The Internal Revenue Service recently proposed to send notifications to taxpayers and tax professionals when returns are filed about errors and missed credits or deductions, a plan that could have the unintended consequence of hindering taxpayer rights.
The agency’s proposal is one of the initiatives in its recently released strategic operation plan detailing how it will use the nearly $80 billion funding increase that the Inflation Reduction Act provided the IRS.
The agency said as part of the error initiative it would improve its ability to systematically review all electronically filed returns for errors in real time, match them against third-party and internal data, and review taxpayer eligibility for credits and deductions. Under the plan, taxpayers and preparers would start getting notified of processing errors and mismatches for simple types of income forms, including W-2 forms, in the 2024 fiscal year.
Notifications about other issues, including tax credits related to children and other dependents and other missed or erroneous credits and deductions, would start going out in fiscal 2025, the plan said. The agency’s notifications would provide instructions on how to correct and resubmit returns, and if returns weren’t corrected, the IRS would follow normal procedures in deciding to either accept or reject them, and taxpayers would be able to resolve errors later, the plan said.
However, the initiative risks violating taxpayer rights if taxpayers who disagree with error flags from the IRS aren’t allowed to electronically file their returns anyway, Ted Afield, director of the Philip C. Cook Low-Income Taxpayer Clinic at Georgia State University College of Law, told Law360.
The agency’s error flag could be based on incomplete information, and filing a return unlocks key procedural protections like the start of the statute of limitations for examination, Afield said.
Allowing taxpayers who get error flags under the initiative to file electronically anyway “is essential to protecting taxpayer rights,” he said.
It would be appropriate for the IRS to defer to a taxpayer’s judgment about whether a return can be filed in the event of a disagreement between the taxpayer and the agency’s system at the point of filing, Afield said. That’s because the taxpayer must sign the return under penalty of perjury, he said, and the IRS can audit it.
An existing example of the IRS denying taxpayers fair access to the tax system is its practice of forcing them to file paper returns when claiming a dependent when a return has already been filed claiming the same dependent, Afield said. That policy denies those taxpayers equal access to the tax system, since paper-filed returns are more susceptible to processing errors and likely face longer processing times that could delay refunds than electronically filed returns, he said.
During a recent Urban-Brookings Tax Policy Center conference, former National Taxpayer Advocate Nina Olson raised concerns that the error-flagging initiative could build on the agency’s practice of making taxpayers file on paper.
“If you ramp that up with all sorts of other things where the IRS is saying, ‘You know, we think you’re wrong here,’ what’s the taxpayer’s choice?” said Olson, who is now executive director of the Center for Taxpayer Rights.
The IRS has to figure out how it will protect taxpayer rights when it begins sending notifications of errors, and discussion of how that will happen is missing from the strategic plan, Olson said.
The agency shouldn’t reject an electronic return solely because it disagrees with it, Olson told Law360. The criteria for establishing a valid return were laid out in a 1984 U.S. Tax Court decision known as Beard v. Commissioner, she said. Under the decision, there are four elements a return must meet, including that it must contain enough data to calculate tax liability and show an honest and reasonable attempt to comply with tax law. Any return that meets those criteria should be accepted by the IRS, Olson said.
Under the error-flagging initiative, if a system detects an error but the return meets the Beard requirements, the IRS should process the e-filed return and then decide if it wants to examine it, she said. Olson said she’s not arguing the agency’s initiative is bad, just that it has to operate in a way that protects the taxpayer’s right to disagree and still electronically file a return.
“It is helpful to have possible errors flagged,” Olson said. However, she added, “We don’t have any info on how the IRS is planning to proceed with this.”
The IRS needs to state how it will protect taxpayer rights under the planned initiative and “engage with those of us in the field” to hear their concerns before it reaches an advanced stage of programming, Olson said.