WASHINGTON -- The government improperly identifies hundreds of thousands of taxpayers every year as potential cheats, forcing them to endure needless delays of up to three years to receive the refunds they deserve, the IRS' taxpayer advocate says.
The Internal Revenue Service does not make a practice of informing taxpayers that they are under investigation or of allowing those it suspects the chance to prove that their returns were accurate or to show that any errors were honest mistakes rather than fraud, the advocate said in a report issued yesterday.
Many of the taxpayers whose refunds have been held back are working poor people who desperately need the money, said Nina E. Olson, who heads the Taxpayer Advocate Service, an agency within the IRS that handles taxpayer complaints.
The report by Olson's office said the way the IRS freezes refunds is one of the most serious failings in the agency's operations. The IRS "cannot and should not treat every taxpayer as a tax cheat," the report said.
The review found that in 80 percent of a sample of cases of frozen refunds brought to the taxpayer advocate, the IRS wound up paying full or partial refunds.
The taxpayers affected were overwhelmingly poor, which Olson said she could not explain. One reason could be the complexity of the earned income tax credit for the working poor.
Olson said in an interview that the refund problem developed as the IRS tried to bolster its enforcement function in response to increasing tax fraud. "The IRS should be doing it," she said, "but it should be doing it well. It shouldn't be tormenting people."
The advocate's findings drew swift reactions from leading senators in both parties with oversight of the IRS.
Senate Finance Committee Chairman Charles E. Grassley, an Iowa Republican, said he was "especially troubled" by the suggestion that refunds for innocent taxpayers were being withheld.
"Refunds have been a source of abuse recently," Grassley said, "but we need to make sure taxpayers have proper due process when the IRS decides to freeze a refund." Taxpayers "often do not know their refund has been frozen and can't effectively challenge the IRS' actions," he said.
The taxpayer advocate's office began its review after receiving 28,500 complaints last year from taxpayers whose refunds had been frozen.
The office examined a sample of the complaints after they had been resolved and found that in nearly two-thirds of them, the taxpayers were "fully entitled" to receive their entire refund or more. An additional 14 percent received partial refunds.
The average adjusted gross income of taxpayers whose refunds were frozen and whose cases were reviewed was $13,300, and the average refund was $3,519. The survey found that the average delay in paying the refunds was 8 1/2 months.
The IRS, given a chance to make its case within Olson's report, said she had "significantly overstated the problem." The taxpayer advocate surveyed only cases of delayed refunds in which the taxpayers complained, and innocent taxpayers are more likely to complain than guilty ones are, the IRS said.
Joel Havemann and Peter Wallsten write for the Los Angeles Times.