Taxpayer Advocate Criticizes IRS Use of EITC Ban, Plans Review

TAXPAYER ADVOCATE CRITICIZES IRS USE OF EITC BAN, PLANS REVIEW (Tax Notes, August 6, 2013)

By David van den Berg

ABSTRACT: The IRS is automatically imposing on some taxpayers two-year bans on receipt of the earned income tax credit without clear guidance or Tax Court precedent, according to National Taxpayer Advocate Nina Olson, who said her office will research the decisions to impose the ban and their impact.

TEXT:

The IRS is automatically imposing on some taxpayers two-year bans on receipt of the earned income tax credit without clear guidance or Tax Court precedent, according to National Taxpayer Advocate Nina Olson, who said her office will research the decisions to impose the ban and their impact.

Olson told Tax Analysts that Congress gave the IRS the authority to ban future receipt of the EITC by taxpayers who recklessly or intentionally disregard the rules for getting the credit, which she said is a high standard. Rather than make a determination about the taxpayer's intent, however, Olson said, the IRS is using an "if, then" chart (Doc 2013-19047) published in the Internal Revenue Manual in January to decide whether to impose the ban.

"Reckless or intentional disregard of the rules is not defined in the statute," she said. "The IRS hasn't issued any regulations under it specifically addressing that language. We could find no U.S. Tax Court cases interpreting that subsection."

The Taxpayer Advocate Service (TAS) said the IRS imposed the two-year ban on approximately 5,500 taxpayers in 2011. In approximately 2,100 of those cases, the taxpayer's account had a "no show/no response" or "undeliverable mail" indicator on it, and additional tax was assessed by default, according to TAS. TAS said a 2002 IRS service center advice memorandum (SCA 200245051 (Doc 2002-25021)) determined that a taxpayer's failure to respond was not sufficient justification for imposing the ban; TAS said that the IRS's position hasn't changed since then and that therefore in 2011, the IRS improperly levied the ban more than 38 percent of the time.

The IRS service center advice memorandum says an analysis has to be done based on facts and circumstances, Olson said. She said she and her staff found that many circumstances under the accuracy-related penalty could be used to decide a taxpayer had flouted the rules, but that a determination has to be made.

Instead, Olson said, the "if, then" chart is being used to make decisions by rote. As an example of a problematic case in which the ban could be enforced, she mentioned taxpayers providing documentation to prove eligibility for the credit that the IRS deems insufficient. Taxpayers in that case can't be said to be acting in bad faith because they've provided some documentation, and they may not have fully understood the type of supporting material they are expected to provide, she said.

In its fiscal 2014 objectives report (Doc 2013-15568), TAS said its research group will generate a representative sample of 450 taxpayers hit with the two-year ban after their 2011 returns were audited. As part of the study, which is slated for completion in December, TAS will review every case in the sample "to determine whether the IRS examiner exercised appropriate care and judgment."

Olson said the issue will be discussed at a conference of low-income taxpayer clinic leaders later this year and will be listed among the "most serious problems" in TAS's next annual report to Congress, which should be released early in 2014.

In response, an IRS spokesman said, "The EITC is an important program for the IRS, and we always review the recommendations and findings from the advocate's office."

LITC Community Welcomes Study

Francine J. Lipman, a University of Nevada, Las Vegas law professor, said the planned project is one that needs to be done because the EITC ban is an unusual penalty in the code.

"To apply it without a very thorough analysis is quite harmful to families and especially children," she said.

Diana Leyden, director of the tax clinic at the University of Connecticut, said that for low-income taxpayer clinics (LITC), having hard data from a study showing why the ban is being imposed would be helpful.

"The LITC community has generally been uncertain of how the IRS is actually administering this ban and so it's really difficult when clients come in, one, to understand if they are caught in it and two, if they are caught in it because they haven't had representation in refuting the ban," she said.

Paul Harrison, director of the tax clinic at the Center for Economic Progress in Chicago, said he doesn't think the IRS has ever provided clear guidance on how and why it enforces the ban.

When asked about what impact the study might have, Harrison said it's hard to say but added, "I think it's always worth asking the question of any of the punitive sections of the code: What is the purpose they're intended to perform and are they in fact performing it?"

Cleveland Cases

Attorneys with the Legal Aid Society of Cleveland are working with a pair of law professors to bring two cases involving taxpayers facing the ban to trial in the Tax Court in September.

One case involves a Cleveland area man who was denied nearly $ 4,000 under the EITC when the IRS disallowed his claim for the credit and imposed the two-year ban on him after auditing his 2011 return, said Susan Morgenstern, an attorney with Cleveland legal aid. The man sought help from a paid tax preparer at a chain of preparers that has locations in lower-income sections of Cleveland, Morgenstern said.

A second case involves a woman from Liberia who lives in the Cleveland area. She received EITC monies totaling just under $ 8,800 over three returns: 2009, 2010, and 2011, said Camille Gill, also an attorney with the Legal Aid Society of Cleveland. The Liberian woman, a refugee, speaks an African language but does not speak English, and when she went to a paid preparer for help with her returns, she was paired up with a Spanish-speaking preparer, Gill said. The IRS has imposed a two-year ban on the woman for each of the three returns and wants the EITC payments repaid with penalties and interest.

Morgenstern said taxpayers facing the ban are vulnerable to unprofessional return preparers and don't receive clear information from the IRS.

"The taxpayers are left with not understanding what the proposed ban means, nor do they understand why it happened," she said.

Morgenstern, Gill, Cleveland State University law professor John T. Plecnik, and Villanova University law professor Leslie M. Book are working on the cases together.

Plecnik said one might be left with the impression that there is no standard at all for imposing the ban on taxpayers, adding that he thinks the IRS is using the dictionary definitions of reckless or intentional disregard. However, the legislative history for section 32(k), in which the ban can be found, shows that section 6662, which does have a clear definition of reckless or intentional disregard, was referenced in relation to section 32(k), he said.

"I think that the correct definition is best laid out in the regulations to 6662, where disregard is reckless if the taxpayer makes little or no effort to determine whether a rule or regulation exists under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe," Plecnik said. "There are tons of cases dealing with when it's appropriate to apply 6662 penalties, and they typically don't apply where someone goes to a return preparer in good faith, essentially does their best, and says, 'Hey, I'm paying you, get it done,' and gives them all the information as best they can."

Plecnik said that under the section 6662 standards, it's clear the Liberian woman acted in good faith and that those rules should be applied to section 32(k). "Otherwise we're left with the current setting where the IRS just says well, does it feel reckless or not?" he said.