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State Tax Implications of the NTA’s 2020 Annual Report

Posted on Mar. 29, 2021
Annette Nellen
Annette Nellen

Annette Nellen is a professor at San Jose State University and director of the graduate tax program. She is the past chair of the American Institute of CPAs Tax Executive Committee and an active member of the taxation sections of the AICPA, American Bar Association, and California Lawyers Association. She is a co-editor and coauthor of the four South-Western Federal Taxation textbooks published by Cengage.

In this month’s Moving Forward? column, Nellen reviews several issues and recommendations included in the most recent report of the IRS national taxpayer advocate submitted to Congress and adds observations about when these issues and recommendations would have implications, including benefits, for state tax systems.

Copyright 2021 Annette Nellen.
All rights reserved.

I. Background on the Report

IRC section 7803(c)(2)(B) requires the national taxpayer advocate (NTA) to produce two annual reports for Congress. The activities report, due by December 31, addresses the actions and operations of the Office of the Taxpayer Advocate (OTA) for the fiscal year ending September 30. This annual report must “contain full and substantive analysis, in addition to statistical information” and must address 13 topics listed in IRC section 7803. Notable topics include:

  • OTA initiatives to improve taxpayer services and the responsiveness of the IRS;

  • the 10 most serious problems encountered by taxpayers;1

  • recommendations for both administrative and legislative actions that can help resolve problems taxpayers face in interacting with the IRS;

  • tax rules that impose significant compliance burdens on taxpayers and how they can be alleviated; and

  • the 10 most litigated areas and suggestions for mitigating these disputes.2

The other mandated report, on objectives, is due by June 30 to the House Ways and Means and Senate Finance committees. It must lay out the OTA objectives for the fiscal year beginning October 1 of that year and should include statistical information.3

These reports provide a wealth of information on tax administration, issues, and recommendations for improvements. Many of the problems and recommendations are repeated in the reports for years. In recent years, report appendices have included additional research and studies to help in understanding the effectiveness of current rules and proposals. For example, the 2018 annual (activities) report included research on whether the penalty for substantial understatement of tax affects taxpayer behavior. This study concluded that the penalty might affect taxpayer behavior regarding the understatement level for assessment. Generally, the findings indicated that compliance is little improved by increasing penalties or reducing the threshold of what constitutes a substantial understatement.4

The 2020 annual report includes results of a research study on an algorithm developed by the Taxpayer Advocate Service to identify if a taxpayer seeking an installment agreement is facing economic hardship.5

Starting with the 2017 report, a “purple book” was added with 50 legislative recommendations to improve tax administration and enhance taxpayer rights. Many of the recommendations were pulled from past annual reports. Many had already been introduced in Congress, and bill references are included in the report. The report’s purple name is used to highlight that these should be viewed as bipartisan proposals — a blend of red and blue. Proposals include not only administrative ideas but also ones to reduce complexity, such as extending the time for making a subchapter S election, or enhance compliance by allowing for voluntary withholding on payments to independent contractors.6 Appendix C includes the 66 legislative recommendations in the 2021 purple book with the NTA’s top 10 highlighted.

No doubt, these annual reports provide a vast archive and roadmap for improving tax administration and compliance at the federal level.7 These issues and recommendations can also help state governments. Because of costs or higher priorities, we are unlikely to see Congress act on many of the legislative recommendations. But particularly when the proposals can reduce tax administration costs, improve compliance, reduce the tax gap, and build taxpayer understanding and respect for the tax system, state legislatures and tax agencies should benefit from the federal government’s effort to provide such detailed analysis of tax issues, research, and recommendations for improvement.

This article highlights items from the National Taxpayer Advocate 2020 Annual Report to Congress (2020 annual report), released in January 2021, that are likely to be relevant for state tax matters. The issues and ideas highlighted from the report are summarized in three categories: COVID-19, tax administration, and tax determination.

II. COVID-19 Issues and Ideas

A. Key Challenges

The 2020 NTA report begins with the challenges the IRS faced as major operational changes were needed to quickly comply with the sheltering in place and social distancing requirements imposed by governments to reduce the spread of COVID-19. While the IRS was able to continue many of its operations in modified form, and issue over 160 million Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) economic impact payments (EIP), not surprisingly, the report notes bad news because of the pandemic. The report describes this bad news as presenting four problems:

  1. Refunds were delayed for millions of taxpayers. While about 90 percent of individuals filers e-file, that still leaves about 16 million paper returns. The IRS was unable to timely open and process this physical mail. Over five million refunds were also delayed because IRS fraud detection filters indicated some type of attention was required with these processes slowed down by the changed IRS operations due to COVID-19.

  2. Millions of individuals eligible for an EIP did not receive one and will have to claim it on their 2020 return.8

  3. Millions of taxpayers received notices after the dates in the notice had passed. The NTA notes this caused “considerable confusion and anxiety for taxpayers who feared they had missed critical response or payment deadlines.”9

  4. Many taxpayers did not have information about changed IRS operations. The NTA notes that some “comments made by IRS officials often were incomplete or misleading.” For example, statements about reopening facilities in July 2020 was interpreted by many as returning to normal operations when they would still only be at partial capacity.

Later parts of the report include other COVID-19 challenges and problems. For example, 89 percent of the volunteer income tax assistance (VITA) and tax counseling for the elderly (TCE) sites closed during the 2020 filing season. The effect of these closings was that in 2020, rather than 3.6 million low-income individuals being helped — as occurred in 2019 — only 2.5 million individuals were helped, a decline of 30 percent.10

From April 1 through July 15 2020, the IRS suspended the opening of new examinations and most collection activity. As with all workplaces, the IRS continues to face uncertainty regarding the timing of office openings and the level of services that can be offered. Continued teleworking and office shutdowns during the 2021 filing season means that operational problems will continue.11

B. EIP Issues

While not noted in the report, the NTA explained in a January blog post12 that when an individual receives an EIP it is not reduced by any outstanding tax liability, only possibly by outstanding child support under section 6428. If the recovery credit is not issued before filing and must instead be claimed as a credit on Form 1040 (recovery rebate per section 6428 or section 6428A), it is subject to the usual offsets for outstanding liabilities. Thus, for a few different reasons, individuals in need of this payment might not receive it at the time it was needed or possibly at all if it is claimed on the 2020 Form 1040 and there is an outstanding tax liability of a greater amount.

In addition, some individuals entitled to payments, but without a filing obligation and who do not receive Social Security or veterans benefits, were not in the system for the IRS to issue an EIP. While the IRS had a website and outreach efforts to find these folks by mid-November 2020 to issue the first round of EIP (from the CARES Act), many likely were not aware of their eligibility and how to get the advance credit. For the second round of EIPs provided by the Consolidated Appropriations Act, 2021,13 a shorter time frame existed to get these payments to all eligible individuals so they would be issued before the 2021 filing season. Many individuals who did not receive the first or second round of EIPs are likely unaware that they can file a 2020 Form 1040 and claim these recovery tax credits even though they otherwise are not required to file.

III. Tax Administration Issues and Ideas

A. Agency Funding Remains Inadequate

Inadequate IRS funding is the key theme in the report’s preface and comes up often in describing most issues. It is legislative recommendation No. 2 of 66 in the 2021 purple book (No. 1 is to codify the Taxpayer Bill of Rights as IRC section 1). The report emphasizes that the most serious problems stem from insufficient funds that lead to staff shortages and outdated technology — factors that lead to other problems. The IT funding shortage is significant. The IRS estimated that it would cost between $2.3 and $2.7 billion over six years to replace outdated systems with modern technologies. The NTA points out that for fiscal 2021, $223 million was allocated to these needs, about $43 million more than for fiscal 2020 “but still a drop in the bucket” when at least 10 times that amount is needed.14

The report often puts staffing-related issues in numerical terms. For example:15

  • If adjusted for inflation, the IRS budget is 20 percent less today than in fiscal 2010 and the number of employees is also 20 percent less.

  • In fiscal 2020 the IRS was unable to answer over 75 million phone calls from taxpayers.

It is no surprise based on report data that the NTA’s major legislative recommendation is to “provide the IRS with sufficient funding to meet taxpayer needs and improve tax compliance.”16

B. Improvements Are Needed to IRS Recruitment, Hiring, and Employee Retention

The age demographics of the federal government do not match the private sector. According to the U.S. Bureau of Labor Statistics, for 2020, about 34 percent of the workforce was under age 35.17 In contrast, the 2020 annual report states that in September 2019, only 8 percent of federal employees were under age 30 and about 44 percent were over age 50.18

In addition to an aging workforce, the IRS is hampered by a workforce in which full-time equivalent (FTE) positions have decreased 22 percent — from 94,711 in fiscal 2010 to 73,554 in fiscal 2019. While the NTA notes that technology advances have mitigated the effect of some of this decline, the IRS needs personnel. Yet it struggles to hire and retain employees. Despite funding to hire over 5,000 FTEs between fiscal 2017 and fiscal 2019, the IRS was unable to hire because its Human Capital Office is unable to handle the hiring needs. The NTA highlights that an aging workforce and problems of hiring and retaining younger workers “threatens [the IRS’s] ability to fairly and efficiently administer the tax laws while providing the best customer service to our nation’s taxpayers.”19

Hiring challenges include pay levels below those in the private sector, inability to recruit for some positions from outside the IRS, and difficulties using direct-hire authority under existing Office of Personnel Management (OPM) rules. In addition, the NTA notes that the IRS is failing to meet most of the promises or pledges it laid out for applicants 20 years ago. These pledges include a user-friendly application process, understandable job announcements, and timely communication with applicants. In addition, despite the OPM’s “end to end hiring” plan to take no more than 80 days from announcing an open position to the applicant’s first day on the job, the IRS time frame is about 120 days. The result is increased challenges in hiring candidates who would be willing to wait so long to start a job.20

The NTA recommends that the IRS make better use of university recruitment opportunities, including hiring interns who might later become full-time employees. Participating in career fairs and networking with professional associations are also recommended. Suggestions for how the IRS can learn from other federal agencies are explained. Basically, the NTA suggests the IRS be more proactive in finding employees.21

The report lays out suggestions to improve employee retention, noting the importance of avoiding losing knowledgeable employees. Employees should learn early on about advancement options, and emerging leaders should be identified early so they can be fast-tracked to high positions. Moving employees around to experience various IRS functions is suggested to help keep employees engaged. The NTA suggests finding opportunities to partner with the private sector to help develop employees.22

C. New and Innovative Technologies Are Needed for Appropriate Service Levels

The NTA highlights that several taxpayer assistance centers have closed in recent years and that telephone response rates remain low. The NTA recommends an “omnichannel approach to customer service” that includes modern and innovative technology and increased staffing. Innovative technology includes use of artificial intelligence and robotics to help taxpayers get to the right person to help them using the communication option that works for them. The NTA notes the need for more employees who are technically trained to help with both procedural and technical tax issues.23

Another serious problem separately listed but tied to technology issues is the need for “robust online accounts” to more readily enable the IRS and taxpayers to share information. This would be like the online interactions taxpayers already have with their banks and with some state tax agencies. Tasks that could be accomplished with the online accounts include viewing one’s payment history, updating contact information, chatting with a customer service representative, sending a secure message, and filing a power of attorney form. If these accounts existed before the pandemic, the NTA notes that delayed mailing of notices would not have been as significant a problem and that some forms could have been uploaded or otherwise entered on the taxpayer’s online account rather than faxed.

While there are online tasks taxpayers can do today at the IRS website, such as getting a transcript or checking on a refund, “there is no consolidated place” to do all these tasks or others. In addition, online applications should be accessible from a smartphone.24

The NTA notes the need for expanded form e-filing, listing over 30 forms that are not eligible for e-filing. In addition, the NTA highlights the need for the IRS to accept forms in any digital format with the ability to transform the information into the format needed by the IRS. The report notes that many paper-filed returns are prepared using tax software. If bar codes or similar machine-readable information could be included on the return, the IRS could easily convert the paper-filed return to the equivalent of an e-filed return.25 Processing cost efficiencies are also noted in that it costs $4.78 to process a paper return but only 18 cents to process an e-filed one.26

D. Correspondence Audits Need Improvements

IRS data indicates that almost 74 percent of fiscal 2019 audits were done by correspondence, with the remaining 26 percent by field examiners.27 Despite this importance of correspondence exams, the NTA highlights numerous long-standing problems with these audits. The first issue is that taxpayers cannot reach a single point of contact at the IRS to help with the correspondence despite this issue being addressed by the IRS Restructuring and Reform Act of 1998 (RRA98). Section 3705(a) of that act required IRS correspondence to prominently note the name, phone number, and unique identification number for an IRS employee to contact. Instead, taxpayers must deal with toll-free phone numbers with no guarantee of an answer.28

E. Problems Processing Amended Returns

While the IRS meets its target of processing most amended returns within 16 weeks, significant problems exist for those that fall outside this goal. For example, the IRS does not let taxpayers know that if the amended return is selected for exam, the processing will take more than 16 weeks. Also, the IRS fails to keep taxpayers aware of the processing steps, which led to over 2.2 million phone calls and only about 1.4 million answered. These problems created the fourth most common reason for a taxpayer to contact TAS.29

F. Flagging of Legitimate Returns Leads to Delays and Frustration

In 2020 more than five million refund returns were flagged by IRS fraud filters. After verifying the taxpayer’s identity or income, most were found to be legitimate refund claims. Instead of the promised 21-day processing for e-filed returns, about 25 percent of these refund returns took over 56 days for processing. About 18 percent took more than 120 days to process. Use of the online tools — Where’s My Refund or the IRS2Go app — did not help much because they do not let the taxpayer know the reason for the delay in receiving their refund. The result is that many seek assistance from TAS. The NTA recommends technology upgrades to better identify potential fraudulent refund claims. Better communication is also suggested to help keep taxpayers apprised of the status of their expected refund.30

G. TBOR Must Be Made More Important (Purple Book No. 1)

IRC section 7803(a)(3) lists 10 taxpayer rights and requires the commissioner to be sure IRS employees are familiar with them and follow them. These rights are:

(A) the right to be informed;

(B) the right to quality service;

(C) the right to pay no more than the correct amount of tax;

(D) the right to challenge the position of the Internal Revenue Service and be heard;

(E) the right to appeal a decision of the Internal Revenue Service in an independent forum;

(F) the right to finality;

(G) the right to privacy;

(H) the right to confidentiality;

(I) the right to retain representation; and

(J) the right to a fair and just tax system.

The IRS promotes awareness of these rights via information on its website, periodic release of tax tips,31 and Publication 1, “Your Rights as a Taxpayer” — now available in Spanish.

The purple book’s No. 1 legislative recommendation is for the TBOR to be IRC section 1 with renumbering done to make this happen (currently section 1 addresses the noncorporate tax rates). The rationale is that this “would make a strong and important statement about the value Congress places on taxpayer rights.”

No further information is provided on who becomes more aware of the rights if included at IRC section 1 in addition to IRC section 7803, where they have been for many years. Few taxpayers read the IRC, and not even all return preparers read it. Thus, it appears this recommendation is more of a symbolic one rather than one to expand awareness of these rights.

H. Minimum Standards for Tax Return Preparers (Purple Book No. 3)

The IRS recommends legislation to allow it to implement “minimum preparer standards.” The Loving decision of 201432 prevents the IRS from carrying out its “well-thought-out” plan from 2011 without a statutory change. The IRS notes that studies conducted by the Government Accountability Office, the Treasury Inspector General for Tax Administration, and other agencies “found that preparers make significant errors that can harm both taxpayers and the public fisc.”33 The NTA’s recommendation for IRS oversight of preparers dates to 2002. The purple book lists congressional proposals for the requisite statutory authority over the years. The NTA continues to push for these efforts; it views knowledge of return preparation, as evidenced by passing a competency test, and engaging in continuing education as demonstrations of “a commitment to return preparation as a profession.”34

I. Increase Use of the Free File Program (Purple Book No. 4)

In 2002, to help meet the 80 percent e-filing goal set by RRA98, the IRS created the Free File Alliance to provide free access to tax preparation software to individuals below a specified income level ($72,000 for 2020 returns35). The NTA states that “free File has largely failed” because while 70 percent of taxpayers qualify to use it, less than 3 percent do use it. In addition, almost 50 percent of those who do use it do not use it in the next filing season.

J. Expand Protections Before Filing a Lien Foreclosure Suit (Purple Book No. 22)

The NTA notes that generally Congress does not expect a residence foreclosure to satisfy a tax lien except as a last resort. While the IRS’s Internal Revenue Manual has added precautions, the NTA suggest that they be added to section 7403. This would include the requirement that the IRS collection officer obtain “executive-level written approval to proceed with a lien foreclosure suit referral.” A related change would prevent the IRS from asking the Department of Justice to file a civil action seeking enforcement of a tax lien and foreclosure on a taxpayer’s home except when specified requirements are met.

K. Ensure That All Jurisdictions Have IRS Personnel (Purple Book No. 36)

RRA98 requires the IRS to be sure an appeals officer is “regularly available” in each state. The NTA observes that 12 states36 and Puerto Rico have no appeals or settlement officers. The IRS finds this situation permissible because of “circuit riding” to have the appropriate personnel on at least a quarterly basis. The NTA report finds that circuit riding does not accommodate requests for in-person hearings or with officers who are familiar with local conditions such as economic circumstances of taxpayers.

L. Increase Funding for Low-Income Taxpayer Clinics (Purple Book No. 64)

IRC section 7526 created by RRA98 allows the IRS to provide funding for matching grants for the creation and work of low-income taxpayer clinics. While Congress has increased the annual funding, the maximum grant per clinic remains unchanged at $100,000 per year and is really much less as the amount is not adjusted for inflation. The NTA recommends that Congress increase the annual cap per clinic to $150,000 and adjust this amount for inflation.

IV. Tax Determination Issues and Ideas

While much of the annual report deals with administrative and compliance matters, it also includes recommendations for technical changes to measuring taxable income or tax liability. Some, such as simplification of the earned income tax credit, would also bring administrative improvements.

A. Quarterly Individual Estimated Tax Due Dates (Purple Book No. 8)

As also sometimes called for as part of small business reform,37 the NTA recommends that the due dates for individual estimated tax payments be more intuitive and fall on quarterly dates, all of which are three months apart. Thus, these payments would be due April 15, July 15, October 15, and January 15.

B. EITC Improvements (Purple Book Nos. 53 and 54)

One of the NTA’s top 10 legislative recommendations is to restructure one of the most complex provisions — the EITC — to make compliance simpler and reduce the number and amount of improper payments made each year. This long-standing proposal is to split the EITC into two credits:

  1. A refundable worker credit based on earned income and not tied to number of children.

  2. A refundable child credit based on the costs of child care. This would be combined with the child tax credit to create one family tax credit.

Simplification is expected in that the credit tied to earnings could readily be computed based on Form W-2, while the portion tied to number of children would be combined with other existing child-related tax credits. Along with the split into two credits, the NTA recommends that the credit be available to workers age 18 or older without any age cap. In addition, the definition of qualifying child should be updated to reflect the broader set of family arrangements found today relative to 1975 when the EITC was enacted. For example, factors to identify the eligible taxpayer should “include which adult performs caregiving efforts and makes caregiving decisions.”

The NTA also recommends a permanent change to IRC section 32 to allow individuals to use their prior year’s earned income for the year of a federally declared disaster and to treat unemployment compensation as earned income for EITC purposes in that year.38

C. Voluntary Withholding on Payments to Independent Contractors (Purple Book No. 61)

To improve compliance and to help independent contractors who want to have taxes withheld from payments, the NTA recommends that Congress allow the service recipient and contractor to voluntarily agree to have the payer withhold and remit amounts from contractor payments. The NTA suggests that this law change include a provision that such a withholding agreement is not a factor to consider in determining if the relationship is genuinely one of employer-contractor.

V. State Tax Relevance of 2020 NTA Annual Report

Following are some state tax implications of the NTA’s issues and recommendations summarized above.

A. COVID-19 Problems

Relief needed for 2019 tax issues likely to linger beyond the current filing season. Many taxpayers have outstanding 2019 tax year issues because of having their paper-filed return processed late or possibly still not processed. Notices about amounts due or questions on tax returns were often delayed and possibly still outstanding. Thus, some taxpayers may be frustrated and uncertain about the true amount owed or to be refunded. These problems may involve state tax issues as well — some of which cannot be resolved until the federal tax issue is resolved. States should find ways to waive penalties for outstanding state tax liabilities that stem from federal tax delays and should consider relief measures for taxpayers facing financial challenges because of COVID-19 and federal tax problems.

Help and relief needed for unfiled 2019 returns. Many individuals may not have been able to get their 2019 return prepared because of closed VITA and TCE sites or they were unable to get assistance because of illness or job loss that took precedence over tax compliance. To help these individuals without causing undue distress in already distressing times, any effort for the IRS and state tax agencies to work together to help nonfilers of 2019 returns get assistance would be beneficial to be sure they get help and do not drop out of the system. States should be sure that a standard question at VITA and TCE sites this year is whether the individual filed their 2019 return and if not, to be sure resources are available at the site to help these individuals, many of whom may be due refunds.

Unexpected reprieve for some taxpayer errors. Some returns that likely should have been examined by the IRS were not and will not be. Thus, potential adjustments for both federal and state taxes are lost. Taxpayers with egregious errors might mistakenly think they got away with such behavior. Examiners should be reminded of this oversight in new examinations when they might otherwise wonder why mistakes on earlier returns were not examined.

Help is needed to be sure all recovery credits are claimed. Individuals entitled to either or both of the 2020 recovery rebates (credits) who did not receive the full amount in advance as an EIP may need assistance to know they are entitled to the funds and that they must file a 2020 Form 1040 to obtain them. This includes individuals who do not have a filing obligation such as some college students, homeless individuals, and those who obtain support from friends and families but are not a dependent. Widespread outreach to all taxpayers is needed to help these individuals know they need to file a 2020 return. Detailed examples of who may be entitled to the credits must be included in these public service announcements to best ensure listeners can readily identify themselves or a friend or family member as eligible for the credits. These announcements should include how to get assistance such as at a VITA site or via the IRS Free File system.

B. Tax Administration

Most of the NTA issues and recommendations deal with tax system administration. Most of these areas, such as inadequate funding and reduced examination coverage, have direct effects on state tax agencies and state revenues. Some ideas for improving compliance and resolving taxpayer issues are possible areas for federal-state tax agency collaboration for greater efficiencies. Following are some considerations for states based on tax administration issues and recommendations from the 2020 annual report.

Push Congress for more IRS funding. As the NTA highlights throughout the 2020 report, inadequate funding underlies many of the problems. IT cannot be modernized to adequately serve taxpayers and make use of today’s efficient technologies. Examination rates will remain low with a smaller workforce. Increased funding is needed to improve the level of in-person examinations. Taxpayer frustration with tax compliance will continue and even grow with continued challenges of reaching the IRS to resolve issues and obtain filing assistance. These problems adversely affect state tax agencies and state tax revenues.

Many taxpayers are frustrated. Another theme throughout many parts of the NTA report is that taxpayers are frustrated because of their inability to reach the IRS, receiving confusing notices, and unclear or incomplete announcements from the IRS such as those on processing times. And this is in addition to dealing with complex tax rules and some degree of federal-state nonconformity. Employees who deal directly with taxpayers should have training on how to help alleviate this frustration, and lawmakers should provide resources and rules to empower employees to truly help taxpayers.

Pursue opportunities for synergies and partnerships. Many of the issues noted in the report present opportunities for federal and state tax agencies to work together. Doing so can lead to sharing of good ideas, better use of resources, and coordinated efforts that will benefit taxpayers as they deal with the IRS and their state tax agencies. Examples include:

  • Joint efforts to recruit interns and examiners such as via college campus job fairs and ads. These efforts can help reach individuals interested in working for a tax agency and reduce agency costs.

  • Shared employee training activities.

  • The possibility of linked online accounts that can make it easier for taxpayers to address tax compliance matters including amended returns, tax payments, and filing of power of attorney forms. The use of similar design and functionality of the accounts will be a tremendous help to taxpayers.

  • Joint efforts to promote VITA and TCE sites for assistance with federal and state returns and the IRS Free File system and any similar resources offered by the state. Efforts for the tax agencies to prepare the returns (ready returns) should also be explored because of advances in technology and likely expectations of younger, more digitally focused generations.

  • Offer space at tax agency offices in states where the IRS does not have appeals and settlement officers.

  • Provide state matching funds for low-income taxpayer clinics and have additional clinics in underserved areas.

  • Ensure that collection procedures work in sync both productively and fairly. For example, procedures to avoid foreclosure of a taxpayer’s home should work similarly to help the individual avoid added hardship.

  • Plan and coordinate efforts to regulate return preparers to consider rules that currently exist in a few states such as California. States can benefit from including state tax testing and continuing education along with federal requirements. Requirements must be realistic and appropriately targeted to be sure any decline in number of preparers does not adversely affect filing.

  • Many NTA reports include the results of research performed by the IRS or by others such as academics. Planning and performance of this research by the IRS and state tax agencies should result in more robust findings of wider application. The NTA and state tax agencies should have a single website for announcing new research projects and listing existing research reports. They should find ways to coordinate ideas for new research, data sources and reviewers, as well as funding.

Coordinate, promote, and practice IRS and state taxpayer bills of rights. The NTA’s efforts to more broadly promote the federal TBOR can present opportunities for state tax agencies to do the same. They should be more prominently displayed and explained on agency websites and in correspondence. New and existing rules and administrative practices should be explained in terms of which bill of rights they support.

C. Tax Determination

Some of the NTA’s suggestions for changes in how tax liabilities are determined can have significant effects on state tax systems. For example, if estimated tax payment due dates are changed at the federal level, taxpayers will demand they be changed for state tax purposes. States will need to find budget adjustments if the June 15 due date is moved to July 15 (after the end of a state’s fiscal year).

Any EITC changes should be considered by states that also have an EITC to eliminate new complexities for taxpayers. In addition, states should be ready to conform to federal changes to allow withholding on payments to independent contractors so they can gain the reduced tax gap benefits of such a change. States should consider taking the lead on these changes as many did with the lowered filing threshold of Form 1099-K by third-party settlement organizations.39

VI. Looking Ahead

The NTA annual report is a significant document detailing many issues with federal tax administration and operation of the tax law. While the focus is naturally on federal matters, there are many lessons for states such as knowing how federal issues may adversely affect taxpayer attitudes and compliance at the state level. The report offers another avenue for generating ideas to improve state tax administration and tax rules. Annotating the annual report including the purple book might be a good opportunity for discussion and analysis by state lawmakers and tax agencies.

Appendix A. 10 Most Serious Problems

The list below shows the 10 most serious problems that OTA identified and are taken from its 2020 annual report. Only item 6 is a carryover from the 2019 list, on which it was issue No. 2. Issue 3 from the 2019 list was insufficient IRS funding to provide quality service.40 While this issue is not on the 2020 list of 10 most serious issues, the NTA noted it as an issue that permeates most of the issues described in the 2020 report.

  1. IRS recruitment, hiring, and employee retention: Quality taxpayer service and protection of taxpayer rights are directly linked to the IRS’s need to improve its recruitment, hiring, and retention strategies.

  2. Telephone and in-person service: Taxpayers face significant difficulty reaching IRS representatives due to outdated information representatives due to outdated information technology and insufficient staffing.

  3. Online records access: Limited electronic access to taxpayer records through an online account makes problem resolution difficult for taxpayers and results in inefficient tax administration.

  4. Digital communications: Limited digital communications with the IRS make problem resolution unnecessarily difficult for taxpayers.

  5. E-filing and digitalization technology: Failure to expand digitalization technology leaves millions of taxpayers without access to electronic filing and wastes IRS resources.

  6. Information technology modernization: Antiquated technology jeopardizes current and future tax administration, impairing both taxpayer service and enforcement efforts.

  7. Correspondence exams: Taxpayers encounter unnecessary delays and difficulties reaching an accountable and knowledgeable contact for correspondence audits.

  8. International: The IRS’s assessment of international penalties under IRC sections 6038 and 6038A is not supported by statute, and systemic assessments burden both taxpayers and the IRS.

  9. Amended returns: The IRS processes most amended returns timely but some linger for months, generating over a million calls that the IRS cannot answer and thousands of TAS cases each year.

  10. Refund delays: Taxpayers whose legitimate refunds are flagged by IRS fraud filters experience excessive delays and frustration in receiving their refunds.

Appendix B. 10 Most Litigated Issues

The list below shows verbatim the 10 most litigated issues included in the 2020 annual report.

  1. Appeals from collection due process hearings under IRC sections 6320 and 6330.

  2. Civil actions to enforce federal tax liens or to subject property to payment of tax under IRC section 7403.

  3. Accuracy-related penalty under IRC section 6662(b)(1) and (b)(2).

  4. Trade or business expenses under IRC section 162.

  5. Gross income under IRC section 61.

  6. Summons enforcement under IRC sections 7602, 7604, and 7609.

  7. Failure-to-file penalty under IRC section 6651(a)(1), failure to pay an amount shown as tax on return under IRC section 6651(a)(2), and failure to pay estimated tax penalty under IRC section 6654.

  8. Itemized deductions reported on Schedule A (Form 1040).

  9. Charitable contribution deductions under IRC section 170.

  10. Frivolous issues penalty under IRC section 6673 and related appellate-level sanctions.

Appendix C. 2021 Purple Book Legislative Recommendations to Strengthen Taxpayer Rights And Improve Tax Administration

Below is the list of the 66 legislative recommendations from the NTA’s 2021 purple book. They are categorized per the report. In the preface to the NTA’s Annual Report to Congress, released in January as one package, the NTA highlights 10 “for particular attention.” These 10 are italicized below.

Strengthen Taxpayer Rights and Taxpayer Service

1. Elevate the importance of the Taxpayer Bill of Rights by redesignating it as section 1 of the Internal Revenue Code.

2. Revamp the IRS budget structure and provide sufficient funding to improve the taxpayer experience and modernize the IRS’s information technology systems.

Improve the Filing Process

3. Authorize the IRS to establish minimum competency standards for federal tax return preparers.

4. Set goals for substantially increasing the use of the Free File program by filing season 2025 and replace Free File if those goals are not attained.

5. Require the IRS to work with tax software companies to incorporate scanning technology for individual income tax returns prepared electronically but filed on paper.

6. Treat electronically submitted tax payments and documents as timely if submitted before the applicable deadline.

7. Extend the time for small businesses to make subchapter S elections.

8. Adjust individual estimated tax payment deadlines to occur quarterly.

9. Harmonize reporting requirements for taxpayers subject to both the report of foreign bank and financial accounts and the Foreign Account Tax Compliance Act by eliminating duplication and excluding accounts a U.S. person maintains in the country where he or she is a bona fide resident.

10. Adjust the filing threshold for taxpayers filing as married filing separately and nonresident alien individuals.

Improve Assessment and Collection Procedures

11. Continue to limit the IRS’s use of “math error authority” to clear-cut categories specified by statute.

12. Require independent managerial review and written approval before the IRS may assert multiyear bans barring taxpayers from receiving certain tax credits and clarify that the Tax Court has jurisdiction to review the assertion of multiyear bans.

13. Allow additional time for taxpayers to request abatement of a math error assessment equal to the additional time allowed to respond to a notice of deficiency when the math error notice is addressed to a person outside the United States.

14. Require the IRS to waive user fees for taxpayers who enter into low-cost installment agreements.

15. Improve offer in compromise program accessibility by repealing the partial payment requirement and restructuring the user fee.

16. Modify the requirement that the Office of Chief Counsel review certain offers in compromise.

17. Amend IRC section 7122 to require the IRS to refund any payment collected pursuant to a federal tax lien that exceeds the amount of an accepted offer in compromise.

18. Require the IRS to mail notices at least quarterly to taxpayers with delinquent tax liabilities.

19. Clarify when the two-year period for requesting return of levy proceeds begins.

20. Protect retirement funds from IRS levies, including so-called “voluntary” levies, in the absence of “flagrant conduct” by a taxpayer.

21. Toll the time periods for requesting the return of levy proceeds while the taxpayer or a pertinent third party is financially disabled.

22. Provide taxpayer protections before the IRS recommends the filing of a lien foreclosure suit on a principal residence.

23. Provide collection due process rights to third parties holding legal title to property subject to IRS collection actions.

24. Extend the time limit for taxpayers to sue for damages for improper collection actions.

25. Direct the IRS to implement an automated formula to identify taxpayers at risk of economic hardship.

26. Revise the private debt collection rules to eliminate the taxpayers intended to be excluded by the Taxpayer First Act.

Reform Penalty and Interest Provisions

27. Convert the estimated tax penalty into an interest provision to properly reflect its substance.

28. Apply one interest rate per estimated tax underpayment period.

29. Pay interest on estimated tax overpayments, allowing taxpayers to help finance the national debt while promoting tax compliance and savings.

30. Reduce the federal tax deposit penalty imposed on taxpayers who make timely tax deposits.

31. Extend reasonable cause defense for the failure-to-file penalty to taxpayers who rely on return preparers to e-file their returns.

32. Authorize a penalty for tax return preparers who engage in fraud or misconduct by altering a taxpayer’s tax return.

33. Clarify that supervisory approval is required under IRC section 6751(b) before proposing penalties.

34. Require an employee to determine and a supervisor to approve all negligence penalties under IRC section 6662(b)(1).

35. Modify the definition of “willful” for purposes of finding FBAR violations and reduce the maximum penalty amounts.

Strengthen Taxpayer Rights Before the Office of Appeals

36. Require that at least one appeals officer and one settlement officer be located and permanently available in each state, the District of Columbia, and Puerto Rico.

37. Require taxpayers’ consent before allowing IRS counsel or compliance personnel to participate in appeals conferences.

Strengthen the Office of the Taxpayer Advocate

38. Clarify that the national taxpayer advocate may hire legal counsel to enable her to advocate more effectively for taxpayers.

39. Clarify the authority of the national taxpayer advocate to make personnel decisions to protect the independence of the Office of the Taxpayer Advocate.

40. Clarify the Taxpayer Advocate Service’s access to files, meetings, and other information.

41. Authorize the national taxpayer advocate to file amicus briefs.

42. Require the IRS to address the national taxpayer advocate’s comments in final rules.

43. Authorize the Office of the Taxpayer Advocate to assist certain taxpayers during a lapse in appropriations.

44. Repeal statute suspension under IRC section 7811(d) for taxpayers seeking assistance from the Taxpayer Advocate Service.

Strengthen Taxpayer Rights in Judicial Proceedings

45. Repeal Flora and expand the Tax Court’s jurisdiction, giving taxpayers who cannot pay the same access to judicial review as those who can.

46. Authorize the Tax Court to order refunds or credits in collection due process proceedings where liability is at issue.

47. Provide that the time limits for bringing tax litigation are subject to the judicial doctrines of forfeiture, waiver, estoppel, and equitable tolling.

48. Amend IRC section 7456(a) to authorize the Tax Court to sign subpoenas for the production of records held by a third party prior to a scheduled hearing.

49. Provide that the scope of judicial review of determinations under IRC section 6015 is de novo.

50. Clarify that taxpayers may raise innocent spouse relief as a defense in collection proceedings and bankruptcy cases.

51. Clarify that taxpayers may seek innocent spouse relief in refund suits.

52. Fix the donut hole in the Tax Court’s jurisdiction to determine overpayments by non-filers with filing extensions.

Miscellaneous Recommendations

53. Restructure the earned income tax credit (EITC) to make it simpler for taxpayers and reduce improper payments.

54. Provide earned income tax credit (EITC) relief during national disasters.

55. Exclude taxpayers in specific circumstances from the requirement to provide a Social Security number for their children to claim the child tax credit.

56. Clarify whether dependents are required to have taxpayer identification numbers for purposes of the credit for other dependents.

57. Allow members of certain religious sects that do not participate in Social Security and Medicare to obtain employment tax refunds.

58. Amend IRC section 36B(d)(2) to prevent individuals from losing some or all of their premium tax credits when receiving lump-sum Social Security benefits attributable to a prior year.

59. Amend IRC sections 108(a) and 6050P to provide that gross income does not include, and the Department of Education is not required to report, income from the cancellation of student loans under the Coronavirus Aid, Relief and Economic Security Act.

60. Amend the Combat-Injured Veterans Tax Fairness Act of 2016 to allow veterans of the Coast Guard to exclude disability severance pay from gross income and file claims for credit or refund for taxes withheld from excluded income.

61. Encourage and authorize independent contractors and service recipients to enter into voluntary withholding agreements.

62. Require the IRS to specify the information needed in third-party contact notices.

63. Authorize the Treasury Department to issue guidance specific to IRC section 6713 regarding the disclosure or use of tax return information by preparers.

64. Increase the individual low income taxpayer clinic grant cap and index it for inflation.

65. Compensate taxpayers for “no change” national research program audits.

66. Establish the position of IRS historian within the Internal Revenue Service to record and publish its history.

FOOTNOTES

1 Criteria used to identify these problems include the effect on taxpayer rights, number of taxpayers affected, financial effect on taxpayers, visibility to all stakeholders, and adverse effect on compliance. See 2020 annual report, at 1. The relevance of the most serious issues to taxpayer rights is highlighted in the report in that for each of the 10 issues, the NTA lists the affected taxpayer rights using the 10 rights listed at section 7803(a). See Appendix A of this article for a list of these issues from the 2020 annual report.

2 See Appendix B of this article for the 2020 list.

3 The legal requirement for these annual reports dates to 1996. The taxpayer advocate position was created by the Taxpayer Bill of Rights 2 (P.L. 104-168; July 30, 1996). That legislation required both the objectives and activities reports be prepared annually for Congress. The advocate position replaced the taxpayer ombudsman created by the IRS in 1979. See Joint Committee on Taxation, “General Explanation of Tax Legislation Enacted in 1998,” JCX-6-98, at 31 (Nov. 24, 1998). The IRS Restructuring and Reform Act of 1998 (P.L. 105-206, July 22, 1998) renamed the taxpayer advocate as the NTA. That act also expanded the required contents of the annual activities report to include coverage of tax rules that impose significant compliance burdens on taxpayers or the IRS and recommendations to address the problems, plus a list of the 10 most litigated issues for each category of taxpayer and recommendations to mitigate those issues. JCT, id., at 34.

5 2020 annual report, at 249-267.

6 2017 annual report to Congress, purple book (Dec. 21, 2017).

7 Links to NTA annual activities and objectives reports back to 2000 can be found at the NTA website.

8 2020 annual report, at iv-v and 7-8.

9 Id. at v and 6.

10 Id. at 39.

11 Id. at 5.

14 2020 annual report, at vi and vii, and 2021 purple book, at 3-6.

15 Id. at vi.

16 Id. at viii.

17 U.S. Bureau of Labor Statistics, Labor Force Statistics From the Current Population Survey, Household Data Annual Averages, tbl. 11b, Employed Persons by Detailed Occupation and Age.

18 2020 annual report at 13.

19 2020 annual report at 13-14.

20 Id. at 16.

21 Id. at 19-20.

22 Id. at 22-23.

23 Id. at 29-30.

24 Id. at 44-74.

25 Legislative recommendation No. 5 in the purple book calls for the IRS to be required to work with tax preparation software companies to have 2-D bar codes or similar type code printed on Forms 1040 that are prepared electronically but paper filed.

26 2020 annual report, at 76-81.

27 2019 IRS Data Book, at 32.

28 2020 annual report, at 102.

29 Id. at 132-138.

30 Id. at 148-158.

32 Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014).

33 2020 Annual Report, at viii; and 2021 purple book at 7-10.

34 2021 purple book at 9. The recommended statutory change is to 31 USC section 330.

36 Alaska, Delaware, Idaho, Kansas, Maine, Montana, North Dakota, New Mexico, Rhode Island, South Dakota, Vermont, and Wyoming; purple book, at 76.

37 For example, see H.R. 593, Small Business Owners’ Tax Simplification Act of 2019 (116th Cong.), and American Institute of CPAs, “Recommendations for Tax Law Changes to Reflect How Small Businesses Operate in the Modern World” (March 2019).

38 2020 annual report, at viii-vix; and 2021 purple book, at 115-121. The Consolidated Appropriations Act, 2021 (P.L. 116-260) provides an example of a temporary change to allow individuals to elect to use the prior year’s earned income for 2020 due to the March 2020 declaration of COVID-19 as a federal disaster.

39 For example, Illinois, Massachusetts, and Vermont require such payment processors to issue a Form 1099-K for payments totaling $600 or more during the year rather than use the federal threshold of IRC section 6050W of more than $20,000 of payments processed and over 200 transactions. The American Rescue Plan Act of 2021 (P.L. 117-2; Mar. 11, 2021), section 9674, lowers the IRC section 6050W filing threshold to $600 for third-party network transactions, effective for the 2022 Forms 1099-K.

40 2020 annual report, at vi, viii, and 8.

END FOOTNOTES

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