Internal Revenue Service Computerization

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Computerization of the IRS ...

... and How it Affects Taxpayers

The technology explosion that has occurred since 1990 has affected many aspects of our daily lives. Credit is given to Tim Berners-Lee (not Al Gore) for inventing the "Web" in 1989. Educational institutions, Non-Profit Organizations, Individuals, Businesses and Governments alike have all sought to take advantage of expanded computer technology.

The Internal Revenue Service may be on the leading edge of all institutions that have aggressively pursued the use of computer technology to replace human functions. Like everything in life, it has a good side and bad side. The old saying about science, "for every action there is an opposite but equal reaction" (or something like that) is very true.
 
Personally, I'm a strong proponent of utilizing technology. Today (Monday morning) I had a client drop in the office with a problem. The client had sold a commercial real estate property three states away, two years ago. The buyer was unable to meet the payment terms of the sale due to the terrible economic times we are experiencing. The client needed to calculate the balance of the mortgage with accrued interest and roll some missed payments into a new note going forward.

The client made a joke when he sat down at my desk about needing this information in ten minutes. He was astounded that I was able to provide the required information to him within probably fifteen minutes. How was I able to do that? Through the use of my computer and software. My friend had spent his entire weekend struggling with manual calculations.

Complex mathematical equations are one of the best things computers do for us (in my opinion), which brings me to the crux of this writing. Computers are good at math, but formulas for interpreting and applying tax law are lacking without human input!

The IRS computer system is good at applying statistical analysis and identifying tax returns that should be scrutinized or reviewed by an IRS employee, but it seems the IRS is attempting to take the computer from the analytical "sorting" stage to the decision making process! Even if the computer identifies a return that stands out from the statistical norm, that doesn't necessarily mean that the taxpayers return is not correct. Unusual things happen. It's a part of life!

Today the IRS computer routinely identifies a potential problem with a tax return but does not stop there. The computer initiates contact with the taxpayer by generating a letter (without a human being even looking at it). I have a real problem with the IRS allowing the computer to contact the taxpayer, just take a look at my article on IRS computer generated letters assessing self-employment tax.

The Problem with the IRS Computer Initiating Contact with Taxpayers

The first problem is the fact that the general public is not aware that the letter they just received was generated by a computer and that a human being at the IRS is not even aware of the letters existence. The IRS should at the very least be required to put a bold statement on computer generated correspondence identifying it as such.

The main reason IRS computer generated letters should be labeled (if not done away with) is because taxpayers do not understand them and many taxpayers will take the wrong action as a result of receiving the IRS letter (immediately send a check). The computer goes a step beyond identifying a potential problem. Usually the computer will go ahead and calculate the difference in tax based on the assumption it has used. For example, "we think you have $2,000 of income that you failed to report, as a result you will owe $552.92".

Many taxpayers will immediately write a check for $552.92 and send it to the IRS. What if the $2,000 of income was from a stock sale? What if the taxpayer had originally paid $5,000 for the stock that was sold for $2,000? In this case the taxpayer would have a $3,000 loss to claim and the IRS would actually owe the taxpayer $750.00!

The IRS could program the computer to include a statement in the letter, where in the event that the unreported income was identified as being from a 1099-B (stock sale transaction), "if you have cost basis to claim against this sale it will lower your tax". The problem with this, is that many taxpayers won't understand anything about the letter other than "you owe $552.92". The computer will even pre-print a payment voucher for the taxpayer because they assume that the computer is correct and you are guilty of under paying your tax (guilty until proven innocent). To reduce taxpayer burden they will enclose a return envelope for the money as well.

When a taxpayer sends the $552.92 instead of receiving their $750 refund, they over-paid their tax by $1,302.92! I wonder how many thousands of times each year something like this happens. Talk about a "Tax Gap", that is your tax gap. The IRS likes to talk about the "Tax Gap" which they define as monies that go uncollected each year that is really owed to the government. I promise you that there is a lot of money paid to them that shouldn't be.

The IRS Measure of Success

The measure of success of our highway patrol is not measured by the dollar amount of traffic tickets they write and how much money they collect. The measure of success of our court systems is not how much money they collect. The IRS has three major departments; Compliance, Collections and Criminal. It is true that "dollars collected" would be a good measurement of success for the IRS Collections department.

To use dollars as a measurement of success for the Compliance department of the IRS is wrong. Compliance is about determining if the taxpayer has been assessed the correct amount of tax. By allowing the IRS computer to generate a scary letter which results in the taxpayer sending in money actually tells us nothing about whether the taxpayer really owed the money to begin with.

The amount of money that taxpayers send the IRS as a result of receiving a threatening, scary IRS letter is more a measure of just how "threatening and scary" the letter is than anything.

Conclusion

This is a huge flaw in our current tax system that nobody is talking about. I have seen this problem grow each year, first hand. Again, I love technology and am all about utilizing it for the many benefits it provides, but the proper application of technology must be monitored or else it will become a problem more than a solution.

Email from IRS - Eight Things to Know If You Receive an IRS Notice!

Coincidentally, I received an email from the IRS while I was writing this article about their letters! Here's what they have to say.

Eight Things to Know If You Receive an IRS Notice

Every year, the IRS sends millions of letters and notices to taxpayers. Many taxpayers will receive this correspondence during the late summer and fall. Here are eight things every taxpayer should know about IRS notices – just in case one shows up in your mailbox.

1. Don’t panic. Many of these letters can be dealt with simply and painlessly.

2. There are number of reasons the IRS sends notices to taxpayers. The notice may request payment of taxes, notify you of a change to your account or request additional information. The notice you receive normally covers a very specific issue about your account or tax return.

3. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry.

4. 4. If you receive a correction notice, you should review the correspondence and compare it with the information on your return.

5. If you agree with the correction to your account, usually no reply is necessary unless a payment is due.

6. If you do not agree with the correction the IRS made, it is important that you respond as requested. Write to explain why you disagree. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.

7. Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right-hand corner of the notice. Have a copy of your tax return and the correspondence available when you call to help us respond to your inquiry.

8. It’s important that you keep copies of any correspondence with your records.

For more information about IRS notices and bills, see Publication 594, The IRS Collection Process. Information about penalties and interest charges is available in Publication 17, Your Federal Income Tax for Individuals. Both publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).


The IRS Is Listening...

UPDATE: 01-12-2010

IRS Announces Streamlined and Simplified Notices to Taxpayers

YouTube Video: Received a Letter from the IRS?

WASHINGTON — The Internal Revenue Service today unveiled its first redesigned notices that are part of an on-going effort to improve the way it corresponds with taxpayers.

The nine new notices are among the first to be reviewed and revised for clarity, effectiveness and efficiency. The agency also will create an office that ensures the effort to improve communications is on-going and permanent.

“One of my priorities is to ensure that we have clear and simple communication with taxpayers. In the past, our notices often looked more like legal documents and not an effort to communicate clearly. The differences between the old and new notices are like night and day. They show the potential of our on-going effort in this area,” said IRS Commissioner Doug Shulman.

In July 2008, Shulman appointed the Taxpayer Communications Taskgroup to review IRS correspondence. The task group found that IRS notices have different looks, messages and do not use consistent language. Because of this, some notices are creating unnecessary confusion for taxpayers.

Nine notices will feature the new design format beginning in January. These notices account for approximately 2 million pieces of correspondence with individuals, businesses and exempt organizations. A revised web page is available at www.irs.gov/notices.

The new format includes a plain language explanation of the nature of the correspondence, clearly states what action the taxpayer must take and presents a consistent, clean design. The new format also guides taxpayers to appropriate pages on IRS.gov where they can find accurate and relevant information quickly and easily.

By reducing the potential for confusion, these notices will improve the taxpayers’ ability to get problems resolved quickly, and improve overall compliance.

Shulman also announced this important work will be made a permanent part of the IRS through a new office to oversee improvements to taxpayer correspondence. The new office, called Office of Taxpayer Correspondence, will be directed by Jodi Patterson, who led the initial effort.

Tax preparers are already seeing some of this effort. In March, the IRS reduced to 2 from 13 the number of inserts included to tax preparers as part of notice CP 161, which is mailed to business taxpayers who underpay their taxes. There are approximately 2.3 million CP 161 notices sent annually.


This article was written by:
Gregory J. Cook, EA, CPA
Accredited Tax Advisor
www.cookco.us

Feel free to copy or reproduce this article as long as you keep the author's name and link to his website as stated.