Tax refunds sought by hundreds of thousands of poor Americans have been frozen and their returns labeled fraudulent, blocking refunds for years to come, the Internal Revenue Service’s taxpayer advocate told Congress today.
The taxpayers, whose average income was $13,000, were not told that they were suspected of fraud, the advocate said in her annual report to Congress. The advocate, Nina Olson, said her staff sampled suspected returns and found that, at most, one in five was questionable.
A computer program selected the returns as part of the questionable refund program run by the criminal investigation division of the Internal Revenue Service. In some cases, the criminal division ordered that taxpayers be given no hint that they were suspected of fraud, the report said.
Most of the poor people whose returns the computer flagged as fraudulent were seeking the earned income tax credit, a benefit for the working poor. The credit can return all of the income taxes and Social Security taxes withheld from the paychecks of poor people. Without the credit, many poor people coming off welfare and going to work would receive less money because of taxes taken out of their paychecks and the loss of health benefits, I.R.S. data and other government documents show.
The average refund sought was $3,500, which under the rules for obtaining the credit means that the vast majority of those suspected of fraud were single parents or married couples with children. The maximum benefit for singles is less than $400.
Ms. Olson said the I.R.S. devoted vastly more resources to pursing questionable refunds by the poor, which she said cannot involve more than $9 billion, than to a $100 billion problem with unreported incomes from small businesses that deal only in cash, many of which do not even file tax returns.
Ms. Olson, whose job Congress created eight years ago to argue for the interests of taxpayers, also said the top priority for the tax system must be simplification. She said the tax system is so complex that millions of people have difficulty complying and can get in trouble for subtle mistakes, while those with aggressive advisers can manipulate the system to escape paying taxes they owe.
Once a return is flagged, requests in future tax returns are also frozen for a number of years that the advocate said she is not allowed to disclose because it goes to law enforcement techniques.
Ms. Olson said that 66 percent of those taxpayers who pressed for their refunds were found to be due all the money they sought or even more than they asked for.
Senator Charles E. Grassley, the Iowa Republican who is chairman of the Senate Finance Committee, said he was troubled that taxpayers were not told that their refunds had been frozen.
“The taxpayer advocate’s report raises serious questions about the I.R.S. criminal investigation division’s freezing taxpayers’ refunds,” the senator said.
“We’ve seen a significant increase in refund abuse in recent years,” he said. “However, I’m concerned by the advocate’s findings that thousands and thousands of taxpayers are having their refunds frozen by the criminal investigation division, yet the taxpayers often do not know their refund has been frozen and can’t effectively challenge the IRS’ actions.”
Leslie M. Book of Villanova University, who runs a tax clinic for the poor and has studied how well the poor comply with the tax laws, said the computer program was a blunt and unfair way to look for fraud.
“Surely there are taxpayers who are ineligible claiming the credit,” Professor Book said. “But freezing refunds without giving taxpayers process is an extremely dangerous way to administer the earned income tax credit,” he said. “These taxpayers often need more rather than less protection because they are not sophisticated, are afraid of government involvement.”
Another 14 percent were issued partial refunds, Ms. Olson reported.
When the I.R.S. criminal investigation division was shown Ms. Olson’s report, it said the finding that 80 percent of refund requests were due all or part of the money sought was misleading because it applied only to people who pressed for their refunds.
Ms. Olson said criminal investigators had broken the questionable refunds into three groups, the most serious of which were labeled “conclusively fraudulent.” In 46 percent of those returns, however, the criminal investigators later acknowledged to the taxpayer advocate that there was no evidence of fraud, according to the report.
Ms. Olson said it was unfair, and a waste of resources, to withhold refunds from poor people when at most one in five of them appeared not to be due refunds.
She also said that the I.R.S. told her that its program had protected $2.1 billion of revenue. But she said this number was misleading.
Just two refunds, from a scheme run by prisoners, accounted to $1.8 billion of the total, she said, citing testimony to Congress by Nancy Jardini, chief of the I.R.S. criminal division.
Ms. Olson told Congress that these two refunds almost certainly would have been detected without the questionable refund computer sweeps.
The staff of Congress’s Joint Committee on Taxation must review all refunds of $2 million or more before they can be issued. Thus, the two refund requests totaling $1.8 billion would have been referred to the Congressional tax staff. New York Times