Watchdog Growls At IRS’ Audits By Mail

Watchdog Growls At IRS‘ Audits By Mail

Source: forbes.com

A new report from the Treasury Inspector General for Tax Administration lends support to growing complaints about the Internal Revenue Service’s big audit-by-mail program.

The IRS has increasingly relied on these correspondence audits, focused on one or two narrow issues, to maintain its audit coverage of normal taxpayers as its auditor corps has shrunk. Taxpayers are sent a letter that, for example, says their charitable or un-reimbursed employee business deductions will be denied and a certain amount of extra taxes assessed unless they provide acceptable documentation supporting the deductions within 30 days.

But the TIGTA report concludes that the correspondence audit results reported by the IRS are “inaccurate and overstated” and that there are operational problems with the program, including significant mail processing delays. These delays can cause taxpayers who respond with documentation within the required time to be assessed extra taxes because their responses don’t get to the right IRS employee in time. Eventually, they may be able to get those taxes abated through an “audit reconsideration,” but the average time to conclude one of those is 159 days, TIGTA estimates.

A new mail-handling system was scheduled to be implemented by the IRS by October 2009, but it might be delayed until the end of fiscal 2010, according to the report. In its response to the report, the IRS was vague: “We have a team studying the possibility of a comprehensive mail sorting process.”

Correspondence audit foul-ups have drawn loud complaints from accountants and “enrolled agents” who handle tax disputes with the IRS for many taxpayers.

“One IRS agent told me, ‘You send us something, you’d better call to make sure we got it,’ ” reports Claudia Hill, an enrolled agent in Cupertino, Calif. who is editor of CCH’s Journal of Tax Practice and Procedure. Hill has heeded that advice and says she recently spent 24 minutes on hold waiting to confirm that information she sent had arrived. (See “Ten Tips For Taming The Tax Cops.”)

One hopeful sign Hill notes: The IRS has added fax machines to accept taxpayer information. “The problems aren’t going to go away,” she concludes. “It’s just a matter of whether they can make things better.”

TIGTA isn’t the first government watchdog to hone in on problems with the program.

In her last annual report to Congress, National Taxpayer Advocate Nina Olson cited difficulties responding to correspondence audits as one of the most serious problems taxpayers encounter.

Even as the complaints have mounted, the number of correspondence audits has steadily increased. The IRS did 1.1 million correspondence audits in fiscal year 2007, up from 440,000 in fiscal year 2000. The bulk of by-mail audits concern the Earned Income Tax Credit.

The new TIGTA report deals with a subset of by-mail audits, the “discretionary” correspondence conducted by the IRS’ wage and income division, which is responsible for the 123 million individual taxpayers who don’t have self-employment, farm or rental real estate income. Discretionary audits don’t deal with the EITC. Instead, the items challenged in these letters are typically un-reimbursed employee business expenses, and charitable and mortgage interest deductions. In fiscal year 2007, the division conducted 234,508 of these audits, more than double the 107,382 in fiscal year 2004. (The IRS is using correspondence audits in the self-employed and small-business division too to challenge items on Schedule Cs, reporting self-employment income, and Schedule Es, for investment real estate.)

Practitioners say one big problem with the wage and investment division letters is that many go to taxpayers who don’t owe anything, but are so scared of the IRS that they send in money anyway. “It seems like the IRS is trying to raise money by plucking low-hanging fruit from frightened taxpayers,” says William Stevenson, a Merrick, N.Y., tax accountant who counsels his clients to call him immediately upon getting an IRS notice.

Over the past four years, the percentage of folks whose cases resulted in no change–meaning after they sent in their documents the IRS agreed they didn’t owe anything extra–ranged from 17% in fiscal year 2007 to 26% in fiscal year 2005. Taxpayers agreed to pay the deficiency in 36% of the total cases, representing only 24% of the dollars assessed in audits. In an astonishing 46% of cases in fiscal year 2007, representing 72% of the dollars assessed by wage and income correspondence audits, folks either didn’t respond or the IRS’ mail was undeliverable. It’s not clear how much the IRS later collects in such cases.

While the IRS reported it assessed $785 million through the discretionary audits in 2007, TIGTA says that number is inflated because it includes the 10% of cases where the IRS later agrees to reconsider the audit on the basis of documentation it hadn’t been sent (or had misplaced) before.

In fiscal year 2007, about 20,000 audit reconsideration cases were closed. Based on a sample of cases, TIGTA found that in 78% of them, the IRS reduced or threw out its own assessment, leading to 68% of the assessed tax dollars in closed cases to be abated. TIGTA estimates that of the $785 million in assessments the IRS credited to the discretionary audits, $44 million was later wiped out during audit reconsiderations.

“The group charged with correspondence audits has completed their work; they’ve charged the assessment; the problem is there are so many bad assessments in there, it’s not fair to the taxpayers,” says Hill.

In reviewing the sample of audit reconsideration cases, TIGTA found that in 8% there was a record of complaints from taxpayers or their representative that documents had been misplaced by the IRS. Moreover, in 4% of the cases, the files contained multiple copies of requested documents, each having different IRS stamp dates.

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