Over the last five years, the Internal Revenue Service (IRS) has issued over $2 billion in erroneous or fraudulent tax refunds related to amended tax returns. On July 31, 2019, the U.S. Treasury Inspector General for Tax Administration (TIGTA) released a report. The report detailed why these mistakes are happening. It also outlined the actions the IRS should take to get on top of this issue.
If you’re thinking about amending a tax return, you may be wondering how this affects you. Here’s a closer look at the situation.
Why Do People Amend Tax Returns?
Taxpayers have the right to amend (make changes) to tax returns for three years after filing the tax return or up to two years after paying the tax associated with the tax return. Typically, taxpayers amend returns to claim additional credits or deductions, but they also amend returns to claim carrybacks.
When you suffer certain types of losses, you have the right to carry the loss back three years and forward for up to 20 years or sometimes indefinitely. To give you an example, imagine you have a $20,000 capital loss due to selling stocks at less than their purchase price. You can’t claim the loss on your current tax return because you don’t have any capital gains. Instead, you carry back the loss to a previous year’s tax return, which reduces your income on paper for that year. Furthermore, it minimizes the amount owed and potentially even generates a refund.
Regardless of the exact amendments they make to their old returns, people generally amend tax returns for a few different reasons. One of the most common reasons is to reduce the amount of tax they owe for previous tax years. For instance, a tax professional may look over old returns to see if making amendments to the return can save you money.
As indicated above, an independent audit of amended returns by the TIGTA demonstrates that the IRS is not dealing with these returns correctly, and the agency is issuing an unwieldy amount of incorrect refunds.
How Does the IRS Process Amended Tax Returns?
Currently, the IRS processes most tax returns electronically, but the agency deals with amended returns manually. At first glance, a manual review process may seem more efficient than an electronic review, but that’s not the case.
With original returns, the IRS’s automated system ensures that the right forms and schedules are attached. It double-checks the math and makes sure the taxpayer meets income requirements for tax credits or deductions. Then, the return goes through the IRS’s fraud detection filters, which flags potentially fraudulent returns, including returns that may involve identity theft.
In contrast, the manual review process for amended returns doesn’t bother with all these steps. In theory, IRS employees also should be checking for the required documentation, looking over math computations, and verifying eligibility for credits and deductions. However, a random sampling of amended returns indicates that the manual review process is rife with mistakes.
What Mistakes Are Happening?
When reviewing amended tax returns, the TIGTA noticed several common issues and mistakes, including the following:
- Math errors by taxpayers and IRS employees
- Incorrect adjustments for refundable credits leading to refunds
- Employee failure to verify claims for deductions
- Adjustments to itemized deductions with returns that didn’t include Schedule A (the schedule that lists itemized deductions)
- IRS employee failure to forward returns with reductions in Net Investment Income Tax to the right department for review
- Using 1040 forms instead of 1040X forms for amended returns
In other words, most taxpayers aren’t using the right form to make amendments to their old tax returns. Math errors are rampant. And again, taxpayers are receiving refunds in error.
How Can the IRS Reduce These Mistakes?
To help the IRS reduce these mistakes and stop sending out refunds incorrectly, the TIGTA issued a number of recommendations:
- Review questionable returns and make sure taxpayers don’t receive any benefits to which they aren’t entitled
- Implement processes to reduce employee errors
- Do a feasibility study and request funding to start e-filing amended returns
- Update verification steps for refundable claims made on amended returns, so they are similar to the verification process used on original returns
- Modify form 1040X so that taxpayers can use an Identity Protection Personal Identification Number (PIN) which can help to reduce fraud and identity theft
- Implement additional processing steps to ensure amended return matches original return in critical ways that can reduce identity theft
The IRS agreed with most of the suggestions. In particular, the agency decided to increase training for employees to minimize errors. Moreover, it requested funding for e-filing and considers making changes to Form 1040X. However, the IRS didn’t agree with the idea of using PINs for identity protection. The agency stated that the average refund for returns affected by this issue is only about $86, and from a cost perspective, putting in these additional safeguards may not be worth the effort.
Is Anything Going to Change?
After receiving such a severe report from the TIGTA and with so many financial losses due to incorrect tax refunds, the IRS may just jump into action and start making changes to tighten up the process associated with amended tax returns. Over the last eight years, TIGTA has issued four reports detailing how mistake-prone manual processing of amended returns is. However, over that period, little has changed.
That said, the IRS has started to move toward electronic processing for amended returns. If funding gets approved, the agency may be electronically processing amended returns by 2021. Until that time, the manual review process is still likely to make mistakes, including issuing unearned refunds.
What Should Taxpayers Do?
If you don’t need changes to old tax returns, but you worry about identity theft, take some steps to protect yourself. For example, freeze your credit report and take other steps to protect your identity until the IRS tightens up its processes.
In all cases, if you owe old tax debt, you should work with a tax firm or licensed tax professional. A tax firm can work out a settlement or resolution with the IRS. It can also help you set up payment plans, or even amend old returns to reduce how much you owe. Contact us today to get help dealing with the IRS.