Tax assessments from the Internal Revenue Service’s Automated Underreporter Program have increased 85 percent in recent years, although the accuracy-related penalties were not always applied, according to a new report.

The IRS’s Automated Underreporter Program matches taxpayer income and deductions submitted on information returns by third parties such as employers, banks, brokerage firm against the amounts reported by taxpayers on their individual income tax returns to identify discrepancies. The Automated Underreporter Program routinely identifies more than 20 million individual tax returns with discrepancies each year and, when warranted, assesses additional taxes along with interest and penalties.

A newly released report from the Treasury Inspector General for Tax Administration found that Automated Underreporter Program tax assessments grew from $4.24 billion in fiscal year 2006 to $7.84 billion in fiscal year 2013, an increase of 85 percent. During FY 2013, the program also assessed approximately $708 million in accuracy related penalties. However, TIGTA found the penalties were not always assessed when they were warranted. For example, the Automated Underreporter Program’s system does not apply the negligence penalty provided for by law unless the taxpayer has repeated the same type of income omission within four consecutive tax years.

In addition, TIGTA’s review of closed cases from fiscal year 2012 found examiners were incorrectly waiving accuracy related penalties, resulting in about $3.25 million in lost penalty revenue. TIGTA also found that, due to inaccurate programming, approximately $2.66 million in accuracy-related penalties were not assessed.

After an in-depth study, the IRS made a number of changes to the taxpayer notice that alerts taxpayers they may owe additional taxes as a result of underreporting. While the revised taxpayer notice was implemented in FY 2013, TIGTA noted the IRS has not evaluated, or established plans to evaluate, the effectiveness of the revised notice on reducing taxpayer underreporting.

TIGTA recommended the IRS implement controls to ensure that accuracy-related penalties are assessed when warranted and only waived in accordance with applicable policies and procedures. The IRS should also address system issues to ensure the penalties are accurately assessed, and the IRS should continue to research and take action on cases TIGTA identified as having potentially inaccurate accuracy-related penalty amounts, suggested the report. In addition, the report recommended the IRS address negligence as it occurs rather than when a taxpayer repeats noncompliance, and the IRS should evaluate the effectiveness of the revised taxpayer notice.

In response to the report, IRS management agreed with four of TIGTA’s five recommendations. However, the IRS disagreed with the recommendation on penalizing taxpayers when the negligence first occurs and stated it would continue its current policy of waiting until taxpayers repeat their noncompliance.

“When we identify taxpayers who have failed to report income for the first time and the failure does not result in a substantial understatement of tax, we notify them of their errors and allow them to pay the additional tax and interest owed,” wrote Mary Beth Murphy of the IRS’s Small Business/Self-Employed Division. “Our approach conforms to the regulations that state that reasonable cause can exist even when a taxpayer commits an isolated computational or transcriptional error, such as a first-time failure to report income. We propose the negligence penalty to repeaters because their mistakes are no longer isolated and the conclusion that they are negligent is more strongly supported.”

TIGTA, for its part, contended this policy may contribute to further noncompliance and that addressing negligence when it occurs would promote fair and consistent treatment of all taxpayers.

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