Taxpayer Advocate Cites Improvement In Backlog. Will It Last?

In the Taxpayer Bill of Rights, Congress directed the Internal Revenue Service to form the National Taxpayer Advocate Service to address problems not resolved through normal IRS channels and large-scale, systemic issues affecting groups of taxpayers. Each year, the Taxpayer Advocate issues a report to Congress identifying the “Ten Most Serious Problems Facing Taxpayers” and outlining administrative and legislative recommendations to mitigate these problems. These reports provide insight into ways in which the IRS has fallen short of its mission of providing “taxpayers top-quality service” and identify areas for improvement.

Last month, Taxpayer Advocate Erin M. Collins issued her 2022 Annual Report to Congress in which she focused attention on the “elephant in the room – the continuing customer service challenges taxpayers are experiencing and the negative impact of the filing season backlog.” Of the top ten “Most Serious Problems Encountered by Taxpayers” identified by this year’s Report, processing delays ranked as the most serious problem impacting taxpayers for the second year in a row. Ms. Collins attributed this recurring problem to the IRS being “knee-deep in paper” due to “a lack of electronic scanning technology and a resulting reliance on manual data entry” with insufficient personnel.

This problem predated the COVID-19 pandemic. As I have previously detailed, including here and here, repeated cuts to the IRS’s budget between 2010 and 2021 left the agency with outdated technology and staffing shortages. The underfunding has had an especially negative impact on the manual processing of income tax returns. While over 90% of all individual returns are filed electronically, due to antiquated technology, the IRS has long had to rely on employees to process paper returns manually, which entails transcribing millions of numbers into the agency’s electronic systems. This process not only is inefficient, but also inevitably results in data-entry errors.

Like many businesses, the IRS was forced to close its offices during the early phase of the pandemic, which led to mountains of unprocessed paper-filed returns and correspondence. While the Taxpayer Advocate’s 2019 Report identified processing delays as a serious issue, the problem exploded in 2021 and by April 2022, the IRS was buried in over 29 million tax returns and pieces of correspondence that needed to be processed, including 23.8 million unprocessed tax returns.

Although the vast majority of taxpayers e-file their returns without errors and receive their refunds promptly, over the past 2.5 years “the IRS has taken ten months or longer to process paper-filed tax returns and issue related refunds, six months or longer to process taxpayer correspondence, and an average of more than a full year to issue refunds to victims of identity theft.” Significant processing delays also resulted from errors on e-filed returns, including errors caused when taxpayers attempted to reconcile the impact of Covid-related legislation on their tax returns. As the Report notes, the failure to process returns on a timely basis not only impacts taxpayers who “depend upon timely refunds to meet critical day-to-day living expenses,” but also results in additional telephone calls to the IRS, which largely go unanswered. In sum, the Taxpayer Advocate found that “[o]verall, the unprecedented processing delays created by a combination of the pandemic and the IRS’s antiquated processing technology have led to widespread taxpayer frustration and … financial hardships for millions of taxpayers.”

Despite describing the “misery” felt by taxpayers and tax professionals, Ms. Collins commended the IRS for having made “major strides” to reduce the backlog during 2022. Between newly hired employees, contractors, and employees reassigned from other functions, the IRS made substantial inroads into the backlog; by early December, the overall inventory of unprocessed returns and correspondence was almost cut in half (from 29 million in April to 15.1 million), with the number of unprocessed returns included in that inventory being reduced by almost 60% (from 23.8 million to 10 million).

In terms of long-term fixes, Ms. Collins anticipates the almost $80 billion in additional funding allocated to the IRS over the next 10 years through the Inflation Reduction Act will be a “gamechanger” in alleviating the IRS’s customer-service challenges. She describes the IRA as a “once-in-a-generation opportunity to bring [the IRS’s] taxpayer service operations into the 21^st century” and details the significant funding the IRA provides for customer service staffing. As I have previously written, a substantial portion of the IRA funding will be devoted to improving taxpayer service, and, in advance of the IRS’s deadline later this month to develop an operational plan for using the IRA funds, Ms. Collins strongly encourages the agency to focus its resources on “its core taxpayer service mission – processing tax returns, paying refunds, answering and addressing telephone calls, and providing in-person assistance to taxpayers who seek it.” Specifically, the Report recommends that the IRS adopt automated solutions, expand the electronic filing system to allow taxpayers to file all IRS forms, and implement scanning technology to clear the backlog and prevent future pileups.

While Ms. Collins is generally optimistic that “we have begun to see some light at the end of the tunnel,” she is “not sure how much further we need to travel before we see sunlight” due to the IRS’s antiquated systems and persistent hiring challenges. Ms. Collins notes that the upcoming filing season will be plagued by a carryover backlog from 2022 and the need to administer tax credits offered through the IRA. Moreover, in order to train new employees, the IRS will temporarily have to pull experienced employees from assisting taxpayers, creating a risk that customer service may get worse before it gets better.

Obviously, not everyone in Washington shares Ms. Collins’ view of the IRA funding as a major step forward. In connection with the Omnibus Spending bill adopted last year, Congress actually cut $275 million from the IRS’s budget (from roughly $12.6 billion in fiscal 2022 to $12.3 billion for the current fiscal year), thereby partially offsetting the additional funding provided by the IRA. And last month, following a pledge from newly-elected House Speaker Kevin McCarthy, House Republicans passed the Family and Small Business Taxpayer Protection Act, which rescinds tens of billions of dollars allocated to the IRS. Although the new legislation lacks the support it will need to pass the Democratic-controlled Senate, it underscores the continuing partisan divide over IRS funding and the agency’s struggles in finding sufficient funding to process tax returns efficiently, issue refunds, and respond to taxpayer concerns.

To read more from Jeremy H. Temkin, please visit www.maglaw.com.

Emily Smit, an associate at the firm, assisted in the preparation of this blog.