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‘Apology Payments’ from the IRS?

Taxpayers who endure excessive expense or drain on their time when the Internal Revenue Service mishandles a case should receive “apology payments” of up to $1,000 each, the national taxpayer advocate told Congress on Wednesday.

The advocate, a position Congress created in 1998, also said a new taxpayer bill of rights should be enacted, one that includes a list of responsibilities requiring taxpayers to conduct themselves honestly and to cooperate with auditors and tax collectors.

Nina E. Olson, the taxpayer advocate, in her annual report on the most serious problems faced by taxpayers, also said that the I.R.S. could use technology to apply the tax system to the underground or cash economy, where small entrepreneurs work for unreported pay. She said that by tracking credit card spending, state sales tax reports and other records, the I.R.S. could identify who collects this cash.

Ms. Olson estimated that the government could collect $100 billion more each year from those who evade taxes by dealing in unreported cash. That would be enough for honest taxpayers to receive a 10 percent cut in their income tax bills.

Ms. Olson also criticized Congress for making changes in the tax laws in November and December. She said such last-minute changes caused a million taxpayers to forgo deductions they were entitled to last year.

Within a long list of problems, shortcomings and backsliding by the I.R.S., the proposal that Congress authorize apology payments is the most unusual.

The proposed apology payments of $100 to $1,000, adjusted for inflation, would go to taxpayers who endure “excessive expense or undue burden” on their time. Britain and Australia already make such payments. The money would not be subject to tax.

“A fair and just tax system should acknowledge I.R.S. mistakes and delays in” resolving issues, Ms. Olson said. She proposed that her office be allowed to authorize such payments up to a total of $1 million a year. The proposed budget implies that the advocate’s office believes 1,000 to 10,000 taxpayers per year should receive apology payments.

Ms. Olson also told Congress that the use of private debt collectors is costing more than the money brought in. Private debt collection “is failing in most respects,” she said.

The I.R.S. had expected private companies to collect $88 million but has now lowered that to as little as $23 million. The collectors are paid almost a fourth of the money they bring in. When the costs of government oversight are added in, Ms. Olson said, the program may even lose money.

If Congress authorized more money for I.R.S. staff and equipment, the agency said it could bring in $20 for each dollar it receives, five times the Bush administration’s official estimate of private debt collector efficiency.

Congressional Republicans oppose hiring more I.R.S. workers, and the administration favors private collection even though it acknowledged in testimony to Congress that it was far less efficient than having the I.R.S. handle all collections.

But the proposal most likely to draw opposition is one that would require partnerships, limited liability companies and S corporations — all of which pass tax obligations on to their owners — to report more about their income.

Such reporting already applies to wage earners, 99 percent of whose income is reported to the I.R.S., compared with as little as 70 percent for entrepreneurs and partners, I.R.S. reports to Congress show.

Ms. Olson said that “a significant number” of S corporations were only distributing dividends, avoiding payroll taxes on compensation.

Previous proposals to add any independent reporting requirements on small businesses have faced opposition from members of Congress who say it stifles entrepreneurship.

Con artists and tax protesters have used the lack of reporting for pass-through businesses like S corporations to cheat the government out of vast sums and, in some cases, cheat their clients out of their life savings, records in federal trials in Washington State and Colorado show.

Charles O. Rossotti, the I.R.S. commissioner from 1997 to 2002, told Congress that rigorous third-party reporting rules for wage earners, but not small businesses, made the system unfair to wage earners.

Ms. Olson also said that the I.R.S. had become much too aggressive in charging fees for services. One manager of a nonprofit organization who asked how to list some unusual income on its tax return was told that an answer would cost $2,700.

Ms. Olson added that despite promises and the creation of a high-level committee, the I.R.S. had failed to enact policies that would bring more nonfilers into the system. Some of these nonfilers have wages withheld from their pay, but do not file, which means the I.R.S. must spend money preparing substitute tax returns for them.

In a similar vein, she said that 80 percent of penalties imposed on tax preparers were not being collected.

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