In recent weeks, the American Bar Association Section of Taxation wrote the IRS, recommending the IRS not exercise its refund offset authority under IRC § 6402 on 2020 individual income tax refunds with respect to three groups: taxpayers claiming the Earned Income Tax Credit; taxpayers with income below 250% federal poverty level, and taxpayers who have pending offers in compromise. Last week, the National Taxpayer Advocate released a blog advocating a similar approach. Because both of these proposals seek to avoid creating economic hardship for taxpayers, I thought it would be a good idea to revisit a proposal I made years ago for the IRS to proactively identify taxpayers who are likely at risk of economic hardship and shield them from potentially devastating collection action. This in turn has led to my next two wishes on my “IRS wish list”:
- That the IRS implement an “economic hardship indicator” that identifies taxpayer accounts with balances due where the taxpayer is at risk of economic hardship as defined by IRC § 6343(a)(1)(D), and use that indicator to trigger further inquiry into the taxpayer’s financial status before issuing levies or placing them into streamlined or other installment agreements; and
- That the IRS utilize the algorithm underlying the economic hardship indicator (or other proxy such as percentage of federal poverty level) to identify taxpayer refunds where the offset of such refund for past tax liabilities would create economic hardship and proactively not offset those refunds.
Proactively Using Data to Protect Taxpayer Rights
One of the things that has bothered me over the years is the IRS’s reluctance to use data to minimize taxpayer burden and protect taxpayer rights, despite its eagerness to use data to identify and address areas of noncompliance. I first confronted this tendency in the first month of my tenure as the National Taxpayer Advocate, when the IRS was ready to implement the provisions of IRC § 6331(h) by offsetting 15% of the monthly social security benefit of any beneficiary who had a tax debt. Despite years of working on the implementation strategy, the IRS apparently had not completed an analysis of the economic condition of Social Security beneficiaries – including the elderly and disabled – and thus had no plans to filter out taxpayers whose income was insufficient to pay their basic living expenses. In a memo to Commissioner Rossotti in April, 2001, I outlined my concerns, and the Commissioner put a moratorium on the Federal Payment Levy Program (FPLP) with respect to social security benefits until those concerns could be addressed. That led to the development of the Low Income Filter, a rudimentary tool which GAO criticized as both over- and under- inclusive. That is, it allowed levies against many taxpayers who could not afford to pay and it excluded many taxpayers who had the ability to pay. Based on this criticism, the IRS ceased using the filter.
This experience taught me, very early on, the importance of well-designed applied research studies for driving appropriate tax administration approaches. Over the years, the research studies published in the National Taxpayer Advocate’s Annual Reports to Congress prompted many changes in IRS policy, simply because the data showed the way. For example, with respect to the flawed Criminal Investigation Questionable Refund Program, TAS’s 2005 research study stopped it in its tracks and brought about major changes, including moving the program from CI and into W&I. We revisited the FPLP Low Income Filter in the 2008 NTA Annual Report to Congress (vol. 2, beginning at page 48), showing that FPLP Social Security levies were being applied to taxpayers who could not pay their basic living expenses and therefore the levies must be released under IRC § 6343(a)(1)(D). As a result of our study, the IRS asked TAS to identify a percentage of Federal Poverty Level (FPL) that could be used as a proxy for the algorithm we developed to identify taxpayers experiencing economic hardship as a result of the levy. The IRS ultimately agreed to use 250% FPL as a proxy for economic hardship and to exclude taxpayers from the FPLP population. This measure is known as the “Low Income Filter” or LIF.
The issue of using data to proactively identify taxpayers who are experiencing economic hardship has popped up time and time again – in the context of Private Debt Collection, streamlined installment agreements (IAs), and now, in the age of the coronavirus pandemic, refund offsets. So it is helpful to review the proposal for an Economic Hardship Indicator and explore the research underlying it.
The Economic Hardship Indicator
Section § 7122(d)(2)(A) requires the IRS to “develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.” The statute also requires the IRS to not use these schedules of allowances where “such use would result in the taxpayer not having adequate means to provide for basic living expenses.” IRC § 7122(d)(2)(B). In these cases, the IRS should review the taxpayer’s circumstances on a case-by-case basis. Treasury regulation 301.7122-1(c)(2)(i) further clarifies what the IRS must do:
A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer’s case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account. [Emphasis added.]
The approach outlined in IRC § 7122(d)(2) and the related regulations gives effect to the taxpayer’s right to a fair and just tax system, which requires the IRS to recognize the taxpayer’s facts and circumstances in determining the ability to pay, and the right to privacy, which requires the IRS to take enforcement actions “no more intrusive than necessary.” The Commissioner is required to ensure his employees adhere to these rights. IRC § 7803(a)(3).
The IRS also applies these allowances in calculating the monthly payment for “non-streamlined” installment agreements, for currently not collectible status, and for determining economic hardship for purposes of releasing levies. The Allowable Living Expenses, or ALEs, are based on data from the Bureau of Labor Statistics which reflect the actual spending based on family composition and income. I have written elsewhere about the shortcomings of using BLS data for this purpose, and TAS research has clearly documented the harmful impact of the IRS’s application of ALEs here and here. But for purposes of the Economic Hardship Indicator, it makes sense to accept the IRS’s ALE figures because they are what the IRS relies on and are very conservative, which should make it easier for the IRS to agree with this approach. That is, the Economic Hardship Indicator algorithm adopts the very allowances and procedures the IRS lays out in its Internal Revenue Manual instructions to staff for determining ability to pay.
TAS’s Economic Hardship algorithm essentially used the greater of total positive income from the taxpayer’s most recent tax return (or from a two-year old return if the most recent was not filed), or the total Information Return income reported for the most recent year. In determining allowable expenses, the algorithm used family composition reported on the most recent tax return, and if no return was on file, it defaulted to a single person household. The algorithm also took into consideration whether the taxpayer had assets. The algorithm allowed ownership and operating expenses for one vehicle if a single or head of household return, and two vehicles for married-filing-jointly. Finally, with respect to home expenses the algorithm used the local allowances based on the zip code shown on the return or income source used as a basis for the income calculation.
To the Injury of Many Taxpayers, the IRS No Longer Conducts Financial Analysis for Most Installment Agreements
With the IRS’s recent expansion of streamlined Installment Agreements (IAs) to seven year terms and liabilities over $25,000, it is clear the IRS wants to drive taxpayers into formulaic IAs rather than engage with them to learn their specific financial circumstances. While streamlined IAs can be less burdensome for many taxpayers, and certainly minimize the use of IRS staff time, they also can extract payments from taxpayers who do not have the ability to pay. The Economic Hardship Indicator maximizes the benefits of the streamlined IA while ensuring the IRS takes into consideration the taxpayer’s specific facts and circumstances where warranted by risk of economic hardship.
Over the years, TAS research has demonstrated that automated levies and streamlined installment agreements can harm taxpayers. In addition to work with the FPLP Low Income Filter, the TAS research studies cited earlier found:
In Fiscal Year (FY) 2018,
- streamlined IAs constituted 72% of all installment agreements;
- 40% of those streamlined installment agreements were entered into by taxpayers whose income was below ALEs; and
- 40% of streamlined IAs entered into by Private Collection Agencies were with taxpayers whose income was below ALEs; and
- Streamlined IAs had high default rates – between 37% and 39%.
In the 2018 Annual Report to Congress, we proposed the IRS apply the algorithm TAS built and adopt the Economic Hardship Indicator (EHI) as a means to identify taxpayers who might experience economic hardship if the IRS levied upon their payroll or accounts, or placed them in a streamlined IA. I clearly stated that the EHI was not a determination of economic hardship or currently not collectible status. Rather, it could be used to program a pop-up screen for IRS phone assistors and collection employees to trigger a few additional questions about the taxpayer’s financial status before placing them in a streamlined IA or issuing a levy. The EHI algorithm could trigger a similar pop-up where a taxpayer is applying for an online IA, prompting the taxpayer to provide a bit more financial information. Moreover, the EHI could be a powerful tool applied during filing season to avoid refund offsets. It would also improve the IRS’s case scoring and selection criteria, so it doesn’t waste resources pursuing uncollectible debts. Thus, the EHI would serve as a trigger for when the IRS should conduct a case-by-case analysis of the taxpayer’s ability to pay basic living expenses, as outlined in 7122(d)(2)(A), the regulations thereunder, and the Taxpayer Bill of Rights.
Economic Hardship Algorithm and the Federal Poverty Level
As noted above, when TAS first tested its economic hardship algorithm in 2008 for Federal Payment Levies on Social Security recipients, the IRS resisted developing an algorithm, and instead proposed using a percentage of federal poverty level for purposes of the Low Income Filter. Although I believe the correct approach is for the IRS to build an algorithm that adheres to the procedures used by IRS employees, 250 percent of federal poverty level is an effective proxy for economic hardship. A chart from one of my last blogs as NTA makes this point:
Comparison of Ability to Pay by Indicated Percent of Federal Poverty Level (Computed on Adjusted Gross Income) to Ability to Pay as Determined by an Analysis of Total Positive Income to ALE
* Single = 1 vehicle allowance; married filing jointly = 2 vehicle allowances
As shown above, using 250% federal poverty level (FPL) as a proxy for the economic hardship algorithm excludes 85% of the taxpayers the algorithm (based on IRS procedures) finds cannot pay a tax debt. And although 250% FPL also has the highest percentage – 3% — of taxpayers who the algorithm finds can afford to pay the debt, that is a small error rate for the significant taxpayer protection of avoiding profoundly damaging collection action. And remember, all we are doing with the Economic Hardship Indicator is requiring the IRS to get more information from the taxpayer before it undertakes collection action that is very likely to result in the taxpayer being unable to pay basic living expenses. (The rationale for using the EHI to bypass refund offsets is slightly different – unlike other collection actions which can be unwound (levy releases) or modified (IAs), the refund offset takes place within a very short window of processing time and cannot be reversed. Thus, if there is a risk of economic hardship, as indicated by the EHI, the IRS should refrain from offset.)
It is baffling to me why, in the face of all this data (including yet another TAS research study from the 2020 Annual Report to Congress), the IRS refuses to adopt the EHI. The IRS complains of not having sufficient resources to do collection work. Well, failure to use the EHI not only harms taxpayers but also results in massive amounts of unnecessary work for those limited IRS collection resources, in the form of defaulted IAs, released levies under IRC § 6343(a)(1)(D) and return of levy proceeds, refund offset bypasses, and unproductive collection work, to name a few. The time is long past for the IRS to “put taxpayers first” by adopting the EHI and proactively act to avoid harming taxpayers. If it won’t do this in the midst of a pandemic, I really don’t know what it will take, other than legislative action. And in fact, per IRC §§ 6343 and 7122, I would argue Congress has already legislated.