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IRS Wrongly Delays Thousands Of Refunds

January 11, 2006

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With millions of Americans preparing to file their income taxes over the next three months, an in-house critic charges the Internal Revenue Service wrongly identifies hundreds of thousands of taxpayers as potential cheats, making them wait years to receive their rightful refunds.

The critic is Nina Olson, who heads the Taxpayer Advocate Service within the IRS.

In her report to Congress for 2005, Olson says many of the taxpayers whose refunds are frozen are working poor, who can least afford to have their money withheld. In most cases, she says, the IRS never contacts them to let them know they are under investigation.

Olsen also says it's not surprising that taxpayers make mistakes when filing out their tax returns. She says Congress could remedy the situation by simplifying the tax code.

"Our tax code has grown so complex that it creates opportunities for taxpayers to make inadvertent mistakes as well as to game the system," Olson said.

"As taxpayers become confused and make mistakes, or deliberately 'push the envelope,' the IRS understandably responds with increased enforcement actions. The exploitation of 'loopholes' leads to calls for new legislation to crack down on abuses, which in turn makes the tax law more complex," Olson said.

"Thus begins an endless cycle – complexity drives inadvertent error and fraud, which drive increased enforcement or new legislation, which drives additional complexity. In short, complexity begets more complexity. This cycle can only be broken by true tax simplification, followed by ongoing legislative and administrative discipline to avoid 'complexity creep.'"

Olson said the tax code should be revised to incorporate six core principles:

• it shouldn't try to "entrap" taxpayers;
• it should be simple enough that most people can fill out their own returns;
• it should be written in a way that minimizes the opportunities for non-compliance;
• it should provide limited choices;
• it should make it easy to administer refundable credits; and
• it should require a periodic review of the code – in short, a "sanity check."

Olsen also expressed the concern that the IRS is expanding enforcement at the expense of taxpayer service.

Her report says the IRS has eliminated TeleFile, significantly reduced the number of returns IRS personnel prepare for taxpayers who seek IRS assistance, reduced the percentage of taxpayer calls IRS telephone assisters answer as compared with FY 2004, and substantially reduced its taxpayer education function for small businesses.

Olsen says Criminal Investigation (CI) refund freezes are a major problem facing taxpayers. Her report says that CI places "freezes" on hundreds of thousands of refunds each year due to a suspicion of fraud and then makes a "determination" whether the returns are, in fact, fraudulent without notifying taxpayers that their refund claims are under review or giving them an opportunity to present evidence supporting their positions.

In FY 2004, more than 28,000 taxpayers whose refunds had been frozen sought assistance from the Taxpayer Advocate Service (TAS). The TAS research function studied a statistically representative sample of these cases and found that, with TAS assistance, taxpayers ultimately received the full amount of the refund they had claimed in 66 percent of the frozen-refund cases and a portion of the refund they had claimed in an additional 14 percent of the cases.

Olson urged the IRS to implement procedures to notify taxpayers promptly that their refunds have been frozen, provide taxpayers with an opportunity to submit supporting documentation, and bring cases to a quicker resolution. The TAS research study is published as Volume II of the report.

Among other problems the report identifies are the need for IRS to develop a comprehensive strategy to address noncompliance in the "cash economy," the adequacy of training for private debt collection employees as the IRS rolls out its Private Debt Collection (PDC) initiative in 2006, and delays and related problems in examining returns that claim the earned income tax credit (EITC).

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