Taxable Talk

I love IRS Direct Pay.  It’s a simple method to make payments to the IRS for most (but not all) taxes individuals might have.  And it works…well, it works most of the time.

I saw on Twitter the following:

On October 20th, the IRS Direct Pay application had issues with processing payments. The issue was fixed but approximately 4,600 taxpayers were impacted and duplicate payments were made and processed.

The Treasury Financial Agent is reaching out to all financial institutions to return the duplicate payments. However, if a taxpayer calls the IRS about this issue, they should be advised to contact their financial institution and have them return the duplicate payment(s) using ACH return reason code R10 (Customer advises not authorized) or R11 (Check truncation entry return).

The issue was sent to all financial institutions via the Federal Reserve Bank Operations Bulletin.

To date, no one has contacted us about this, but we do have individuals who used Direct Pay after October 17th to pay taxes.  If you are an impacted taxpayer, follow the instructions noted above.  If you’re one of our clients who was impacted, feel free to call our office.

TIGTA (the Treasury Inspector General for Tax Administration) came out this morning with its interim report on the 2022 Tax Filing Season.  I would love to report statistics that make me feel warm and fuzzy; instead, we’re left with more of the same: lots and lots of items sitting around in bins (both virtual and real).

One of the major issues the IRS has faced is hiring.  TIGTA allows us to give numbers to the IRS issues.  On the good side, the IRS has “onboarded” (aka hired) 3,827 Accounts Management employees out of a goal of 5,000 (76.5% of the goal).  However, the IRS hired just 521 Submission Processing employees out of its goal of 5,473 (9.5%).

The backlogs of returns remain.  Here is Figure 3 from the TIGTA report (click on the figure for a larger version):

This is depressing, and I am not changing my estimates of how long paper will take to be processed by the IRS.  If you submit a paper-filed tax return, expect it to take one year to be processed.  If you submit a paper-filed amended return, expect it to take 18 months (1.5 years) to be processed.  If your electronically filed return is unlucky enough to go through Error Resolution, Rejects, or Unpostables (which does not mean you did anything wrong), you’re looking at an average delay of four months.

The report briefly touches on the delays with IRS Account Management functions.  I’m telling clients that when a response is sent to an IRS notice, expect it to take six months to receive the response back from the IRS.  My oldest case is going on three years–it involves a C-Corporation return incorrectly processed as an S-Corporation.  The client owes tax but cannot pay it because it will be sent back to the corporation until the IRS fixes the problem!  (Yes, that has already happened.)  The file has been sent back and forth two times between the IRS offices in Ogden and Cincinnati, and I have no idea when this will be resolved.  We think this case is getting closer–the last two “we need more time” notices have noted the corporation is a C-Corporation (but I’m not holding my breath).  But I digress….

The IRS’s ability to answer telephone calls also remains poor.  The IRS says they answered 19.5% of net calls with a 24 minute average wait.  Recently, the Taxpayer Advocate said that it was about 5% of calls that were answered.  No matter, neither statistic is good, and improvement is desperately needed.

There was one bright spot: The IRS is finding more Identity Theft returns (confirmed fraudulent returns); so far in 2022, they have found 9,626 versus 2,499 found in 2021.  The IRS stopped $807.9 million of fraudulent returns this year versus $12.6 million in 2021.

The conclusions of this report are obvious.  If at all possible, efile your return.  If you do have to mail something to the IRS, bring patience (a whole lot of patience).  And if you’re Commissioner Rettig and you’re stating “everything will be cleared up by year-end,” let’s just say I hope you’re right but I really, really doubt it.

In Part 1 of this series we looked at what went wrong with the IRS.  (That post might have been shorter if I had written what went right.)  Today, let’s look at what should be done by Congress and the IRS to fix this mess.

1. Simplify the Tax Code.  Our Tax Code is a mess.  It is far, far too complex.  Most tax professionals now prepare returns for the proverbial husband, wife, 2.2 children living a relatively simple, straightforward life because they cannot do their own taxes due to the complexity!  Congress should (a) pass simplification, not complexity and (b) stop making the IRS a benefits agency (which it isn’t).  Unfortunately, there is no chance of anything like this coming from this Administration.

2. IRS Needs to Stop Stupid Make-Work.  As I noted in Part 1, the Schedule K-2/K-3 regulations on purely domestic partnerships with no foreign operations are a perfect example of this.  There’s no reason for this.  Unfortunately, I have seen no signs of the IRS understanding tax professionals’ needs over the past few years and I have significant doubts of anything like this happening in the near future.

3. Get IRS Employees Back in the Office. One of the things that has led to the massive amounts of paperwork sitting in bins is that IRS employees are still not fully back at their offices.  The IRS announced that all employees will be back in their offices by June 30th.  Here, it’s time for me to give kudos to the IRS for resolving one of the factors that has led to issues.

4. Hire More IRS Employees.  To the IRS’s credit, they are trying to hire more employees but the current environment and the federal government’s pay scale makes this difficult.  I do expect this to resolve over time.

5. Congress Needs to Increase the IRS’s Budget to Allow Multi-Year IT Projects.  Congress did increase the IRS’s budget for the current year, but IRS management has (rightly) complained about the budgetary process.  The main IRS computer system is older than I am (it dates to 1959).  Do you, in your office, use 63-year old computers?  To be fair to Congress, one of the reasons the IRS’s budget got cut was the Lois Lerner/IRS nonprofit scandal from a few years ago: The only tool Republicans had to protest was cutting the IRS’s budget.  While I see the IRS’s budget being increased, I think Congress will do it incrementally rather than significantly because Republicans still don’t trust the IRS.  A factor that impacts this is the ProPublica release of taxpayer information–which the current Administration appears to be ignoring.

6. Change the Tax Filing Deadline to May or June 15th.  I hated writing this, but the reality is that Tax Season is far too compressed and tax returns have gotten more complicated with more busy work.  It’s just impossible for most tax professionals to set a mid-March deadline and get all the returns filed.  (Indeed, as I’ll mention in Part 4 we plan on changing our deadline for receiving paperwork.)  Many of our clients didn’t receive their brokerage 1099s until late March.  Many of our clients still haven’t received their K-1s.

7. Go to the California System Where Extensions Are Automatic (But You Need to Pay the Tax).  I’m not a fan of how California taxes residents, but the California system where extensions are automatic as long as you pay 90% of the tax due is an excellent one.  Filing extensions is more make-work.  This would also cause more individuals to make estimated payments–an added benefit to our tax system.  Unfortunately, this change likely requires legislation, and getting this through Congress is unlikely.

I would love to be an optimist and see these seven solutions implemented.  The reality is that other than seeing IRS employees in their offices, only small incremental change at the IRS is likely.  Who suffers from this?  All of us: taxpayers, tax professionals, and the IRS.  But I promised to be realistic in this series, and we have to deal with the world as it is, not as we want it to be.

In Part 3 of this series (next week) we’ll look at the failures of my business.

Mr. Murphy says, what can go wrong will go wrong.  This was definitely the case for the 2022 Tax Season.  In this four-part series, we’re going to cover IRS and government (Congress and the President) failures, our failures, and what we can do to get this right–or at least better–in the future.  As for the prognosis, well, it’s not pretty.

For this series:

Part 1 covers IRS and government issues.  In Part 2, we’ll look at government solutions and the possibility that any of them will occur.  In Part 3, I’ll take a look at taxpayer and tax professional issues this year (including the failures of my company).  In Part 4, we’ll look at solutions for taxpayers and tax professionals, and an overall conclusion.  So onward into the Tax Season From Hell!

This year began with the promise of a “normal” Tax Season.  The pandemic was going to be in the rear-view mirror, we would have the IRS and state tax agencies back to normal, and we could play “Oh What a Beautiful Morning” every day.  Let’s see what went wrong with that picture–starting with the failures of the IRS.

1. The Internal Revenue Service misplaced the word “service.”  In actuality, this could be points 1 to 5.  The failures of the IRS this year were legion.  First, there is some large number of tax returns sitting in bins at IRS Service Centers.  As the National Taxpayer Advocate has said, paper is the IRS’s Achilles heal.  Well, there are (we think) 20-30 million tax returns and an unknown amount of correspondence that are taking forever (or something akin to that) to be processed.  Tax refund processing is 90% of the time excellent.  Unfortunately, if you are in the 10% that has to be manually processed it makes the DMV look good.  And if you want to make that 10% look good, pity those of you who get an IRS Identity Protection verification notice.  It’s close to impossible for you to reach that group.  When you make the DMV look good….

2. The IRS issued nonsensical regulations impacting Tax Season, further condensing Tax Season.  A perfect example are the new K-2/K-3 regulations.  The IRS believed (almost certainly correctly) that they weren’t getting enough information to accurately assess partnerships with foreign operations.  So they issued the new Schedule K-2 and K-3 regulations last summer.  I looked at them when the rules were issued, but believed (wrongly) that they had little impact on my practice.

Au, contraire!  In January (2022), the IRS issued new instructions that (a) causes a circular problem and (b) forced K-2/K-3s onto purely domestic partnerships with no foreign operations and no foreign partners.  The instructions state if a partnership has an owner who must file Form 1116 (foreign tax credit), the partnership must issue these Schedules.  Assume Acme Manufacturers LLC makes widgets here in Las Vegas.  Russ and Scott are the active owners, but there’s a third owner: Martin.  Martin is a passive investor, and invests in all sorts of businesses.  He and his wife file Form 1116 every year.  Thus, under the new instructions Acme must file Schedules K-2 and K-3.

As an experiment, I prepared K-2s and K-3s for my own business.  It added about 20 minutes of work, but for a completely domestic entity wasn’t difficult.  However, there is no reason that this needs to be done.  If Martin is audited, the IRS from the already prepared Schedule K-1 has all the information needed to accurately assess Martin’s liability for his investment in Acme.  The IRS doesn’t need the K-2/K-3–it’s useless make-work.

But that’s not all.  Let’s assume Martin doesn’t have a Form 1116 filing requirement each year, but occasionally does.  What should Debbie, who prepares Acme’s returns do?  Include the useless K-2/K-3s which most of the time aren’t needed or wait until September when she might know for certain?  Neither answer helps in tax preparation for obvious reasons.

But there are other “make-work” items thrust on tax professionals.  We must record IRS Submission ID Numbers (the number assigned by the IRS to each submission of a tax return) on either the signature document or in some other method.  It doesn’t take long–but the minute spent on this (and our tax software automatically notes this for posterity) is a waste of time.  Consider a tax practice with 500 clients.  That’s 500 minutes wasted, or about a day’s worth of work that I must pay someone for.  (Yes, that cost is passed on to you, the tax professional’s customer.)  There are needless interviews we are required to do with clients regarding various tax credits or I can be fined.  And these are just two of many examples.

3. Like all businesses, tax professionals must deal with an array of regulations–many of which are at cross-purposes.  And you, the tax professional’s clients, pay for them all.  We, like most tax professionals, have an Engagement Letter we require all clients to sign. When I started it was one page.  It’s now just over four pages.  Why has it grown?  Regulations and our litigious society.

The IRS requires I engage in best practices (it’s part of Circular 230, how I’m regulated).  I think it’s a good idea to use best practices as much as realistically possible.  But we’re not just regulated by the IRS.  Other regulatory agencies that have jurisdiction over me include:

• City of Las Vegas Business Licensing
• Clark County (Nevada) Health Department
• State of Nevada Health & Safety
• OSHA
• Federal Trade Commission (FTC)

The above is not an exhaustive list.  When I started my office here in Las Vegas the regulatory notices fit on a single poster.  They now take two.  You, the tax professional’s customer, pay for this.  I, the regulated, also pay for this in having to do many things that are not useful but are required by law and regulation.

Please don’t misunderstand me: I do not believe in violating the law.  Most regulations and laws are in place for good reasons.  However, it’s like mandatory ethics training for two hours every year (and yes, I am required to take that).  I listen, and every so often learn something (usually something I must now implement to cover myself, not something that helps taxpayers).  I have in the past taught ethics to tax professionals.  But consider if I were an unethical tax professional.  Couldn’t I just goof off during those two hours since just being in the audience gets me the required continuing education hours?  I leave that for you, the reader, to decide.

4. Government regulations cause the tax professional community to shrink.  There’s an excellent quote: “Whatever you tax you get less of.”  Regulations have the same impact.  My professional society, the National Association of Enrolled Agents (NAEA), strongly believes that the IRS should regulate all tax professionals because it would weed out bad preparers.  I disagree.  If someone wants to be a bad professional, it’s easy and no amount of regulation will stop it.  It’s “whack-a-mole.”  But regulations also make it harder for me to operate, with costs passed on to you (the taxpayer).

5. Covid regulations. One of my employees got Covid in March.  He was ill for one day, and he felt fine and ready to come back to work a couple of days later.  Well, one week later he was back in the office.  He was out three to five extra days because of regulations.  (No one else in our office got Covid, but you will see in Part 3 we weren’t very lucky on the illness side this year.)

For those who think I have just become a killer, well, I disagree.  We’ve always had the policy that if you’re ill you go home.  That’s common sense.  It’s also common sense that (a) Covid is now ubiquitous (if you haven’t had it, unfortunately you will), (b) that anyone who wants to can get vaccinated (now, up to four times), and (c) for almost everyone, Covid today is akin to the flu in the death rate (and the death rate for children without serious pre-existing conditions is 0% per the Wall Street Journal).

Overall, the biggest problems came from the IRS.  In Part 2, I look at how we can fix these issues and give you the odds of any of my solutions happening.

A client, living in a foreign country but who receives his mail in New Jersey (because mail to New Jersey is far more reliable than where he resides) received an IRS notice on his 2021 tax return:

Your refund has been reduced
We’ve reduced your penalty for failing to pay estimated taxes

We reviewed your Form 1040 for the tax period ending 2021 and found that you miscalculated your estimated tax penalty.

If you were in a disaster area, you may have been granted additional time to file returns and pay taxes. We considered any such time when we computed your penalty. Our correction reduces the penalty to $2,000.00.  You are due a refund of $4,500.00.

The taxpayer, when we filed his return, made an EFTPS payment of $200,000 which included a $6,500 estimated tax penalty. He owed tax–substantial tax, as noted.  He paid it in full.  It wasn’t a refund being reduced; rather his estimated tax penalty was reduced causing him to receive a refund.

Additionally, he doesn’t deserve this refund.  He does not reside in North America and the last time I checked the President cannot declare a disaster area in Europe.

In any case, my client was baffled by the wording and I think we have a “winner” (or, at minimum, an early leader) in the worst written IRS notice of the year.