National Taxpayer Advocate Releases Annual Report

I shall state upfront: this post is not limited to the nonprofit sector. Instead, it should be of interest to all taxpayers. I confess that each year I look forward to the National Taxpayer Advocate's Annual Report to Congress. Although the report was of greater importance to me during the six years that I served as director of the Texas Tech University School of Law Low-Income Taxpayer Clinic, today, many years after I have moved on to other things, I still look forward to hearing what the Taxpayer Advocate has to say in the Annual Report to Congress.

Early this morning, I received the news: National Taxpayer Advocate Erin M. Collins had released the 2023 Report to Congress, describing the year as an “extraordinary transition for the IRS and therefore for taxpayers.”

The report credits the Internal Revenue Service with substantially improving taxpayer services and developing plans to transform the taxpayer experience in the coming years. However, it identifies some areas of weakness, including paper processing. 

Now, the annual report is required to identify the 10 most serious problems taxpayers are experiencing in their dealings with the IRS and to make administrative and legislative recommendations to address those problems. This year's report presented the following administrative recommendations to address some of the serious problems the Advocate identified:

1. Prioritize the improvement of online accounts for individual taxpayers, business taxpayers and tax professionals to provide functionality comparable to that of private financial institutions. Of all the steps the IRS can take to improve the taxpayer experience, creating robust online accounts has the potential to be the most transformative and should receive the highest priority. However, the report says, online accounts must be significantly improved so more taxpayers will see the benefits of using them, and the IRS must do a much better job of promoting them. During 2023, individual taxpayers filed more than 160 million income tax returns, yet only 16.8 million users accessed individual online accounts. That’s just over 10%. Not good enough.
2. Improve the IRS’s ability to attract, hire and retain qualified employees. The report says the IRS continues to struggle to hire qualified candidates in many key areas. It says three of the main reasons are failure to advertise positions to the optimal target audience by job series, the slow pace of the hiring process and non-competitive pay. The report recommends the IRS devote more effort to identifying and conducting outreach to target audiences by job series, work to continue to shorten the clearance and onboarding process for selected applicants, and work with the Office of Personnel Management and Congress to obtain more pay flexibility for hard-to-fill positions.
3. Ensure all IRS employees – particularly customer-facing employees – are well-trained. The report says the IRS has historically faced challenges providing adequate training to customer-facing employees, partly due to the complexity of the tax system and lack of funding. However, those challenges are greater when the agency is staffing up, as it is currently doing. Results from the recently concluded 2023 Federal Employee Viewpoint Survey show nearly a quarter of IRS employees provided a negative response to the statement, “I receive the training I need to do my job well.” The report says: “It is critical that the IRS make comprehensive training a priority and ensure that new hires receive adequate training before they are assigned to tasks with taxpayer impact.”
4. Upgrade the back end of the “Document Upload Tool” (DUT) to fully automate the processing of taxpayer correspondence. The IRS has created and implemented the DUT to allow taxpayers to upload documents electronically in response to an IRS notice, letter, telephone conversation or visit. The report says that is “great news” for taxpayers. Once the documents reach the IRS, however, they are still processed as if they came in on paper. All documents go to a central location and then must be parceled out to the appropriate function for processing and response. As part of its Paperless Processing Initiative, the IRS said that “[h]alf of paper-submitted correspondence, non-tax forms, and notice responses will be processed digitally” by the 2025 filing season. Digital processing will shorten response times and enable the IRS to reassign employees to other high priority areas. The report recommends the IRS continue its efforts to digitize the processing of more taxpayer submissions and create back-end processes for DUT submissions.
5. Enable all taxpayers to e-file their federal tax returns. While the significant majority of taxpayers e-file their tax returns, the IRS still received more than 11 million individual returns and 15 million business returns on paper last year. The processing of paper returns causes delays in delivering refunds and increases administrative costs for the IRS. Some taxpayers may prefer to file on paper, and the report says the IRS should continue to improve the filing experience for paper filers. But many taxpayers who would prefer to e-file their returns cannot do so for a variety of reasons. For example, about 150 to 200 IRS forms still are not eligible for e-filing. The report describes the main barriers to e-filing and recommends steps the IRS can take to remove them.
6. Extend eligibility for first-time penalty abatement to all international information return penalties. U.S. persons who receive gifts or inheritances from foreign persons or who own interests in certain foreign partnerships and corporations and engage in cross-border business activities are potentially subject to a wide range of U.S. reporting requirements. The report says many of these reporting requirements are obscure and complex, and they sometimes apply to lower-income taxpayers and immigrants who may not be aware of them. Yet taxpayers who do not comply with applicable reporting requirements are subject to penalties that “are automatically assessed, broadly applied, needlessly harsh, and often unexpected,” the report says. These penalties apply if a filing is late, incomplete or inaccurate. “Rather than promoting tax compliance through taxpayer education and support,” Collins wrote, “the IRS has opted to flex its administrative muscle and bring down the enforcement hammer on good-faith taxpayers and bad actors alike.” The report recommends that the IRS offer first-time penalty abatement in these cases in appropriate circumstances.

The report also proposed 66 legislative recommendations intended to strengthen taxpayer rights and improve tax administration. The following five legislative recommendations are noteworthy:

1. Require the IRS to timely process claims for credit or refund. Millions of taxpayers file claims for credit or refund with the IRS each year, yet under current law, there is no requirement that the IRS pay or deny them. It may simply ignore them. The taxpayers’ remedy is to file a refund suit in a U.S. district court or the U.S. Court of Federal Claims. For many taxpayers, that is not a realistic or affordable option, as full payment of the disputed amount is generally required, and there can be sizeable litigation fees. “The absence of a processing requirement is a poster child for non-responsive government,” the report says. While the IRS generally does process claims for credit or refund, the claims can, and sometimes do, spend months and even years in administrative limbo within the IRS. TAS recommends Congress require the IRS to act on claims for credit or refund in a timely manner and impose certain consequences for failing to do so.

2. Authorize the IRS to establish minimum standards for paid tax return preparers and revoke the identification numbers of sanctioned preparers. The IRS receives over 160 million individual income tax returns each year, and most are prepared by paid tax return preparers. While some tax return preparers must meet licensing requirements (e.g., certified public accountants, attorneys and enrolled agents), most preparers are not credentialed. Numerous studies have found that non-credentialed preparers disproportionately prepare inaccurate returns, causing some taxpayers to overpay their taxes and others to underpay, which may lead to penalties and interest charges. In FY 2022, the IRS estimated the improper payments rate attributable to improper EITC claims was 32%, amounting to $18.2 billion. Among tax returns claiming the EITC prepared by paid tax return preparers, 94% of the total dollar amount of EITC audit adjustments was attributable to returns prepared by non-credentialed preparers.

   The report says federal and state laws generally require lawyers, doctors, securities dealers, financial planners, actuaries, appraisers, contractors, motor vehicle operators and even barbers and beauticians to obtain licenses or certifications and, in most cases, to pass competency tests. Both to protect taxpayers and the public fisc, TAS recommends Congress authorize the IRS to establish minimum competency standards for tax return preparers and to revoke the Preparer Tax Identification Numbers of preparers who have been sanctioned for improper conduct.

3. Expand the U.S. Tax Court’s jurisdiction to adjudicate refund cases. Under current law, taxpayers who owe tax and wish to litigate a dispute with the IRS without paying the tax first can go to the U.S. Tax Court, while taxpayers who have paid their tax liability and are seeking a refund must sue in a U.S. district court or the U.S. Court of Federal Claims. Although this dichotomy between deficiency cases and refund cases has existed for decades, TAS recommends Congress give taxpayers the option to litigate both deficiency and refund disputes in the U.S. Tax Court. Due to the tax expertise of its judges, the Tax Court is often better equipped to consider tax controversies than other courts. It is also more accessible than other courts to unsophisticated and unrepresented taxpayers because it uses informal procedures, particularly in disputes that do not exceed $50,000 per tax year or period.

4. Extend the “reasonable cause” defense for the failure-to-file penalty to taxpayers who rely on return preparers to e-file their returns. A taxpayer who files a tax return after the filing deadline is subject to a penalty of up to 25% of the tax due unless the taxpayer can show the failure was due to “reasonable cause.” Most taxpayers hire tax professionals to prepare their returns, and tax professionals sometimes fail to meet filing deadlines without notifying the taxpayer. In 1985, when all returns were filed on paper, the Supreme Court held that a taxpayer’s reliance on a preparer to file a tax return did not constitute “reasonable cause” to excuse the failure-to-file penalty. In 2023, a U.S. Court of Appeals extended that holding to e-filed returns.

   For several reasons, it is often much more difficult for taxpayers to verify that a return preparer has e-filed a return than to verify that a return has been paper-filed. “Penalizing taxpayers who engage preparers and do their best to comply with their tax obligations is grossly unfair and undermines the congressional policy that the IRS encourage e-filing,” the report says. “Under the recent Court of Appeals’ ruling, astute taxpayers would be well advised to ask their preparers to give them paper copies of their prepared returns and then transmit the returns by certified or registered mail themselves so they can prove compliance.” TAS recommends Congress clarify that reliance on a preparer to e-file a tax return may constitute “reasonable cause” for penalty relief and require the Treasury Department to issue regulations detailing what constitutes ordinary business care and prudence to evaluate reasonable cause requests.

5. Enable the Low-Income Taxpayer Clinic (LITC) program to assist more taxpayers in controversies with the IRS. The LITC program effectively assists low-income taxpayers and taxpayers who speak English as a second language. When the LITC grant program was established in 1998, the law limited annual grants to a maximum of $100,000 per clinic. The law also imposed a 100% “match” requirement (meaning a clinic cannot receive more in LITC grant funds than it is able to obtain from other sources). The nature and scope of the LITC program has evolved considerably since 1998, and those requirements are limiting the number of taxpayers the program is able to assist. While the Consolidated Appropriations Act, 2023, raised the per-clinic cap to $200,000 for one year and that provision may be carried forward into 2024, TAS recommends that Congress remove or substantially increase the per-clinic cap permanently and allow the IRS to reduce the match requirement to 25% where doing so would expand coverage to additional taxpayers.

Now we wait to see whether the IRS and Congress will address the recommendations put forward by the National Taxpayer Advocate.

Prof. Vaughn E. James, Texas Tech University School of Law