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How Did We Get Here? Correspondence Exams and the Erosion of Fundamental Taxpayer Rights – Part 2


In my last post, I reviewed compelling IRS data, including from the National Taxpayer Advocate’s 2021 Annual Report to Congress, that show the IRS Automated Correspondence Exam (ACE) system disproportionately harms low income taxpayers and is desperately in need of a fix.  The IRS maintains the batch processing approach to correspondence (corr) examinations is efficient.  But the long-term goal of an audit should be to educate the taxpayer about what they did wrong (or for the IRS to learn what it got wrong), so the taxpayer (or IRS) does not repeat the mistake.  If the taxpayer never responds, or does not understand why additional tax is assessed, then the audit may result in more tax dollars, but from a voluntary compliance and taxpayer rights perspective the audit is a failure.  Correspondence exam, with its batch processing, assembly-line approach, may result in a high number of audits and assessments, but it does not promote understanding and in some cases has a negative compliance effect.  Moreover, researchers report that taxpayers who experience a correspondence audit report relatively low perceived levels of procedural, informational, interpersonal, and distributive justice.

If the IRS were truly taxpayer-centric and designed its compliance programs from a taxpayer-rights foundation, it would look at the data presented by the Taxpayer Advocate Service in this year’s report, as well as all the past reports, and conclude that the process isn’t working for the lowest income taxpayers.  It would ask itself how it could improve the audit process so that taxpayers engage with the auditor and learn what, if any, error they made and how to avoid it going forward.  That engagement and education is at the heart of voluntary compliance, and while it appears to require more upfront resources, it is way more cost effective in the long run than current correspondence exams, which have little educational value.  For example, in a 2007 TAS survey of taxpayers who experienced correspondence examinations for EITC claims, 45% did not understand how the documents requested by the IRS related to the questions the IRS had.  One study found that only 39.7% of Schedule C taxpayers audited by correspondence recalled being audited at all, as compared to 72% of field audited taxpayers and nearly 80% of office audited taxpayers.

The IRS doesn’t need to look far or use much more in the form of resources to be both more effective and in greater compliance with taxpayer rights.  In this post I will set several recommendations for improving the correspondence exam process.  All of these can be accomplished with a modicum of resources, and you can pay for the rest by minimizing, if not eliminating, the expensive downstream work caused by poorly handled correspondence exams (for a sense of this downstream cost, see Figure 2.9.7, page 156 of the 2021 Most Serious Problems for a chart of average pay of downstream employees).

First, the IRS should rename correspondence exam as “virtual office exam.”  Specifically, the IRS should reap the benefits of the pandemic-spurred “zoom” revolution by designing a virtual correspondence exam process that more closely follows in-person office exam procedures.  With this approach the IRS would still send the taxpayer an audit initiation letter, with a suggested date and time for a virtual audit appointment.  Behavioral researchers have found that people are more likely to respond when an appointment time is set, even if the response is to request a different appointment time. 

Second, the audit initiation letter should set out – in common parlance/plain language — the issue that is being examined (since IRS insists correspondence exams are “single issue” exams) and describe the types of documentation that may be helpful to establish eligibility for a credit or deduction.  Here’s an excerpt of an actual Notice CP-75 (correspondence exam audit initiation letter) sent to a low income taxpayer in February 2022:

Notice how vague the letter is about what, precisely, the IRS is auditing; the letter lists 5 different possible issues, each of which have different eligibility criteria.  This sure doesn’t look like a single-issue audit to me.

This notice goes on to identify the “audit items that require documentation” to be: EIC, Dependents, Filing Status, AOC, CDC Credit.  The notice helpfully includes the following enclosures:

According to the 2021 Annual Report to Congress, only 3% of taxpayers with Total Positive Income under $50,000 were represented in individual correspondence exams.  For unrepresented taxpayers, the above enclosures will be overwhelming and the sheer volume of them could lead an unrepresented taxpayer to just give up.  It is no wonder that the no-response rate for correspondence exam is higher than any other form of exam.  The inability to reach a live assistor to ask questions increases the administrative burden exponentially.  (In FY 2019, IRS answered the correspondence exam phone line 40% of the time.) 

Third, the IRS should completely trash its current notice system and use some of the IT funding it is getting for FY 2022 to replace it with a 21st century system that is flexible and graphically robust in terms of layout, type, and design.  IRS letter format is currently dictated by an aged, obsolete correspondence system that is completely inflexible.  Trying to get a change in wording to an IRS letter can take more than a year of endless reviews and negotiations, and even then you have to wait for the programming to be complete.  There is lots of good research, some conducted by IRS and TAS, about how to communicate complex information.  The benefits field, in particular, has lots of studies about how to plan effective communication.  IRS needs to apply that research to its correspondence exam notices and make them salient to the taxpayer’s specific situation.  Presumably, the IRS knows the exact reason the taxpayer’s return was selected for audit.  The audit initiation letter should include that specific reason, not a list of “and/or” possibilities.  The enclosures should relate to that specific reason.  (If there is more than one reason, then the audit should be conducted as an office or field exam, per the IRS’s own justification for “single issue” correspondence exams.)  The IRS should apply its IT resources to get this done, ASAP.

Fourth, the IRS should assign one audit employee to each case.  The audit initiation letter should include the name, badge number, and phone number of the employee to whom the case is assigned, as is required by IRC §7602(a).  Providing this information “personalizes” the process.  It reassures the taxpayer there is a live human being who will work with you on the case, rather than the impersonal, faceless IRS.  The letter should also encourage taxpayers to contact the office immediately if they need to reschedule or would prefer to conduct the audit by phone or correspondence.  By inviting the taxpayer to call to state their preference, the IRS not only signals its willingness to meet the needs of the taxpayer but also gains an opportunity to talk to the taxpayer about the issues.  This approach also increases IRS accountability.  As it stands today, no one employee is accountable for the conduct of a correspondence exam.  If the taxpayer does not respond, the assigned audit employee should be required to make at least two outbound call attempts (or emails/texts if that is available) at different days of the week and times of day. 

(I note that the IRS frequently justifies its “next available assistor” approach to correspondence exam by saying it is good for the taxpayer.  But all IRS functions where employees maintain case inventories – field exam and collection, Appeals, Counsel, and the Taxpayer Advocate Service – have established some type of buddy system to cover for vacations, sick leave, or training.  And the IRS could treat these taxpayers as adults and give them the choice of speaking to their assigned auditor or the next available assistor.)

Fifth, the audit initiation letter should also include a separate sheet providing information for signing on to the virtual appointment, including the requirement for a phone or other device that has a camera, and providing a contact for the taxpayer to discuss any technological challenges the taxpayer may face.  This is where QR code technology could be helpful, providing links to appropriate sites and information.  If the taxpayer is unable to sign on via a device with a camera, a telephone appointment should be arranged.  When the taxpayer requires specific reasonable accommodations, the audit should be converted to an in-person office exam or conducted via telephone, whichever is best for the taxpayer.

Sixth, when the taxpayer attends the virtual office audit appointment, the auditor should iteratively explain the specific issue that is being reviewed and what the IRS needs to see to establish eligibility.  If the taxpayer has documentation, the IRS auditor should look at it via the taxpayer’s device camera and instruct the taxpayer on how to upload, email or fax it.  As with an in-person office audit, at the close of the appointment the taxpayer should know what additional documentation, if any, is needed to prove eligibility.  The employee should memorialize the requested additional documentation in a letter to the taxpayer (or email if allowed).

Seventh, in order for this approach to work, the IRS must test its Documentation Upload Tool (DUT) or similar technology (such as the virtual office platform) with low income taxpayers to determine whether they are able to access and utilize it.  It should work with both the National Institute of Standards and Technology (NIST) and other government agencies and external groups to identify secure but accessible methods for low income taxpayers to sign on and submit information and documentation digitally.

Eighth, the IRS should adopt in correspondence exams the same procedures it uses in office and field exams for identifying alternative mailing addresses.  This approach will minimize the number of default assessments due to taxpayers moving around, especially low income taxpayers who comprise more than half of the correspondence exam population.

Ninth, with respect to all CTC/EITC audits, the IRS should allow taxpayers to establish proof of residency by using Form 8836 and its accompanying Schedule A.  These forms walk taxpayers through how to prove their child or relative lived with them for more than 6 months by having certain officials or professionals attesting under penalties of perjury and completing the periods of time they either have personal or official-records knowledge of the child’s residence.  In an exhaustive 2005 IRS study, this form was shown to be more reliable and probative than the usual documents and notarized statements the IRS currently accepts.  Since that time, I have recommended the IRS use this form in all EITC audits, which the IRS has steadfastly refused to do.  Given its obvious benefits, including reducing taxpayer burden, the IRS’s refusal is just plain baffling and counterproductive.

Tenth, the IRS should conduct a research study to test the effectiveness of certain messages in eliciting a response from low income taxpayers.  Several studies have already been conducted, including one by Day Manoli and Nicholas Turner on Nudges and Learning: Evidence from Informational Interventions for Low-Income Taxpayers.  This study found that timely reminder notices about the availability of the EITC increased take up of the childless worker EITC by 80% among the test population in the year of the notice.  A similar study designed around increasing responsiveness to correspondence exams, including focus groups exploring how letter recipients perceived the messages, could greatly enhance taxpayer communication and participation. 

The IRS should also build upon the important research conducted by TAS in 2016 and 2017 in which it sent out educational letters, under the signature of the NTA, to taxpayers whose returns claiming children had broken certain rules in the Dependent Database.  The letter referenced the specific issue and explained the eligibility rule in plain language.  One part of the study offered a toll-free Extra Help line to get questions about eligibility for the EITC and the CTC.  The letters had significant future compliance effects in several areas, without the cost of an audit.  The IRS should conduct a follow up study including focus groups to determine whether taxpayers understood the eligibility rules as a result of the letter.

The IRS recently announced the permanent establishment of the Customer Experience Office.  From the announcement, it appears the office will primarily focus on taxpayer service.  I hope the office defines “taxpayer service” more broadly, to include how taxpayers are served by the audit and collection process of the IRS (answer = poorly).  If it does so, the correspondence exam process is a good place to start.  While it is at it, the office can look at how to create a ”feedback loop” so correspondence auditors can learn what happens to the cases after they leave correspondence exam, as this post suggests.  Taxpayers who are under audit, and their representatives, will be enormously grateful for any improvements, and the rest of us taxpayers will be very happy that the IRS no longer wastes resources and violates taxpayer rights in this audit process.



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