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January 7, 2011

Your voice at the IRS

Every year, the National Taxpayer Advocate sends a report to Congress filled with complaints about the U.S. income-tax system — really.

The latest report came out this week, and since income taxes can have a huge impact on personal finance (to say the least), we thought we'd share a few excerpts from the report in our Personal Finance Friday post.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that acts as an in-house critic. It is headed by Taxpayer Advocate Nina Olson.

Below is some of what she wrote in her 10th annual report to the U.S. Congress.

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The most serious problem facing taxpayers — and the IRS — is the complexity of the Internal Revenue Code.
A TAS analysis of IRS data shows that taxpayers and businesses spend 6.1 billion hours a year complying with tax-filing requirements. To place this in context, it would require more than three million full-time employees to work 6.1 billion hours, making "tax compliance" one of the largest industries in the United States....

Perhaps most troubling, tax law complexity leads to perverse results. On the one hand, taxpayers who honestly seek to comply with the law often make inadvertent errors, causing them to either overpay their tax or become subject to IRS enforcement action for mistaken underpayments. On the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities....

Because of tax complexity, taxpayers often suspect that the "special interests" are receiving tax breaks while they themselves are paying full freight. Tax simplification would go a long way toward addressing these concerns.

The most promising approach would involve reducing tax preferences (often referred to as "broadening the tax base") in exchange for lower rates. However, it is essential that the taxpaying public have a realistic sense of the difficult trade-offs involved....

[W]e must understand that, in exchange for lower rates, some tax breaks will be eliminated immediately and others will be phased out. If tax reform proceeds on a revenue-neutral basis, however, the average taxpayer's liability will not change, and we will end up with a tax system that is simpler, more transparent, and easier and cheaper for taxpayers to navigate....

The IRS needs automation to administer tax laws and tax-based social programs efficiently.... [But] automation can substitute for judgment and discretion, to the taxpayer's detriment....

[P]olicies programmed into decision-tree tools...can result in decisions and determinations that harm taxpayers and that IRS employees, following the law and their good judgment, would not arrive at....

A little human contact and conversation can work wonders in understanding the taxpayer’s financial circumstances....

[If the collection process is] not handled appropriately, real and lasting harm can be visited upon taxpayers — destroying people’s lives and businesses....

Since 1999, the IRS has increased annual lien filings from 168,000 to 1,096,000, a rise of 550 percent. Lien filings can badly damage or destroy a taxpayer's creditworthiness because they are picked up by the credit rating agencies and retained on the taxpayers' credit reports for seven years from the date the tax liability is resolved, or longer if it is not resolved.

If lien filings were clearly correlated with substantial increases in revenue collection, one could at least understand the IRS's position. But over the same period that the IRS has increased lien filings by 550 percent, revenue collected by the IRS's Collection function has remained flat.... By damaging taxpayers' creditworthiness, the IRS may even be reducing long-term revenue collection.

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The National Taxpayer Advocate's full report is online here.