IRS destroyed 30M paper information returns due to the backlog

The Internal Revenue Service decided to destroy an estimated 30
million paper-filed information return documents in March 2021 because
of its inability to process its backlog of paper tax returns,
according to a new report.

The report, released Monday by the Treasury Inspector General for Tax
Administration, noted that the IRS typically uses information return
documents for post-processing compliance matches to identify taxpayers
who don’t accurately report their income. The report focuses on how
the IRS should be doing more to encourage the electronic filing of
business tax returns and reduce paper filing. TIGTA reported that,
while the e-filing of business tax returns has continued to increase,
the e-filing rate still lags behind that of individual tax returns.

“Repeated efforts to modernize paper tax return processing have been
unsuccessful,” said the report.

During the pandemic, millions of paper tax returns and other documents
accumulated at IRS facilities and the agency has been working overtime
to catch up on the backlog. Another recent TIGTA report noted that
more than 16.4 million individual tax returns, transactions, and
Accounts Management cases remained in inventory as of the end of 2021.
During a Senate oversight hearing last week, IRS Commissioner Chuck
Rettig testified that the number of unprocessed tax returns from 2021,
as of April 21, had been reduced to 1.8 million (see story).

The IRS continues to receive large volumes of paper-filed tax and
information returns, leading to significant costs to process them
every year, according to the new TIGTA report. In the fiscal year
2020, the IRS spent more than $226 million on processing paper-filed
tax returns.

The report acknowledged that the IRS has taken a number of actions and
developed initiatives to increase e-filing. On top of that,
legislative requirements have resulted and will continue to lead to
increases in e-filing. But TIGTA believes the IRS needs an overall
strategy.

“The backlogs of paper tax and information returns to be processed
along with the inability to ship paper tax returns and/or retrieve
paper tax returns from Federal Records Centers due to the pandemic
demonstrate the need for the IRS to develop a Service-wide strategy to
further, increase e-filing,” said the report. “However, the IRS does
not have a Service-wide strategy that identifies, prioritizes, and
provides a timeline for the addition of tax forms for e-filing or an
accurate and comprehensive list of tax forms not available to e-file.”

The problems led to the wholesale destruction of millions of
information returns. The report does not explain exactly why the IRS
destroyed millions of information returns, but it seems to be part of
an effort to expedite the processing of the backlogged business tax
returns.

“This audit was initiated because of the IRS’s continued inability to
process backlogs of paper-filed tax returns contributed to
management’s decision to destroy an estimated 30 million paper-filed
information return documents in March 2021,” said the report. “The IRS
uses these documents to conduct post-processing compliance matches to
identify taxpayers who do not accurately report their income.”

The documents help the IRS’s Automated Underreporter Program identify
taxpayers who are not accurately reporting their income, but IRS
officials told TIGTA that once the tax year ends, the information
returns, such as Forms 1099-MISC, Miscellaneous Information, can no
longer be processed due to system limitations. That’s because the
system used to process the information returns is taken offline for
programming updates in preparation for the following filing season.

Since 2014, the overall percentage of business tax returns e-filed has
increased from 41% to 63%. Employment tax returns continue to provide
the most significant opportunity for growth in business e-filing,
TIGTA noted. The IRS has yet to establish processes and procedures to
identify and address corporate, employer, and Heavy Highway Vehicle
Use Tax filers that do not comply with e-file mandates. TIGTA’s
analysis of tax return filings identified 15,108 filers that
paper-filed 22,569 the tax year 2018 returns that were required to be
e-filed. TIGTA estimates that the processing of these returns costs
the IRS $30,196 in comparison to the $3,405 to process the required
e-filed tax returns.

TIGTA recommended the IRS develop a Service-wide strategy to
prioritize and incorporate all forms for e-filing; develop processes
and procedures to identify and address potentially non-compliant
corporate filers; and develop processes and procedures to ensure that
penalties are consistently assessed against business filers that are
non-compliant with e-filing requirements.

The IRS agreed with the first recommendation to develop a Service-wide
strategy to incorporate all forms for e-filing but didn’t agree with
the report’s other two recommendations. IRS officials said they didn’t
need to develop processes and procedures to identify non-compliant
corporate filers because all requirements needed to assess penalties
are not known at the time of filing.

The IRS also has systemic processes in place for e-filed partnership
returns, which were found to be working as intended. Other types of
business returns have differing criteria for e-filing requirements and
exceptions to the requirements, which prevent the implementation of a
standard process for all business filers.

TIGTA, for its part, said it believes that IRS management’s
justification for taking no action on two recommendations is
insufficient. “In view of the backlogs of paper tax returns, the IRS
should take additional steps in an effort to continue to reduce paper
return filings,” said the report.

The IRS pointed out that it’s facing a tight budget but is continuing
to pursue more ways to spur the e-filing of various types of business
tax returns. “Constrained funding is the foremost obstacle we face in
implementing our modernization strategies,” said Kenneth Corbin,
commissioner of the IRS’s Wage and Investment Division, in response to
the report. “In 2015, we developed business tax return strategies for
the employment tax family of returns (forms 94x), Form 990, Return of
Organization Exempt from Income Tax, and Form 2290, Heavy Highway
Vehicle Use Tax Return. Each of the strategies provided a framework of
opportunities to increase the business return e-file rates.”

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