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Eight Tax Myths – Lessons for Tax Week Part III

Posted on Apr. 16, 2015

We welcome back guest blogger Bryan Camp for part three of his three part series dispelling tax myths. In Part III he covers myths 7 and 8.  Post 1 can be found here and Post II can be found here. Keith

This post originally appeared on the Forbes PT site on April 15, 2015.

7. The IRS Abuses Taxpayers

Some myths are based on a kernel of truth and this is one of them. But the abuse is not what you think it is.

Taxpayer abuse happens when a taxpayer is not treated fairly according to his or her circumstances. The key to abuse is the idea of discretion.  On the one hand, if there is no discretion in applying rules, then some folks will inevitably be abused because their circumstances were not foreseen by those who wrote the rule.  On the other hand, giving someone discretion to bend the rules also results in abuse because the humans exercising discretion will inevitably make poor judgments in exercising the discretion.  That’s what it means to be human: to make mistakes.

Here’s a simple example: let’s say we want to give “equal” access to justice and so we have a rule that one must climb 39 steps to reach the courthouse door and file suit.  If you don’t climb those 39 steps, you cannot obtain justice.  If that rule applies to everyone “equally” so that there are no exceptions, then the rule abuses those folks who cannot climb the 39 steps because of some disability.  But if we station a person at the bottom to decide who must climb the 39 steps and who need not do so, we now create opportunities for abuse by that person.  We may put rules in effect by which that person must exercise the discretion but, at bottom, it’s a case-by-case determination.

So it is with the IRS. Both types of abuse exist but it is the second kind that most of us associate with taxpayer abuse.  For example, the gist of the so-called “targeting scandal” is that IRS employees had discretion on how to approve applications for exemptions and abused that discretion in giving extra scrutiny to applications from conservative organizations.  The mythology being built on top of this story is impressive, but my purpose here is to simply note the example.  Interested readers can find a lucid and geekily comprehensive take on the matter by Professor Philip Hackney of LSU.

This abuse of discretion certainly exists because IRS employees often have discretion to decide what actions to take on a taxpayer account, and so if follows that IRS employees sometimes abuse that discretion. You can even find court cases on this, where a court—usually the U.S. Tax Court—finds that an IRS employee abused discretion.  For example, taxpayers generally cannot ask for forgiveness of their tax liabilities, but there are exceptions and certain IRS employees have discretion to compromise the tax liability—i.e. forgive some or all of it—in some situations.  In a case called Szekely v. Commissioner, heard by the Tax Court in 2013, Mr. Szekely asked to compromise his tax debt and the IRS employee reviewing his request refused. The Tax Court ruled that the IRS employee did not treat Mr. Szekely right because the employee rejected the request a mere one day after Mr. Szekely missed a deadline to provide additional information.  Under the circumstances of Mr. Szekely’s situation—detailed in the Court opinion—that refusal was an abuse of discretion. Mr. Szekely got a “do-over.”

While this second idea of abuse—IRS employees abusing discretion—is sometimes true, it is a myth that such abuse is widespread. One has to go back to 1997 to even find allegations of widespread taxpayer abuse.  In was then that Senators Roth and Grassley held hearings—one set in September 1997 and one set in April 1998—hearings for which they had spent over a year carefully gathering the stories of this kind of supposed IRS abuse.  The hearings were high political theater and, as with most theater, were mostly fictional: the dramatic allegations made from behind face screens and voice screens turned out to be almost all false, according to later independent investigations from the General Accounting Office and the Treasury Inspector General’s office.

If you really want a juicy IRS “scandal” you need to go back to the 1940’s, as I have explained in gory detail elsewhere. That scandal resulted in the removal or resignation an extraordinary number of high-level officials, including the Assistant Commissioner in Charge of Operations, the Chief Counsel, the Assistant Attorney General in Charge of the Tax Division of the Department of Justice, and 9 high-level agency employees, 3 of whom were also criminally prosecuted.

In contrast, the 1997 and 1998 so-called scandals resulted in no criminal prosecutions, no forced resignations, no removal from office. The sole individual implicated in the congressional hearings was a mid-level manager.  And yet, of the 20 allegations against this individual—described in an 80 page narrative report with 2,200 pages of attachments reflecting interviews with 140 people, including every revenue officer and manager in the this individual’s office—only 6 violations of policy were substantiated, none involving abuse of specific taxpayers.

And the current “tea party” scandal? There have been two forced resignations and no prosecutions.

The clear-eyed view of our tax system is to see how it is effectively administered by computers, not humans.  Once the myth that humans run the show is exposed, one can more easily see the devastating effects of budget cuts as I have elsewhere blogged. And so we move to Myth #8.

8. The IRS is Run by Humans

Lots of folks work at the IRS. Even after five years of punitive budget cuts, the IRS still employs some 80,000 workers.  It is true that the IRS budget is mostly spent on personnel costs.  It is true that the face of the IRS is human, currently the Commissioner John Koskinen, who appears as able a Commissioner as any since the redoubtable George S. Boutwell held the position in 1862.

But behind those employees, behind that elfin face of Koskinen, lies the heart of our tax administration system: computers. The story of tax administration since WWII is the story of increased reliance on automation, on computers.  And computers run on rules.  Strict rules. The basic job of the humans at the IRS is actually to prevent the abuse that results from rigid application of rules.

The myth that humans run the IRS, that the fiendishly complex Tax Code (not IRS Code!) created by Congress is administered by actual human beings, obscures both what is good and what is not good about the current state of tax administration. Let’s look at two examples.

First, on the tax assessment side, we have already seen in Myth #4 how IRS computers rule the returns processing function. If one in a series of computer filters flags a return, the IRS will not process that return unless, and until, an IRS employee decides to accept it.  Put another way, it is the computer that decides whether to assess the tax reported on a return.  It takes a human to override the computer’s decision.  The good part about this is that the computers can process millions of returns far more efficiently than humans.  The bad part is that if the computer makes an error, the risk falls entirely on the taxpayer because it is up to the taxpayer to see the error and find some human IRS employee to fix it.

Similarly, the IRS has other computer systems that relentlessly propose increases to tax liabilities, increases that will be assessed unless and until a human IRS employee decides to override the decision of the computer. One example is the Automated Underreporter system.  It compares the W-2’s or 1099’s filed by third parties to what the taxpayer reports on the Form 1040.  If the numbers from the third party information returns are more than what the taxpayer has reported on his or her return, the computers follow the rule that the numbers on the W-2’s or 1090’s are correct.  The computers (not humans) send out a notice to the taxpayer.  And if the taxpayer does not respond to the computer-sent proposal in the right amount of time and to the right office with (often) the right-sized envelope, the computers (not humans) automatically print out the increased tax for assessment.  No human being ever reviews these cases before assessment unless and until there is a recognized taxpayer response to stop the computers.  The IRS employs a similarly automated system for what it calls “correspondence exams.”  Here is how the National Taxpayer Advocate described that system:

Once the IRS engages the batch system, cases move through the examination process automatically. Each step in the process has a pre-established period programmed into the system.  Files are not created or examiners assigned to the cases until the IRS receives and controls a taxpayer‘s correspondence.  If a taxpayer fails to furnish the requests documentation precisely within the prescribed period, the case automatically moves to the next phase in the process.  … Because the batch system automatically processes a case from its creation through the issuance of a Statutory Notice of Deficiency and subsequent closing, the IRS has effectively eliminated the need for human involvement in every case in which a taxpayer does not reply in a timely fashion.

We see the same model of computer action on the collection side, in the Automated Collection System. This is the computer system that collects unpaid taxes.  The computer, not humans, matches the W-2 information filed by employers and the Form 1098 information filed by banks to identify where taxpayers work or have assets.  Then the computer, not a human, sends out a Notice of Levy to grab wages or grab a taxpayer’s bank account.  It is the computer, not a human that will file a Notice of Federal Tax Lien (NFTL), which not only makes it difficult for taxpayers to sell their homes but also results in a major hit to the taxpayer’s credit rating.  If the taxpayer wants to undo any of these actions, or if the taxpayer believes the actions were abusive or unfair, the taxpayer must find a human IRS employee and persuade that employee to use discretion to ameliorate the damage.

Just look at the volume of levies and NFTLs in FY14: over 2 million levies and some 535,000 NFTLs.  That’s the work of computers, not humans.  And while the computers might be shutdown if the IRS shuts down, they will keep on working, even if employees must be furloughed. So finding the human to override the computer becomes increasingly difficult.

The clear-eyed view of our tax system is to see how it is effectively administered by computers, not humans. Once the myth that humans run the show is exposed, one can more easily see the devastating effects of budget cuts.  First, fewer and less trained employees means that taxpayer will be increasingly unable to undo the mistakes that computers will inevitably make.  Second, the less money the IRS has to hire and train competent employees, the more reliant tax administration will be on computers.  One sees this in the current IRS plea for expanded math-error authority.  The problem with this expanded authority, as Keith Fogg promises to explain in his typically thoughtful way, is that it will simply shift more work current done by humans to computers, creating more room for computers to make automatic initial decisions against taxpayers that then can only be undone by humans if and when the taxpayer responds.

This concludes my series on myths about tax and tax administration. I have little doubt most of them will persist.  That does not trouble me.  As a teacher, my job is to introduce curious minds to new ideas and give those who are interested tools to pursue their interests further.  I hope at least to have accomplished that.

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