlined critical pay provision in 2013.