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2013 IRSAC General Report

GENERAL REPORT

OF THE

INTERNAL REVENUE SERVICE ADVISORY COUNCIL

The Internal Revenue Service Advisory Council (the “IRSAC”), the successor to the Commissioner’s Advisory Group established in 1953, serves as an advisory body to the Commissioner of Internal Revenue. The purpose of the IRSAC is to provide an organized public forum for Internal Revenue Service (the “IRS”) officials and representatives of the public to discuss relevant tax administration issues. The IRSAC reviews existing tax policy and recommends policies regarding both existing and emerging tax administration issues. In addition, the IRSAC suggests operational improvements, conveys the public’s perception of professional standards and best practices for tax professionals and IRS activities, offers constructive observations regarding current or proposed IRS policies, programs, and procedures, and advises the Commissioner and senior IRS executives on substantive tax administration issues.

The IRSAC has 24 members with substantial, disparate experience and diverse backgrounds. Members include educators, and tax professionals including accountants, certified public accountants, attorneys and enrolled agents.  Many provide tax advice to clients, while others guide their large employer with respect to tax issues. Many are active in the volunteer income tax community.  In addition to representing different sized organizations, industries and geographic regions of the United States, members also represent several occupations that interact with the IRS and the tax community in a variety of ways. Each member has a unique tax policy perspective and is committed to providing meaningful input and feedback to the IRS.

The IRSAC is organized into four subgroups - the Wage and Investment (W&I) Subgroup, the Small Business/Self-Employed (SB/SE) Subgroup, the Large Business and International (LB&I) Subgroup, and the Office of Professional Responsibility (OPR) Subgroup. The members recognize the invaluable assistance, dedication and support provided by personnel from the IRS Office of National Public Liaison (NPL) and the operating divisions - Candice Cromling, Director, NPL; Carl Medley, Chief, Liaison Advisory Groups, NPL; Lorenza Wilds, IRSAC Program Manager, NPL; Rose J. Smith, NPL; Anna Millikan, NPL; Maria Jaramillo, NPL; Brian Ward, NPL; Johnnie Beale, W&I; Tonjua Menefee, SB/SE; and Kate Gregg, LB&I. The IRSAC appreciates the invaluable assistance provided by the IRS executives and support personnel throughout the year. We thank them for the discussions and dialogue that each subgroup held on current and emerging tax policy and procedural issues. The IRSAC members were honored and privileged for the opportunity to be able to work with each of these truly remarkable individuals! Their dedicated service to the IRSAC and IRS should be recognized as truly exemplary.

Issues selected for inclusion in the annual report represent those to which IRSAC members have devoted particular attention during four working sessions and numerous conference calls throughout the year. The issues included in the IRSAC annual report are issues that members consider especially important and include issues that IRS personnel brought to our attention. Nearly all issues involved extensive research efforts.

We acknowledge the many challenges that the IRS has recently experienced and, knowing the demands of the IRS executives and operating division representatives, we sincerely appreciate the time and effort extended to the IRSAC during the year.

The 2013 W&I Subgroup, chaired by Andre’ Re, prepared the attached report that  provides recommendations for reducing processing time for the Form 2848, Power of Attorney and Declaration of Representative, modifying the Transcript Request Policy, enhancing the Practitioner Priority Service Toll Free Line and assisting tax preparers who are victims of identity theft. 

The 2013 LB&I Subgroup, chaired by Janice Lucchesi prepared the attached report which provides recommendations for risk assessing large employers to assist in the audit process; revising the Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 million or More to increase its usefulness; and increasing IRS understanding of industry issues by suggesting ways to enhance LB&I industry specialization.

 The 2013 SB/SE Subgroup, chaired by Cecily Welch, prepared the attached report that reviews and provides strategies to increase the use of on-line payment agreements, modifications to Notice CP2030 and strategies to more fully utilize technology for stakeholder outreach.

The 2013 OPR Subgroup, chaired by Charles J. Muller, prepared the attached report that provides recommendations for guidance to practitioners regarding professional obligations and for changing the Circular 230 rules regarding enrollment of former IRS employees and the contingent fee rule.

The following two discussion points were not assigned to a specific IRSAC subgroup but are being presented due to their importance throughout our system of tax administration.

 

ISSUE ONE:  THE IRS NEEDS SUFFICIENT FUNDING TO OPERATE EFFICIENTLY, PROVIDE TIMELY AND USEFUL GUIDANCE TO TAXPAYERS AND ENFORCE CURRENT LAW, SO THAT RESPECT FOR OUR VOLUNTARY TAX SYSTEM IS MAINTAINED

Executive Summary

The IRS accomplishes its mission by issuing clear, concise tax law guidance, providing assistance to taxpayers, enforcing current tax law, and collecting taxes used by the U.S. government. Reducing the IRS’s budget constrains IRS effectiveness and efficiency, which results in taxpayers’ loss of respect for the agency and our voluntary tax system.  IRSAC is very concerned that prior year and proposed budget cutbacks have so diminished IRS effectiveness that most taxpayers are now experiencing increased compliance costs.  This undermines the voluntary tax system, reduces government revenues and promotes the underground economy.  The IRS must be provided sufficient resources to continue to operate as a world-class financial institution while maintaining the integrity of our voluntary tax system.


 

Background

The IRS fiscal situation has remained relatively constant for the past 4 years:

Budget Data and Trends: Dollars by Appropriation Account, Fiscal Years 2010 through 2014

 

Appropriation account

FY 2010 enacted

FY 2011 enacted

FY 2012 enacted

FY 2013 annualized continuing resolution

(a)

FY 2014 requested

Dollar change FY 2012 enacted compared to FY 2014 requested

Percent change FY 2012 enacted compared to FY 2014 requested

Enforcement

$5,504

$5,493

$5,299

$5,331

$5,667

$367

7%

Operations support

4,084

4,057

3,947

3,971

4,481

533

14%

Taxpayer services

2,279

2,293

2,240

2,254

2,413

173

8%

Business Systems Modernization (BSM)

264

263

330

332

301

-29

-9%

Health Insurance Tax Credit Administration (HITCA) (b)

16

15

-- b

-- b

-- b

n/a

n/a

Subtotal

$12,146

$12,122

$11,817

$11,888

$12,861

$1,044

9%

Other resources, e.g., user fees

539

655

695

905

497

-198

-29%

Total funding available for obligation

$12,686

$12,777

$12,512

$12,793

$13,358

$846

7%

 

Legend: n/a = not applicable.

Source: Fiscal Year 2012, 2013, and 2014 Congressional budget justifications for IRS.

Note: Dollars are nominal and not adjusted for inflation, and numbers may not add due to rounding.

(a) A full-year 2013 appropriation for this account was not enacted at the time the budget was prepared; therefore, the budget assumes this account is operating under the Continuing Appropriations Resolution, 2013 (P.L. 112–175). The amounts included for 2013 reflect the annualized level provided by the continuing resolution and do not include reductions due to sequestration.

(b) In fiscal year 2012, administrative resources for HITCA were moved to the Taxpayer Services appropriation under the Consolidated Appropriations Act, 2012 (Pub. L. No. 112-74).

 

When inflation and the new IRS enforcement responsibilities are considered, it is clear that the IRS’s fiscal situation has significantly deteriorated.  The increased enforcement responsibilities include the administration of the various taxes imposed by health care reform and the foreign account reporting of Foreign Bank and Financial Accounts Reporting (FBAR) and Foreign Account Tax Compliance Act (FATCA).  At the same time, the IRS must combat significant increases in identity theft, Earned Income Tax Credit (EITC) and other fraudulent refund schemes. 

 Tax administration is enhanced with the promulgation of clear, concise rules and regulations and readily available assistance for taxpayers and tax professionals.  These factors reduce taxpayers’ compliance burdens, allowing resources to be used for more productive activities. The IRSAC commends the IRS for continuing to seek ways to improve taxpayer service, while reducing taxpayer burden by adding new and improved technology.    

However, the IRS needs to be given sufficient resources to maintain its performance standards as a world class financial institution, able to handle and accurately account for numerous transactions with 140 million taxpayers, while protecting against identity theft, EITC and other fraudulent refund schemes. 

Several IRSAC members have specific examples of increased inefficiency in operations due to the IRS reduced budget.  These examples all show how budget cutbacks are increasing the taxpayer’s inefficiency, reducing productivity of taxpayers and their professionals.

  1. One member received a notice asserting that their employer corporation had an employment tax penalty.  The corporate tax department conferred with their employment tax auditor who stated that the penalty related to a B notice relating to Form 1099.  The taxpayer could not locate the B notice and the employment tax auditor stated that a copy of the B notice could only be obtained by calling an 800 number in Cincinnati.  The corporate taxpayer was on hold for more than one and a half hours and was then informed that since there was not an appropriate power of attorney on file, IRS personnel could not discuss the notice.  Other members report that it takes an hour or more to get through to the Practitioner Priority Services Line or to general phone numbers listed on notices and that calls are often dropped after long waits.  It is clear to all IRSAC members that there is a drastically shrinking level of service on the phone lines. 
  2. There are many delays in getting certificates of U.S. residency.  Many foreign countries require a certificate to claim treaty benefits and avoid foreign withholding on royalty or interest payments.  In prior years, the certificate could be obtained 1 to 2 months after the request was made, but this process now takes 3 to 4 months.  When certificates cannot be filed timely, the foreign payer withholds tax and the U.S. taxpayer is forced to claim a foreign tax credit on their U.S. return to avoid double taxation.  This generates unnecessary filings.
  3. Many members report that examination and collection cases are taking longer to process than in past years.  In addition, Examination often issues a notice of deficiency rather than give the taxpayer the opportunity to handle the case administratively in Appeals, even when there is sufficient time on the statute of limitations for referral to Appeals.
  4. IRS speakers often cancel speaking engagements, limiting face-to-face contact with practitioners. Taxpayer Executive Institute (TEI) meetings with IRS professionals and corporate tax professionals have been cancelled due to limited travel budgets. Region V and VI of TEI (Midwest and southwest states) have traditionally held a liaison meeting with the IRS. The attendees are IRS leadership (e.g., Territory Managers, Transfer Pricing Practice personnel, Field Operation Directors) and TEI chapter leadership. Planning began in early 2013 and the IRS requested that IRS attendance be limited to those near the meeting venue.  Subsequently, it was determined that IRS representatives could not attend. Therefore, a meeting used by the IRS to connect with a small group of large corporate taxpayers to understand issues and concerns was not possible.   A second meeting involving IRS representatives (e.g., managers and counsel) and about 100 TEI attendees was cancelled because local transportation costs could not be incurred. The inability to incur minimal costs to meet with taxpayers limits the effectiveness of taxpayers and the IRS.  In August 2013, IRS speakers cancelled participation in classes held at the National Association of Enrolled Agent’s National Conference due to travel restrictions caused by budget cuts.  Similarly, it appears the number of IRS Nationwide Tax Forums will be reduced in 2014; the forums are another way for tax professionals to understand IRS positions and help the IRS with tax compliance. Without face-to-face participation, meetings are not as well received and many participants are not as likely to have as valuable a learning experience. Practitioner meetings are useful for the IRS to understand taxpayer compliance issues and allow the IRS to communicate technical positions and the basis for those positions to taxpayers.

Recommendations

  1. Congress should appropriately fund the IRS to assure continued success in service, compliance and enforcement.  Without adequate funding, both taxpayers and the tax system will continue to suffer.  IRS personnel must receive the appropriate tools, training and technology to perform effectively.  Advances in private sector technology are outpacing a resource-challenged IRS at a time when it is critical for the IRS to improve its technology and increase its full-time staff so it can operate effectively.  Without adequate funding the IRS will continue to face difficult decisions when allocating limited resources between the compliance, enforcement and service functions.  While the IRSAC recognizes the extreme importance of service to taxpayers, we also recognize that increased compliance and enforcement efforts are critical to the proper functioning of our voluntary tax system.
  2. The IRSAC recommends that resource allocation decisions focus on ensuring that the service, compliance and enforcement efforts of the IRS are properly balanced. Inappropriately allocated limited service, compliance or enforcement resources only serve to foster future noncompliance and undermine respect for our voluntary tax system.  Encouraging future compliance is of equal importance to punishing prior non-compliance.  Tax administration is a constantly evolving process that requires the IRS to have adequate resources to react quickly, efficiently and effectively.

 

ISSUE TWO:   THE IRS SHOULD CONTINUE TO EXPAND VOLUNTARY CORRECTION PROGRAMS TO FACILITATE TAXPAYERS SELF REPORTING PRIOR YEAR NONCOMPLIANCE

Executive Summary

Our federal tax system is a voluntary tax compliance system, which relies upon annual income tax returns filed by taxable and nontaxable entities such as individuals, corporations, trusts, partnerships, and tax exempt entities.  Generally the taxpayer, rather than the government, has the necessary information to determine the tax liability.  Enforcement relies on the information that taxpayers provide and the IRS needs to facilitate voluntary compliance.

Background

Mistakes inevitably will occur and taxpayers need simple and efficient methods to correct errors and pay the appropriate amount of tax.  Accounting method changes that are voluntarily requested by the taxpayer, and not part of an IRS audit, typically are more favorable to the taxpayer.  For over two decades, the IRS has allowed qualified retirement plans to correct errors using an agreement between the IRS and the plan or plan sponsor that specifies how to correct the error and may include paying a compliance fee.  More recently, the IRS has used a number of voluntary disclosure programs for reporting foreign income.  In 2012, the Classification Settlement Program, used by taxpayers who have misclassified workers as independent contractors, was expanded to include a voluntary procedure. 

The third-party information return filing system serves as a vital tool to both ensure proper tax compliance and to combat fraud and identity theft, and matching third-party reporting of income is the most efficient audit technique available to the IRS. Each year, the IRS closes many cases in which a discrepancy was identified between the taxpayer’s return and third-party information, resulting in corrected tax returns.  Undoubtedly, third-party information return reporting will continue to play an important role in tax administration and compliance enforcement.

Although many individual taxpayers file amended returns when changes are necessary, a more efficient way to process these adjustments is to promote correcting information returns such as Form W-2 and Form 1099.  By allowing the preparer of information returns to pay unpaid taxes, the IRS can avoid processing numerous amended income tax returns with small additional taxes due. Sometimes, an error affects hundreds or even thousands of taxpayers, each in an insignificant way. Preparers of information returns strive to report accurately.  Providing an efficient way to correct these errors and pay any unpaid tax without burdening the recipients, results in significantly less work for taxpayers and the IRS.  Providing an effective way to correct these errors also avoids needlessly creating business issues in the case of incorrect Form 1099s and poor employee morale issues in the case of incorrect Forms W-2.

Given the finite resources available for IRS enforcement efforts and the voluntary nature of the U.S. tax system, it is appropriate for the IRS to encourage taxpayers to discover tax compliance errors.  This can be done by promoting standardized methods to correct errors.  When an error is discovered, the entity should be able to bring the error to IRS’s attention and pay a negotiated amount that approximates the actual tax liability if the error was not made.  Closing agreements could be used for some taxes; for income taxes this could involve a process for adjusting the current year’s tax filing.  In cases where the error is relatively small and not likely to have a material tax affect, it should be possible to avoid adjusting the information returns, but rather just to pay a negotiated compliance fee amount.  

Currently, IRS policy and taxpayers’ anecdotal experiences are more discouraging than encouraging. For example, Internal Revenue Manual Exhibit 8.13.1-12 contains a pattern information reporting closing agreement program for understatement of income on Forms 1099 and states that “[i]n cases of underreported income brought to the attention of the Service by a payer, a rate of 28 percent will be applied to the total amount of the understated reportable income.” In addition, Internal Revenue Manual Section 4.23.8.8 provides that the supplemental wage withholding rates (currently either 25 percent or 39.6 percent) generally should be used when income taxes are not withheld unless the employer is eligible to use the 25 percent rate and can establish each employee’s allowable number of exemptions from Form W-4. Because errors may be discovered years after they occurred, information regarding the Form W-4 is often not readily available and the supplemental rate would be used.  In most cases, the IRS mandated rates create a result in excess of the tax owed.  Similarly, the tax rate applicable to interest, dividend and other miscellaneous income reported on a Form 1099 is usually less than 28 percent.

The IRS is often unwilling to enter into a closing agreement for unpaid employment taxes if the number of affected employees is small, even if the taxpayers are unsophisticated in tax matters and will need professional advice to determine if an amended return is required and to prepare the amended return.

Employers have anecdotally found that the IRS has been increasingly unwilling to allow Form W-2 underreporting to be resolved by the employer without furnishing Forms W-2c to the affected employees, even when the only meaningful change to report is a change in social security wages. Most employers want to provide the Social Security Administration with updated wage information if the change affects an employee’s social security benefits, but are reluctant to confuse their workforce with these forms when no amended returns income tax returns are required. 

With business income tax returns, small omissions or errors are often discovered after a return is filed.  In the case of an income tax year currently being audited, a list of items is typically handed to the agent at the start of the audit and adjustment is made in the audit.  However, many taxpayers are not audited and while loss carry forwards can be adjusted, being able to adjust small errors and omissions in a current filing would result in less costly tax compliance.  The adjustment could be on a separate schedule that details the error.  Because tax rates may vary, it would be possible to require tax to be paid at the prior year’s rate.  By using a separate schedule, current year’s taxable income would not change.  Easing the burden of adjusting small errors and omissions would likely result in more corrections.  

Adjusting returns for flow-through taxpayers (e.g., partnerships, S corporations, trusts) is particularly burdensome.  Correction for errors and omissions on those returns could more easily be handled with a current year adjustment, even if a separate schedule is used to show the amount related to the prior year.  If the prior year is adjusted, it is most important that the adjustment be able to be done at the entity level to reduce the burden of adjusting at the shareholder, partner or beneficiary level.  Flow-through entities cause other problems for their partners, shareholders and beneficiaries who often rely on estimated amounts to file individual returns earlier than when the flow-through information is finalized.  Allowing individuals to correct estimated information in a subsequent year’s return would eliminate the need for filing amended returns.  

Finally, the IRC Section 409A rules for nonqualified deferred compensation often result in errors that generate a 20 percent additional tax for the employee or service provider.  Where the employer or service recipient has made the error, they want to pay that tax and not be required to inform employees or service providers of the error.  This is not possible under the current correction programs, as reporting of the error on an annual income tax return is required.  In addition, the current correction programs are only available for errors found within two years of the occurrence of the error.  This is not often long enough to allow for the correction of all discovered errors. 

The recent Supreme Court decision invalidating the Defense of Marriage Act is a good opportunity for the IRS to allow corrections for overpaid taxes to be recognized in the current year.  As a result of the Court decision, many individuals not previously recognized as spouses, or eligible for the tax benefits associated with being a spouse, are now eligible for those benefits retroactively.  With respect to the taxation of fringe benefits available to spouses, this will affect individuals and employers preparing information returns if the tax year is not closed.  To avoid numerous amended income tax returns, an adjustment could be made in 2013 returns to approximate the tax benefit available had the tax benefit available to spouses been recognized in the prior year.

Recommendations

  1. Issue administrative guidance and revise the Internal Revenue Manual to allow closing agreements to be entered into to correct underreporting errors on Forms 1099 and W-2 by having the entity responsible for the error pay a negotiated amount approximating the actual tax liability the affected population would have paid if the error had not occurred.  Also require Form W-2c to be prepared and filed with the Social Security Administration only for those employees who have an increase social security wages as a result of the additional reported income.  This should be able to be used for both open and closed years.
  2. With respect to minor errors and omissions, issue administrative guidance and forms so that taxpayers can either amend the tax return for the year of the error or include corrected income amounts on a special schedule on the current year’s filing.
  3. Issue administrative guidance and revise current forms to allow flow through entities to pay a compliance fee at the entity level if an amended return is not desired.
  4. Expand the correction program for IRS Section 409A to allow employers and other service recipients to pay a negotiated sanction approximating the actual tax liability and an appropriate gross up amount that the affected population would have paid if the error had not occurred. To the extent such errors affect social security wages and recipient’s social security wages are below the annual wage base for the affected year, require that Form W-2c is prepared and filed with the Social Security Administration.  No other Form W-2cs should be required to be filed and none should be required to be furnished to individuals.

 

Conclusion 

The IRSAC members are grateful for the opportunity to serve the Internal Revenue Service and taxpayers. It is readily apparent that the IRS is continually required to “do more with less” resources while operating in a complex, ever-changing environment throughout the world. The IRS is to be highly commended for its historical and continued efforts, and vast accomplishments, on behalf of tax administration.

 

Page Last Reviewed or Updated: 15-Nov-2013