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Eskimos and the IRS: A Winter’s Tale

Posted on Jan. 16, 2015

This post is not about tax procedure issues in the native American population in Alaska but a recent Treasury Inspector General for Tax Administration (TIGTA) report concerning frozen credits at the IRS made me think about the number of ways Eskimos have to say snow. Anyway, I always wanted to have Eskimos in the title of a paper and this seemed like a good way.

Eskimos have a lot of words for snow as we all learned as little children when our teachers sought to impress or depress us as they introduced yet another English word meaning the same thing as something else. It turns out the IRS has over sixty kinds of freezes.  When I read this, I immediately thought of the many ways Eskimos could say snow.  All of the thoughts of snow and freezing make for a good tax story this time of year.

The TIGTA report determines that “further actions are needed to resolve millions of dollars of frozen credits in taxpayer accounts.” This report centers on a part of the IRS that we do not write about enough because this part really stands at the center of all the IRS does – Accounts Management.  The reports states that there are more than 60 freeze conditions that can apply to a taxpayer’s account.  That’s a lot of frozen money sitting with the IRS that someone would probably like to have as their own.  The report only focuses on three of the types of freezes the IRS employs.  If you ever have a client not receiving funds from the IRS they expected, you may have need to look into one of the many ways that the IRS holds taxpayer funds through the various types of freezes.  I will not try to discuss them here, but merely highlight the process.

Most freezes have a relatively short life span. They should because the nature of a freeze on an account does not seek to make a final determination of the outcome of the funds but merely to hold them pending some other event.  Still, the amounts at issue are staggering.  TIGTA reported that at the end of FY 2012 the IRS had approximately 8.6 million in business master file (BMF) tax modules containing $736 billion and 13 million in individual master file (IMF) tax modules containing $293 billion frozen for six months or less.  The amount of money sitting in some time of freeze is astonishing.  As the IRS suffers cutbacks, the amount of time to process the freezes will no doubt grow making for many more unhappy customers.  Understanding what causes a freeze and how to thaw one can serve as important skills in a time of shrinking government resources to close the accounts correctly.

One of the areas where the IRS uses a freeze includes identity theft. If the IRS identifies a return as one potentially filed by someone using a stolen identity, it freezes the refund claimed on the return while it works out its position regarding the return. Another common situation in which the IRS freezes a refund occurs with returns claiming the earned income tax credit (EITC).  The IRS routinely freezes the refundable credit claimed through the EITC while it audits the return (and litigates the result of the audit.) This freeze has a major impact on low-income taxpayers for whom the refund might represent a third of their annual income.  Not only is getting the freeze lifted a critical part of the case but the existence of the freeze can drive an outcome because the taxpayer needs or wants some funds quickly.  Low income taxpayers will resolve these cases at an early stage because of the freeze in order to gain access to some of the funds.  So the freeze can have unintended consequences.

The TIGTA report focuses on only three types of freezes and I will discuss two of those: 1) accounts with no return filed and 2) bankruptcy.  As it happens these two conditions were the subjects of a recent post regarding bankruptcy discharge. Here the two conditions do not carry a link except that they independently form bases for the application of a freeze.  If the taxpayer has withholdings, or estimated payments associated with his account, and does not file a return or if the return fails to post, any credits related to that module will freeze pending the filing or posting of the return.  If the taxpayer never files a return, the frozen credits will eventually, years later, move from the account into the general Treasury fund for excess collections.  When the taxpayer has failed to file a return, the freeze provides the only logical way for the IRS to deal with the funds pending a proper claim for their return or application to an account.  Because millions of people fail to file returns each year and many have withholding credits on the system, this freeze occurs frequently.  The report provides statistics on the numbers and types of these freezes.

When a taxpayer files a petition in bankruptcy, the IRS must stop all collection action because of the automatic stay in Bankruptcy Code 362(a)(6). The automatic stay also stays others actions of the IRS although no has the sweeping impact of the stay on collection.  Until 2005 the code prevented offset during the stay and the IRS routinely froze refunds in that circumstance in order to hold onto the money pending the lifting of the stay.  Sometimes those types of freezes could occur for years.

Because of the number of different types of credits and the different reasons for imposing or lifting the credits, most of the work on accounts management with respect to the freezing and releasing of credits occurs as a result of computer programming rather than human intervention. Because the computer starts the freeze and will likely end the freeze the programming serves a vital and sometime incorrect link in the system of freezes.  Of the sample of cases reviewed by TIGTA, the IRS mishandled a decent number of the accounts.  Sometimes the mishandling benefits the taxpayer such as the failure of the IRS to restart collection action after the lifting of the automatic stay and sometimes it has a harmful impact on the taxpayer.

You cannot assume that the sixty plus freezes occur correctly. While not surprising news, this will probably occur with more frequency as the IRS deals with workload issues.  If a client’s account remains frozen improperly, it becomes important to identify the source of the freeze and the mechanism for lifting it in order for this winter’s tale to have a happy ending.

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