IRS creates $36K per-worker Obamacare fine

If you were planning on sending workers out onto the insurance exchanges with a lump-sum of cash for premium costs, you’ll want to read the feds’ latest warning.

But the feds don’t want employers to think they can simply shift their workforces onto the exchanges.

So the IRS is reminding firms – via the most expense health reform penalty to date – that such a strategy isn’t a wise move.

Per-worker penalty up to $36K

In a new FAQ, the feds clarified that if firms set up a plan that contributes un-taxed money an employee can use to pay for insurance premiums, it violates the health reform law.

And the feds could slap firms with a $100 per day, per employee fine for setting up such a plan, which is also known as a stand-alone health reimbursement arrangement (HRA).

End result: a potential $36,5000 annual per employee fine.
This ruling means that employers can’t offer any tax-free money to pay for insurance premiums for non-employer-sponsored healthcare plans.

This type of arrangement is prohibited because the stand-alone plans with set limits (the maximum amount of money the company promises to contribute) violates the Affordable Care Act’s lifetime and annual limits on coverage ban.

‘Integrated’ HRAs, taxed funds OK

There are, however, a few things the IRS says employers can do. Firms can offer “integrated” HRAs, which are HRAs that are combined with a employer’s group health plan.

Many firms have set up high-deductible health plans for reimbursing co-pays and deductibles.

But the feds also made it very clear that an HRA will only be considered integrated with a health plan if the employee who uses it is enrolled in that health plan.

And employers can still provide their workers with a set amount of money to buy insurance on their own, which many firms feel is cheaper than sponsoring a group health plan.

They just can’t offer this option untaxed. Employers that choose to offer a lump sum must do it by increasing employees’ taxable wages.

IRS to Step up Penalties for Delinquent Payroll Taxes

Employers owed the Internal Revenue Service approximately $14.1 billion in delinquent Social Security, Medicare and individual federal income taxes that they had withheld from employee paychecks as of June 30, 2012, and the Internal Revenue Service is being urged to do more to assess penalties against them.

A new report from the Treasury Inspector General for Tax Administration found that the IRS’s penalty actions against employers who don’t remit payroll taxes are oftentimes neither timely nor adequate. When a business does not remit trust fund taxes withheld from its employees, the IRS can collect the unpaid taxes from the individuals responsible by assessing a Trust Fund Recovery Penalty, or TFRP, when appropriate.

Employees who have taxes withheld from their wages expect the funds to be properly remitted to the IRS, the TIGTA report noted, and businesses that do not pay their taxes have an unfair advantage over businesses that do pay their taxes in full and on time.

TIGTA found that the IRS’s TFRP actions were not always timely or adequate in 99 of the 265 cases it reviewed in a statistically valid sample of cases. For 59 of the 99 cases, the untimely actions averaged more than 500 days to review and process the penalty assessment. Among the problems, TIGTA found incomplete investigations, unsupported collectibility determinations and expired assessment statutes.

When the penalty assessments are not made in a timely way, taxpayers’ financial ability to pay can decline and the IRS’s chances of collecting the overdue taxes decrease. In addition, the government’s interest is not protected if the potential tax assessments are overlooked or missed.

In recent years, TIGTA acknowledged, the IRS has introduced new guidance to better control the Trust Fund Recovery Penalty process and has achieved some improvement in the average time it takes to complete investigations and assess the TFRP. However, significant untimeliness still exists, the report added.

TIGTA recommended that the IRS emphasize to group managers their responsibilities to monitor TFRP cases and ensure that revenue officers take timely TFRP actions; and enhance TFRP communication and training. The IRS should also ensure the completion and adequacy of scheduled system improvements and take appropriate actions to implement the changes, TIGTA suggested. In addition, the report recommends the IRS revise its TFRP guidance regarding the accuracy of the collectibility determination support and controlling the completion of TFRP investigations when installment agreements or currently not collectible closures are approved.

In response to the report, IRS officials agreed with all of TIGTA’s recommendations and plan to take corrective actions.

Karen Schiller, commissioner of the IRS’s Small Business/Self-Employed Division, pointed out that the IRS has significantly improved the timeliness of its TFRP case actions in response to a 2008 report from the Government Accountability Office that found businesses owed billions of dollars in federal payroll taxes. She noted that the IRS’s overall average improvement in the timeliness of TFRP case actions increased from 74 percent in fiscal year 2010 to 93 percent in fiscal 2013, and that the sample TIGTA used for the analysis in its report included cases with actions prior to 2012 before the IRS’s improvements had been fully implemented.

“As we discussed during the audit, we worked diligently to implement the recommendations made by GAO and to improve the timeliness and adequacy of all TFRP actions,” she wrote. “Limiting your review to case actions that occurred after FY2012, when increased controls and guidance had been completely implemented, would have provided a more accurate picture of our current program.”

The IRS plans to make programming changes in its Automated Trust Fund Recovery system to ensure it works more efficiently and it will provide additional training to managers.

“We remain committed to continued improvement and recognize the opportunity for additional systemic enhancements to increase our case processing efficiency and accuracy,” said Schiller.

IRS Oversight Board Opposes Private Debt Collectors

The IRS Oversight Board has sent a letter to the leaders of Congress’s main tax committees urging them not to re-instate a privatized tax debt collection program.

A provision in the tax extenders legislation, the EXPIRE Act, introduced last month by Senate Finance Committee chairman Ron Wyden, D-Ore., would restore the private debt collection program that the IRS discontinued in 2009 (see IRS Nixes Private Collection Contracts). The controversial program had attracted both proponents and opponents in Congress.

The IRS Oversight Board said it was siding with National Taxpayer Advocate Nina Olson, who also expressed her opposition to the private debt collection program earlier this month.

“The concept has already failed twice,” said IRS Oversight Board chairman Paul Cherecwich, Jr., in a letter Tuesday to the leaders of the House Ways and Means Committee and the Senate Finance Committee. “When direct administrative costs are included, which the Joint Committee on Taxation failed to do, the program costs more to administer than the revenue retained. We concur with the NTA in that outsourcing federal debt collection is a bad idea and it makes little sense to resurrect, let alone expand the program to include the assignment of all ‘inactive tax receivables’’ to PCAs [private collection agencies]. The IRS Oversight Board respectfully suggests that if Congress wishes to improve revenue collection, it should invest in IRS priority enforcement programs, such as the Automated Collection System (ACS), which has a proven 20:1 return on investment. Funding another private debt collection program is throwing good dollars after bad, and in our view, should be summarily rejected.”

Cherecwich pointed to the two previous efforts at private debt collection of delinquent taxes owed the federal government. “Although America’s taxpayers were promised a high return on investment from the collection of old debts, the opposite proved true,” he said. “The NTA correctly notes that the IRS terminated the last version of the program after concluding it lost money—$17 million—when opportunity costs, such as diverting IRS collection personnel to administer the PDC, were taken into account. In other words, there was a negative return on investment.”

Cherecwich pointed out that independent studies have confirmed that private collection firms did not outperform IRS employees. During the most recent failed private debt collection program from 2006 to 2009, he noted, employees who worked in the IRS’s Automated Collection System function needed to stop working on their own inventory of cases so they could help the private collection agents who could not resolve tens of thousands of cases. If the nearly $68 million in total costs for the 2006 private debt collection effort had been invested in an additional 700 full-time equivalent employees in the IRS’s ACS function, he observed, they would have collected an estimated $1.4 billion in enforcement revenue rather than the loss incurred by the private debt collection program.

“Moreover, the PDC program never came close to being self-funded or operating independently of the appropriations process as promised,” Cherecwich added.

In a letter earlier this month, National Taxpayer Advocate Olson also wrote to leaders of the House Ways and Means Committee and the Senate Finance Committee arguing against the program.

“The Office of the Taxpayer Advocate and I personally were intimately involved in the development of the 2006-2009 PDC program,” she wrote. “We also handled more than 3,700 cases involving taxpayers against whom PCAs sought to collect. Based on what I saw, I concluded the program undermined effective tax administration, jeopardized taxpayer rights protections, and did not accomplish its intended objective of raising revenue. Indeed, despite projections by the Treasury Department and the Joint Committee on Taxation that the program would raise more than $1 billion in revenue, the program ended up losing money. We have no reason to believe the result would be any different this time.”

IRS commissioner John Koskinen has also objected to the program, telling a hearing of the House Ways and Means Committee this month that the IRS ended up losing money on the private debt collection program.

Sen. Chuck Grassley, a senior member and former chairman and ranking member of the Senate Finance Committee, pointed out last week after reading Olson’s comments in the Washington Post that the non-partisan congressional Joint Committee on Taxation, the official estimator of tax provisions, said the current proposal in the tax extenders bill to engage private contractors to collect tax debts would generate $2.4 billion over ten years for the U.S. treasury.

“The use of private contractors is meant to get at legitimate tax debts that the IRS can’t or won’t collect on its own,” Grassley said in a statement. “These contractors are set up to do the work. They aren’t meant to detract from the IRS’ work. They’re meant to make up for what the IRS can’t do, while saving money. And there’s no getting around the estimate from the Joint Committee on Taxation that the current proposal would raise $2.4 billion over 10 years. That says the proposal would work, as intended. Collecting tax debt is only fair to all taxpayers who pay what they owe.”

Sen. Charles Schumer, D-N.Y., reportedly inserted the provision in the tax extenders legislation, according to the Post. Two of the firms that have been approved by the IRS to provide private debt collection services are located in his state, ConServe and Pioneer Credit Recovery. Another approved contractor, the CBE Group, is in Grassley’s state, Iowa. The other approved contractor, Performant Financial, is in California.

Cherecwich disputed the estimate from the Joint Committee on Taxation, noting that it relies solely on gross receipts and the assumption that they will come in for 10 years regardless of the administrative costs.

“From a private sector perspective, such an approach would be contrary to fiduciary responsibility and full financial transparency,” he wrote. “What private sector company would make business decisions based solely on gross revenue while ignoring costs and still stay in business? It is doubtful they would. It would be like a major construction firm making a bid for a contract without taking into account labor costs. In this regard, we believe the JCT should modify its 10-year revenue score for any PDC program.”

IRS Finds Problems with Employee Plan Terminations

The Internal Revenue Service’s Employee Plans Compliance Unit recently looked at whether employee benefit plan sponsors had completed all the necessary steps after filing a Form 5500-series return showing they had adopted a resolution to terminate the plan, and found that many did not.

The IRS unit set up a Termination Project to learn if employee plan sponsors who indicated they adopted a resolution to terminate their plan had completed the termination process, complied with Revenue Ruling 89-87 for their wasting trusts, filed a final Form 5500-series return, and distributed all the trust assets as soon as administratively feasible.

The Employee Plans Compliance Unit found that some plan sponsors who indicated they had adopted a resolution to terminate their plan didn’t file a final Form 5500-series return. In general, the IRS noted, plan sponsors must continue to file a Form 5500-series return for their terminated plan until the last return filed is marked “final return/report” and shows zero assets at the end of that plan year. This is required even if the sponsor was exempt from filing a Form 5500-EZ (the annual return of a one-participant retirement plan) in previous years.

Over 75 percent of the sampled sponsors showed that, although they took additional steps to terminate their plan beyond adopting a resolution to terminate, they didn’t complete the termination process. In many cases, they didn’t file a Form 5500-series return marked as the ‘final return/report’ showing zero assets at the end of the plan year. The IRS noted that being in the process of terminating doesn’t eliminate the Form 5500-series filing requirement. Employee plan sponsors must continue filing their annual return until all plan assets are distributed.

In other cases, the plan sponsors distributed all the plan assets but didn’t mark the Form 5500-series return as final. The IRS noted that sponsors can correct this by filing an amended return. Review your Form 5500 return carefully before filing to prevent errors.

In other cases, plan sponsors terminated the plan but weren’t aware there were still assets in the trust. “All plan assets need to be distributed for the plan termination to be complete,” the IRS cautioned.

In some cases, it took a long time to distribute the plan assets because of difficulty locating participants and beneficiaries. Many plan sponsors weren’t aware of the requirements and procedures for locating missing participants and beneficiaries. Plan sponsors can use the Department of Labor’s Field Assistance Bulletin 2004-2 for guidance in locating missing individuals for benefit distributions. The IRS no longer provides letter-forwarding services (Revenue Procedure 2012-35).

In other cases, the plan sponsors distributed all the plan assets but didn’t indicate zero assets at the end of the plan year on their final Form 5500 series return. The IRS pointed out that sponsors can correct this by filing an amended return.

Other plan sponsors didn’t distribute all the plan assets as soon as administratively feasible after the plan termination date. “Some plan sponsors had difficulty distributing certain types of plan assets, such as real estate or partnership investments,” said the IRS. “Generally, a distribution which isn’t completed within one year following the date of plan termination will be presumed not to have been made as soon as administratively feasible unless facts and circumstances show otherwise (Revenue Ruling 89-87, 1989-2, C.B. 81). If sponsors don’t distribute all plan assets as soon as administratively feasible, the IRS considers the plan to be ongoing.”

If sponsors don’t complete all termination actions, there is also potential for plan disqualification, discrimination in favor of highly compensated employees, abusive tax avoidance, and administrative penalties, the noted.

Other filing errors included sponsors who mistakenly indicated they were terminating their plan when they actually did not intend to do so. Some plan sponsors incorrectly marked line 5a on the Schedule H (Financial Information) or Schedule I (Financial Information – Small Plan) of their Form 5500-series return to indicate they had adopted a resolution to terminate the plan.
Some plan sponsors mistakenly indicated the plan was terminated when it was actually frozen.

“These sponsors weren’t aware of the differences between a frozen plan and a terminated plan,” said the IRS. It noted that in a frozen plan, participants don’t accrue any additional benefits (whether because of service or compensation) except under special circumstances. A frozen plan must continue to meet annual information reporting and plan qualification requirements including having the plan sponsor amend the plan for current law by the required deadlines; otherwise, the plan may lose its qualified status for tax benefits.

Some plan sponsors mistakenly used the same plan number from a previous or different plan. Once plan sponsors use a plan number, they should continue to use it for that plan on all future filings with the IRS, the Labor Department and the Pension Benefit Guaranty Corporation. Even if the plan sponsor terminated their plan, they can’t use the same plan number for any other plan, the IRS cautioned.

There were also some processing errors that occurred before the implementation of the Department of Labor’s electronic filing system. Plan sponsors now must file Forms 5500 and 5500-SF electronically using DOL’s EFAST2 web-based filing system or through an EFAST2 approved vendor. Plan sponsors paper file the Form 5500-EZ with the IRS. Plan sponsors can’t paper file Forms 5500 or 5500-SF. For more information, see DOL’s EFAST2 site or the IRS Form 5500 corner.

The IRS recommended that employers review their terminated plans to see if they have finished all the steps in the termination process, including:
•  Filing all current and prior Form 5500-series filings
•  Filing a final Form 5500-series return showing zero assets
•  Distributing all assets
•  Finding all missing participants and beneficiaries

Plan sponsors should also recognize the differences between active, frozen, and terminated plans. They should correct any errors you discover and amend your return, if needed. Correct the plan administrative procedures so the mistakes don’t happen again. It may be helpful to ask at least two people to review the 5500 return before it is filed.

IRS Employee Took Home Data on 20,000 Workers at Tax Agency

An Internal Revenue Service employee took home a computer thumb drive containing unencrypted data on 20,000 fellow workers, the agency said in a statement.

The tax agency’s systems that hold personal data on hundreds of millions of Americans weren’t breached, the statement said Tuesday.

“This incident is a powerful reminder to all of us that we must do everything we can to protect sensitive data—whether it involves our fellow employees or taxpayers,” IRS Commissioner John Koskinen said in a message to employees. “This was not a problem with our network or systems, but rather an isolated incident.”

The IRS is contacting the current and former employees involved, almost all of whom worked in Pennsylvania, Delaware and New Jersey. The information dates to 2007, before the IRS started using automatic encryption.

IRS officials were told of the breach “a few days ago,” Koskinen’s message said.

The Social Security numbers, names and addresses of employees and contract workers were potentially accessible online because the thumb drive was plugged into the employee’s “unsecure home network,” Koskinen’s message said.

The IRS said it had no knowledge of the information being used to commit identity theft.

Inspector General
The IRS said it’s working with its inspector general to investigate the incident. The IRS statement didn’t say why the incident was discovered now, didn’t include the name of the employee who used the thumb drive and didn’t say whether the employee still works at the IRS.

David Barnes, a spokesman for the inspector general’s office, declined to comment.
House Ways and Means Committee Chairman Dave Camp, a Michigan Republican, said in a statement that the IRS in the past has released taxpayer information to the public and “has not been able to effectively prevent and detect identity theft.” He said the committee will look into the incident.

The IRS’s data breach is much narrower in scope than the security incident at Target Corp., where hackers stole credit- card information used by millions of shoppers.

It comes during a trying year for the tax agency, which has been under congressional investigation for its spending at conferences and its scrutiny of small-government groups.

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IRS Criminal Prosecutions Climbed 23% under Obama

The number of criminal prosecutions referred by the Internal Revenue Service to the Justice Department has increased 23.4 percent during the Obama administration.

Prosecutions in fiscal year 2013 alone jumped 30.6 percent from the previous year, according to a new report by Syracuse University’s Transactional Records Access Clearinghouse.

Convictions for tax crimes under the Obama administration are also drawing slightly longer average prison terms, 27 months under Obama, compared to 25 months during the George W. Bush administration, according to information obtained by TRAC under the Freedom of Information Act from the Executive Office for United States Attorneys.

Among U.S. federal judicial districts, Alaska registered the highest per capita rate of IRS prosecutions, 53 per million people, compared with 6.4 prosecutions per million nationally. Next in line was the Middle District of Alabama (Montgomery), with 30 per million, followed by the District of Columbia with 27 per million.

Court Rules in Favor of IRS on Obamacare Tax Credits

A federal district court judge has ruled in favor of the federal government in a lawsuit that claimed the Internal Revenue Service did not have the authority under the Affordable Care Act to write rules providing tax credits to individuals purchasing health insurance on the health insurance exchange set up by the federal government.

The IRS issued a final rule in May 2012 implementing the premium tax credit provision of the Affordable Care Act, in which it interpreted the ACA as authorizing the agency to grant tax credits to individuals who purchase insurance on either a state-run health insurance exchange or a federal exchange such as the one that has been available on the problem-prone HealthCare.gov site for people in states that have not set up state exchanges.

The plaintiffs in the lawsuit, who include the conservative advocacy organization, the Competitive Enterprise Institute, contended that the IRS’s interpretation was contrary to the statute, which, they asserted, authorizes tax credits only for individuals who purchase insurance on state-run exchanges, but not on federal exchanges. The plaintiffs in the case, known as Jacqueline Halbig, et al v. Kathleen Sebelius, et al, claimed that the rule promulgated by the IRS exceeded the agency’s statutory authority and was arbitrary, capricious and contrary to law, in violation of the Administrative Procedure Act.

The U.S. District Court for the District of Columbia heard oral arguments in the case last month and a judge on the court tossed out the lawsuit Wednesday, agreeing with the federal government that the law made clear that the tax credits should be available on both state-run and federally run health insurance exchanges.

“In sum, the Court finds that the plain text of the statute, the statutory structure, and the statutory purpose make clear that Congress intended to make premium tax credits available on both state-run and federally-facilitated exchanges,” wrote U.S. District Judge Paul Friedman. “What little relevant legislative history exists further supports this conclusion and certainly—despite plaintiffs’ best efforts to suggest otherwise—it does not undermine it.”

Sam Kazman, general counsel for the Competitive Enterprise Institute, said he planned to appeal the judge’s ruling.

“The court’s ruling today delivers a major blow to the states that chose not to participate in the Obamacare insurance exchange program,” Kazman said in a statement Wednesday. “It is also a blow to the small businesses, employees and individuals who live in those states as well. In upholding this IRS regulation that is contrary to the law enacted by Congress, this decision guts the choice made by a majority of the states to stay out of the exchange program. It imposes Obamacare penalties on employers and on many individuals in those states, penalties that Congress never authorized, putting their livelihoods and the jobs of their employees at risk. Worst of all, it gives a stamp of approval to the Administration’s attempt to substitute its version of Obamacare for the law that Congress enacted.”

IRS Offers Tips for Year-End Giving

Individuals and businesses making contributions to charity should keep in mind several important tax law provisions that have taken effect in recent years. Some of these changes include the following:

Special Tax-Free Charitable Distributions for Certain IRA Owners
This provision, currently scheduled to expire at the end of 2013, offers older owners of individual retirement arrangements (IRAs) a different way to give to charity. An IRA owner, age 70½ or over, can directly transfer tax-free up to $100,000 per year to an eligible charity. This option, first available in 2006, can be used for distributions from IRAs, regardless of whether the owners itemize their deductions. Distributions from employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans, are not eligible.
To qualify, the funds must be transferred directly by the IRA trustee to the eligible charity. Distributed amounts may be excluded from the IRA owner’s income – resulting in lower taxable income for the IRA owner. However, if the IRA owner excludes the distribution from income, no deduction, such as a charitable contribution deduction on Schedule A, may be taken for the distributed amount.
Not all charities are eligible. For example, donor-advised funds and supporting organizations are not eligible recipients.
Amounts transferred to a charity from an IRA are counted in determining whether the owner has met the IRA’s required minimum distribution. Where individuals have made nondeductible contributions to their traditional IRAs, a special rule treats amounts distributed to charities as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions. See Publication 590, Individual Retirement Arrangements (IRAs), for more information on qualified charitable distributions.
Rules for Charitable Contributions of Clothing and Household Items
To be tax-deductible, clothing and household items donated to charity generally must be in good used condition or better. A clothing or household item for which a taxpayer claims a deduction of over $500 does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with the return.
Donors must get a written acknowledgement from the charity for all gifts worth $250 or more that includes, among other things, a description of the items contributed. Household items include furniture, furnishings, electronics, appliances and linens.
Guidelines for Monetary Donations
To deduct any charitable donation of money, regardless of amount, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. Bank records include canceled checks, bank or credit union statements, and credit card statements. Bank or credit union statements should show the name of the charity, the date, and the amount paid. Credit card statements should show the name of the charity, the date, and the transaction posting date.
Donations of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, a Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.
These requirements for the deduction of monetary donations do not change the long-standing requirement that a taxpayer obtain an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. However, one statement containing all of the required information may meet both requirements.
Reminders
To help taxpayers plan their holiday-season and year-end giving, the IRS offers the following additional reminders:
  • Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of 2013 count for 2013. This is true even if the credit card bill isn’t paid until 2014. Also, checks count for 2013 as long as they are mailed in 2013.
  • Check that the organization is eligible. Only donations to eligible organizations are tax-deductible. Exempt Organization Select Check, a searchable online database available on IRS.gov, lists most organizations that are eligible to receive deductible contributions. In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even if they are not listed in the database.
  • For individuals, only taxpayers who itemize their deductions on Form 1040 Schedule A can claim deductions for charitable contributions. This deduction is not available to individuals who choose the standard deduction, including anyone who files a short form (Form 1040A or 1040EZ). A taxpayer will have a tax savings only if the total itemized deductions (mortgage interest, charitable contributions, state and local taxes, etc.) exceed the standard deduction. Use the 2013 Form 1040 Schedule A to determine whether itemizing is better than claiming the standard deduction.
  • For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes this information, as well as the fair market value of the property at the time of the donation and the method used to determine that value. Additional rules apply for a contribution of $250 or more.
  • The deduction for a car, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value is more than $500. Form 1098-C or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return.
  • If the amount of a taxpayer’s deduction for all noncash contributions is over $500, a properly-completed Form 8283 must be submitted with the tax return.
  • And, as always it’s important to keep good records and receipts.

IRS Contends with Billions Lost to Stolen EINs

The Internal Revenue Service is losing billions of dollars to fraudsters every year from stolen Employer Identification Numbers, according to a new government report, even though it has some processes in place to authenticate individuals who apply for an EIN.

The report, released publicly Thursday by the Treasury Inspector General for Tax Administration, found the IRS needs to do more to prevent fraud from the use of stolen EINs.

The IRS issues EINs to identify taxpayers’ business accounts. Individuals who try to commit tax refund fraud oftentimes steal or falsely obtain an EIN to file tax returns that report false income and withholding. TIGTA estimated that such fraud could top $11.4 billion in potentially fraudulent refunds over a five-year period.

The overall objective of TIGTA’s review was to assess the IRS’s processes for issuing EINs and identifying stolen or falsely obtained EINs for reporting income and withholding. TIGTA acknowledged that the IRS has developed processes to both authenticate individuals applying for an EIN and ensure that there is a valid business reason to obtain an EIN.

However, TIGTA identified 767,071 electronically filed individual tax returns in tax year 2011 with refunds based on falsely reported income and withholding. Of the 285,670 EINs used on these tax returns, 277,624 were stolen EINs used to report false income and withholding on 752,656 tax returns with potentially fraudulent refunds issued totaling more than $2.2 billion, while 8,046 were falsely obtained EINs used to report false income and withholding on 14,415 tax returns with potentially fraudulent refunds issued totaling more than $50 million.

The IRS has processes to prevent fraudulent refunds claimed using stolen and falsely obtained EINs, but it does not have the third-party Form W-2 information that it needs to make significant improvements in its detection efforts. Nevertheless, the IRS does maintain data that could increase its ability to detect tax returns with false income and withholding associated with stolen or falsely obtained EINs, TIGTA noted.

“With an estimated tax gap in excess of $450 billion, it is imperative that the IRS use all available data to increase its ability to detect tax returns with false income and withholding associated with stolen or falsely obtained EINs,” said TIGTA Inspector General J. Russell George in a statement.

In response to the report, the IRS said it takes refund fraud and identity theft very seriously. “The IRS continues to increase its efforts against refund fraud, which includes identity theft,” the IRS said in a statement. “As a result of these aggressive efforts to combat identity theft since 2011, the IRS has stopped 12.6 million suspicious returns, and protected over $40 billion in fraudulent refunds. The IRS appreciates TIGTA’s recognition of the effective processes we have developed to identify and prevent the fraudulent use of Employer Identification Numbers (EIN). The creation of the Business Master File Identity Theft Team is a substantial step forward in identifying threats associated with the misuse of EINs and developing effective mitigation strategies. We are taking additional steps for the coming filing season, including preparing a new Return Review Program for 2014 that will incorporate EIN validation into our fraud detection process.”

TIGTA recommended that the IRS update its fraud filters to identify potentially fraudulent tax returns and develop processes to identify individuals who submit tax returns that report income and withholding using the EIN of a closed business. IRS officials agreed with TIGTA’s recommendations and plan to update the fraud filters.

Peggy Bogadi, commissioner of the IRS’s Wage and Investment Division, pointed to the steps the IRS has already taken to combat identity theft and tax return fraud, including the creation of the Business Master File Identity Theft Team and the Return Review Program. She pointed out, however, that the IRS is facing a number of challenges, including the potential delays in processing tax returns. That is what happened last year when the IRS tightened the identity theft filters and millions of taxpayers were left waiting months for their tax refunds from tax year 2011.

“Using the business tax return filing and withholding information will be helpful in identifying potentially fraudulent refund claims by individuals using false wage and withholding information; however, there is a risk of delaying the processing of legitimate tax returns filed by individuals whose employers are not compliant with their tax and/or information filing obligations,” Bogadi wrote in response to the report. “Our sample review of the potentially fraudulent tax returns, identified by the Treasury Inspector General for Tax Administration, found situations where the employers had remitted payroll tax deposits but were delinquent in filing employment tax returns. We also noted instances where wage and withholding information from the employer was present for prior and/or subsequent periods that, in our experience, indicate either data anomalies or non-compliance with filing requirements. In these situations, non-compliance by employers does not equate to refund fraud by employees. With filings of individual income tax returns exceeding 140 million annually, we must ensure that corrective actions do not have the unintended result of flagging legitimate returns as being potentially fraudulent.”

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IRS Sent Erroneous Penalty Notices

 

The Internal Revenue Service has admitted to mistakenly assessing penalties on businesses that had requested extensions on filing the Form 5500 for their employee retirement plans.

The IRS is telling its help center representatives to apologize remove the penalties when they are contacted about the error, acknowledging a timing problem in posting the extension requests, according to a directive obtained by the site BenefitsPro.

“Form 5500 filers that file their return before their extension Form 5558 has had a chance to post are receiving CP 283s assessing them a late filing penalty,” said the IRS. “Proposed changes to the penalty program would allow time for extensions to post before penalty notices are generated. However, until these changes can be implemented, tax examiners and telephone assistors should abate these penalties as Service Errors.

The IRS telephone assistance representatives and tax examiners are also supposed to prepare a Letter 168C explaining that the penalty has been removed due to a “Service Error.”

“If the caller is an administrator or sponsor with multiple plans/clients, you may abate up to five penalties for the caller,” said the IRS. Benefit plan administrators who get more than five penalty notices from the IRS need to put their requests for abatement in writing and send them to the IRS.

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