Governments at all levels are faced with the need to raise more revenue in the wake of the current fiscal crisis. Both the Treasury Inspector General for Tax Administration and the Government Accountability Office have issued reports addressing the weakness in unpaid tax collection, the role of private debt collectors in attempting to collect some of that debt, and the misreporting of rental real estate activities that contribute to the tax gap.The GAO said that while collecting unpaid tax debt is part of any strategy to help ensure compliance and confidence in the tax system and reduce both the annual tax gap and the cumulative unpaid tax debt inventory, Congress and other stakeholders have raised questions about the effectiveness of the Internal Revenue Service collection process in helping ensure compliance.
The report identified material weaknesses in IRS controls over unpaid tax assessments and collections, partly due to the lack of agency-wide cost-benefit data and related performance measures that the GAO recommended in the past.
The reforms could help resolve the annual tax gap, according to the GAO.
"The GAO has been reporting on IRS collection issues for more than 10 years," said Sen. Chuck Grassley, R-Iowa, ranking member of the Senate Finance Committee. "This report, like all the others, presents some troubling facts. For fiscal years 2002 through 2007, while collections increased by $10 billion, unpaid debts increased by the same amount. During this same time, the IRS wrote off from 31 percent to 46 percent of unpaid debts because it essentially ran out of time to collect these debts."
Grassley generally has supported the move by the IRS to use private debt collectors, which was authorized by Congress and began being implemented in September 2006. A recent TIGTA report found that the IRS and private contractors have generally taken actions consistent with the procedures developed for the program. The report did not address whether the program has been successful or whether the policy to use private debt collectors is appropriate.
"There's been a lot of union opposition to private debt collection and that has dominated the debate," said Jeff Trinca, a vice president at based Van Scoyoc Associates. Trinca, who served as tax counsel at the Senate Finance Committee and was chief of staff of the National Commission on Restructuring the IRS, believes the IRS can use all the help it can get in reducing the tax gap.
"There were $290 billion in gross accounts receivables as of a year ago. Part of that figure is financial receivables," he explained. "These are debts that are collectible on their face if the IRS takes action."
A BROKEN SYSTEM?
"The GAO report highlighted what it called the IRS's 'complicated system,'" Trinca said. "In reality, it's broken up into three pieces. Endless notices is one, where they send you a threatening note and you pay up. It's very inexpensive, just the cost of computer-driven notices."
"Then the debt goes into an automatic collection system or field collection," he said. "Field collection is a person out in the field who looks for where a taxpayer works or has a business. A favorite technique is to drop off their card at a neighbor's house. The neighbor calls up the taxpayer and says, 'Hey, the IRS was out here looking for you.' It's inefficient, but it's a way to get at large accounts."
"The automatic collection system is for accounts that are too small for field personnel," he said. "ACS masquerades as a modern call center, but in reality, it's an inbound call system. The IRS takes some sort of action which triggers the taxpayer into calling in to negotiate - for example, it sends a letter to the employer saying, 'Please remit X out of taxpayer's paycheck,' or they freeze a certain amount from his bank account. The taxpayer finds his checks are bouncing and calls the IRS. This is fairly efficient when they can find the assets."
The larger part of accounts receivables do not get touched by this system, according to Trinca: "They go into a queue. This is made up of accounts where they tried to do ACS but couldn't spot the assets. These are low-productivity cases - small dollar amounts. They don't like to talk about tolerances, but anything below $10,000 is considered low priority. The queue is the ultimate aging space, but a taxpayer can get plucked out of the queue a number of ways. For example, if the taxpayer files a return a couple of years later and asks for a refund, the computer will spot it."
"What the agency doesn't have is an outbound call system that proactively tries to find the taxpayer, get him on the phone and negotiate the debt. That's the only method the private sector has - the ability to call and get someone back their good credit rating," he said. "So the thinking for years has been that the IRS needs to put less resources into field collection. ACS was invented in the 1970s but hasn't changed. It needs to be updated with an outbound system. They can do it themselves or hire the private sector."
If a debt sits in the queue long enough, it gets kicked out of the queue and goes into a "non-queue" queue, said Trinca.
"Both TIGTA and the GAO point out that $3 billion was lost by this from 2002 through 2007," he said. "After 10 years, accounts receivable just go away. That's the secret that no one likes to talk about - you can hide out for 10 years and not have to pay these debts. And that's what TIGTA said - if you don't have the resources, then put them into private debt collection."
And the truth is that the IRS doesn't have the resources to work the cases, according to Trinca.
"Former IRS Commissioner [Charles] Rossotti realized he would never get enough funding to work these cases. Just keeping up with attrition was daunting enough, and even if proper funding was received from Congress, it's hard to keep the people you hire," said Trinca. "That's why he pushed for the ability to use private debt collectors."
"Even with 1,000 more employees, they would just keep up with the point they were at 10 years ago. And by hiring another 2,000 ACS people, they still wouldn't work all those cases," he said.
Roger Harris, former Internal Revenue Service Advisory Council chairman and chief executive officer of Padgett Business Services, agreed. "When I was on IRSAC and they were contemplating doing this, everyone's first reaction was, why doesn't the IRS just do this themselves?" he said. "When you have an agency and one if its primary arms is collection, it's hard to understand. But this is money that would never be collected. If the IRS hired additional revenue agents, they would be working other cases that were higher-priority. Given the restraints of the budget, these were cases that would never be worked."
GET REAL (ESTATE)
Meanwhile, the GAO just estimated that another part of the tax gap is generated by the misreporting of rental real estate income.
In fact, according to the GAO, 53 percent of individual taxpayers with rental real estate misreported their rental real estate activities for 2001, depriving the Treasury of an estimated $12 billion of misreported income. Misreporting of expenses was the most common type of rental real estate reporting.
The study found that limited third-party information reporting and complexity were among the reasons for noncompliance.
Harris agreed. "You can always improve compliance with increased third-party reporting. The question is when have you crossed the line and made it too burdensome for the benefit."
The rental real estate area is a prime example of the Tax Code's complexity for individuals, according to Harris.
"For people self-preparing their returns, there are rules regarding rental real estate they have no chance of understanding," he said. "Passive-activity rules, vacation home, multi-use, buying a home and having a relative live in it part of the time, basis for depreciation - it's just not a simple area of tax law."
"Of course, no one complains about complexity when it lowers your tax bill," he observed. "At that point, your complexity is my tax break.
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