A recent TIGTA report discusses the processes the IRS uses to evaluate tax returns that reflect a claimed casualty loss deduction. TIGTA criticizes the IRS for allowing casualty loss deductions that are not allowed under current law. It recommends that the IRS institute up front checks to prevent the processing of returns that may reflect an erroneous casualty loss deduction. In so doing, I believe TIGTA is recommending that IRS violate a fundamental taxpayer right to access Tax Court through normal deficiency procedures. To IRS’s credit, IRS disagreed with TIGTA. In this post I will discuss the (admittedly wonky) issue.
As readers may know in the Tax Cuts and Jobs Act Congress substantially cut back the ability of taxpayers to claim casualty deductions for the years 2018-2025, with losses only allowed when connected to claims associated with Federally declared disasters.
How does this relate to tax procedure and tax administration?
The path from tax return filing to IRS processing is confusing, even for tax professionals. A recent helpful blog by NTA Erin Collins discusses the lifecycle of a tax return, including detailing the IRS’s review process before it posts to the IRS system. As the NTA notes, the vast majority of returns IRS processes without hiccup. If the return reflects an overpayment it either generates a refund (or offset) or begins the separate post-assessment collection stream.
As the NTA notes, however, there are a number of detours a return can take that delay the normal process, including error resolution system (ERS): “ERS systemically identifies potential errors made on a taxpayer’s return and then requires an employee to manually review to address the identified error.”
If a return goes to ERS the return is manually reviewed. If ERS review confirms that there is an error, IRS generally sends either 1) a letter requesting additional information or 2) a math error letter.
The TIGTA report reviews the process IRS uses to evaluate returns that reflect a claimed casualty loss deduction:
When the President declares a Federal disaster or emergency, immediate notification is made to the Governor of the affected State or U.S. Territory, appropriate members of Congress, and Federal departments and agencies. The Internal Revenue Service (IRS) Disaster Assistance and Emergency Relief Program Office prepares and distributes an internal Disaster Relief Memorandum to the IRS that summarizes the tax relief to be provided. Individuals and businesses in eligible counties are identified by zip code. For those individuals and businesses affected, the IRS adds the specific Federal Emergency Management Agency (FEMA) disaster declaration number (hereafter referred to as a FEMA number) that identifies the Federally declared disaster to the tax account. Taxpayers who live outside the identified zip codes and are affected by a Federally declared disaster can self-identify by calling the IRS’s disaster toll-free telephone line. The IRS will automatically grant tax relief and manually input the FEMA number on the taxpayer’s account.
TIGTA has previously reviewed post TCJA returns claiming casualty loss deductions and has noted that returns claiming casualty losses have failed to include the FEMA declaration disaster number (i.e., the FEMA number) as required on Form 4684, Casualties and Thefts. TIGTA found over 12,000 2019 returns that failed to include the FEMA number. Those returns reflected over $309 million in casualty loss deductions.
TIGTA’s solution to the problem of a missing FEMA number is for IRS to add this issue to the vast pile of returns in ERS that could trigger a summary assessment without the bother of sending a post audit statutory notice of deficiency. This up front flagging is important from TIGTA’s perspective because prior studies showed that due to dollar criteria and resource issues under 2.5% of the returns that failed to include a FEMA number would be potentially subject to examination (and many fewer would actually be examined).
IRS partially disagreed with TIGTA, noting that the “absence of the FEMA number on Form 4684 is not a condition the IRS could use to summarily determine whether the claim is unallowable. Such a determination must be made under deficiency procedures, which is beyond the scope of the Error Resolution function.”
As the response reflects, summary assessments are the exception and require statutory identification. (We have previously discussed one form of summary assessment, math error notices. See Keith’s post from last week.)
Congress could have chosen to add the casualty loss issue to the summary assessment category, but it did not. That should not be a determination IRS makes. Kudos to the IRS for pushing back on TIGTA’s recommendation.
There are other ways to address the problem without abridging taxpayer rights. IRS noted that it has changed the Form 4684 to more explicitly require the FEMA number. It will evaluate the results of the change. IRS stated that it would also work with software providers to make more explicit a prompt that a FEMA number is needed.
In addition, former NTA Nina Olson has previously written in testimony, blog posts and recommendations in reports to Congress that IRS should use data and information that it has to identify issues that would help get to the right answer or minimize harm to taxpayers. (See here at page 12, for example, linking to Senate testimony from 2018 tying the concept to using data to identify taxpayers who are at risk of economic hardship). Disaster relief is based on zip codes. At least for some group of these returns, the IRS could determine whether the zipcode of the taxpayer’s address matches the zipcode for the Presidentially declared disaster. For other returns, the taxpayer isn’t in the zipcode but is affected by the zipcode, and the taxpayer has called the IRS Disaster Office, and as TIGTA notes the IRS places the FEMA code on their account. So in the vast majority of cases the IRS has internal data that can verify the legitimacy of these returns and casualty loss claims without a human needing to look at the return. Thus, IRS could (1) reduce administrative burden on taxpayers who have already suffered extraordinary losses and have more important things to worry about than a specific number to tag on a return and (2) reduce the number of returns going to ERS by instituting a machine-learning program to identify likely legitimate returns.
TIGTA’s mission is to promote “integrity, economy, and efficiency in the administration of the Nation’s tax system.” In so doing, however, it should be mindful of the statutory rights taxpayers enjoy.
There are a couple of related points to this post as well that will soon merit their own posts. The infrastructure legislation contains proposed language that will amend Section 7508A(d), which addresses the authority to postpone deadlines due to presidentially declared disasters or terroristic or military actions. A prior post on that topic is here is here.
The concept of burdens that taxpayers experience is the topic of a proposed law review article that Keith, Nina and I have submitted to journals this cycle. The paper explores the concept of administrative burdens and proposes a new framework to identify and mitigate those burdens, tying it all to protecting taxpayer rights.