Tax Administration: Little Evidence of Procedural Errors in Collection Due Process Appeal Cases, but Opportunities Exist to Improve the Program
Released: 2006-11-06T00:00:00

Letter

Background

When Congress passed the Restructuring Act, it created new and expanded taxpayer rights, including the right to CDP hearings and judicial review to challenge IRS’s liens and levies. IRS’s Collection Appeals Program (CAP), established before the Restructuring Act, allows taxpayers to appeal several IRS collection actions. However, taxpayers that do not agree with CAP’s determination cannot go to court because CAP’s decisions are not subject to judicial review. According to a Senate Finance Committee report, CDP was intended to afford taxpayers with protection from IRS collection methods similar to the protection they have in dealing with any other creditor. The report stated that IRS should provide taxpayers with adequate notice of collection activity and a meaningful hearing.

IRS issues several different types of collection notices that also inform taxpayers of their due process rights, including the right to request a CDP hearing. IRS issues a Notice of Federal Tax Lien (lien notice) to establish the priority of the tax lien over other liens against the taxpayer’s assets for the amount of unpaid tax liability. IRS issues a Notice of Intent to Levy (levy notice) to inform taxpayers that failure to pay their tax liabilities could result in an IRS levy on the taxpayers’ assets held by financial institutions or other parties. Lien or levy notices may be issued by IRS’s Automated Collection System (ACS) or Collection Field Function (Field Collection). Taxpayers may also request CDP hearings in response to notices received related to automated levy programs, specifically the State Income Tax Levy Program (SITLP), the Federal Payment Levy Program (FPLP), or the Alaska Permanent Fund Dividend (PFD) Program. In addition, some taxpayers request and receive CDP hearings based on multiple due process collection notices, such as a combination of lien and levy notices. Taxpayers are given a CDP hearing after a levy on a state income tax refund, and a levy is issued when the IRS finds collection of the tax is in jeopardy.

Any taxpayer that receives a lien or levy notice has the right to dispute the action by filing a written request for a CDP hearing within 30 days of the date of the notice. Taxpayers that file for CDP hearings within the 30-day period are granted hearings with a right to judicial review from the U.S. Tax Court or U.S. District Court if they do not agree with Appeals’ determination. Taxpayers that file a request for CDP hearings after the 30- day period will be given an equivalent hearing (EH), but have no right to judicial review. Once IRS receives a CDP hearing request, all tax collection efforts are generally suspended until Appeals issues its determination to the taxpayer. Under the EH process, IRS may continue to enforce collection efforts although IRS’s policy is generally to suspend collection during an EH. Interest and penalties continue to accrue during the hearing period for both EH and timely CDP hearings.

By statute, during CDP hearings, taxpayers may raise issues related to (1) the appropriateness of the lien filing or levy; (2) offers of collection alternatives, such as IAs, OICs, and posting bonds or substitution of other assets; (3) appropriate spousal defenses; and (4) challenges to the existence or amount of the tax, but only in cases where they did not receive statutory notice of deficiency or did not otherwise have an opportunity to dispute the tax liability. The Internal Revenue Manual allows the taxpayer to raise issues related to a hardship determination. However, a taxpayer may not raise an issue that was raised previously and considered at a prior administrative or judicial hearing if the taxpayer participated meaningfully in that hearing or proceeding.

Once IRS receives a CDP request, Collection attempts to work with the taxpayer for approximately 45 to 90 days to resolve the issue prior to transferring the case to Appeals. If Collection is successful in resolving the case with the taxpayer, the taxpayer can formally withdraw from CDP. When Collection is unsuccessful in resolving the case with the taxpayer, it forwards the case file to Appeals for its independent review. However, in certain situations, Collection immediately forwards the taxpayer’s case to Appeals, such as when collection alternatives have already been explored and discussions are at an impasse, the taxpayer raises frivolous or constitutional issues, the taxpayer appears to be using CDP as a delaying tactic because the taxpayer is not responding to requests for information, or the taxpayer does not want to work with Collection after requesting the CDP hearing.

Appeals’ mission is to independently resolve tax disputes prior to litigation on a basis that is fair and impartial to both the government and the taxpayer. By statute, when Collection forwards the case to Appeals, Appeals will (1) verify that the requirements of any applicable law and administrative procedures have been met, (2) consider any relevant issues relating to the unpaid tax or the levy, and (3) determine whether any lien filing or levy balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection be no more intrusive than necessary. Appeals then renders a decision on the case in which it may either agree that the lien filing or levy is appropriate (that is, “sustain” or uphold the collection action) or not appropriate (that is, “not sustain” the collection action). Appeals may also include in its final determination a description of the terms for any collection alternative negotiated with the taxpayer, such as an OIC or IA.

As shown in figure 2, the volume of CDP case closures has increased steadily from the inception of the CDP program from fiscal year 1999 through fiscal year 2004 and then declined in fiscal year 2005. In fiscal year 2005, CDP cases accounted for more than one-quarter of Appeals’ annual caseload.

CDP Appeals Identified Few Errors by Collection, but Some Taxpayers Received a Different Outcome

Our case file review indicates that during the CDP review process Appeals found evidence that Collection had not followed proper procedures in an estimated 2 percent of the cases closed in fiscal year 2004. For reasons unrelated to an error by Collection, in an estimated 27 percent of cases, taxpayers emerged from the CDP hearing process with a different outcome than the lien filing or levy action. Of these, Appeals agreed to a collection alternative for an estimated 16 percent of all taxpayers, and approximately 11 percent of all taxpayers fully paid their tax liabilities or no longer had balances due to IRS. In addition, an estimated 11 percent of all taxpayers withdrew from the CDP process. Finally, in about 60 percent of cases, Appeals upheld the lien filing or levy for a variety of reasons, including because taxpayers did not file required returns, had not paid their taxes for certain periods, or both.

Appeals Rarely Found Evidence of Procedural Errors by Collection

As previously shown in figure 1, Appeals found evidence that Collection had not followed proper procedures in an estimated 2 percent of CDP cases. Although Appeals did not identify any instances in our sample where “requirements of applicable law and administrative procedure” were not met, our case file review did identify instances where Appeals detected other types of procedural errors during the collection phase of a case. For example, in one case IRS misapplied a payment to the taxpayer’s ex-spouse. Appeals reapplied the payment to the taxpayer’s account and did not uphold the lien filing and levy because there was no balance due. We included these types of cases in our estimation of procedures not followed as they represented other examples of situations where taxpayers utilized the CDP appeal process consistent with the provisions of the Restructuring Act—that is, as an opportunity to correct any errors made by Collection.

Of approximately 27 percent of CDP cases that resulted in a different outcome after taxpayers appealed, Appeals negotiated a collection alternative with taxpayers in about 16 percent of the cases. However, when Appeals negotiates a collection alternative, it is not necessarily disagreeing with the lien filing or levy. Appeals may accept a taxpayer’s collection alternative but sustain the filing of the lien in order to protect the government’s lien priority in the event of default. In addition, taxpayers may present Appeals with new information not previously provided to Collection for consideration. For example, in one of our cases, the taxpayer requested an IA with both Collection and Appeals. After submitting requested financial information and a down payment with Appeals, the taxpayer qualified for an IA. The taxpayer benefited from the CDP process by negotiating a collection alternative with Appeals. In an estimated 11 percent of all CDP cases, Collection’s lien filing or the levy was no longer appropriate because the taxpayer had since fully paid the liability or had no balance due. In these cases, the lien or levy was no longer necessary because the taxpayer no longer owed any tax to IRS. Appeals officials stated that some taxpayers file for CDP to delay imminent collection action while they find revenue sources to pay off their unpaid liabilities. For example, one taxpayer in our sample obtained a loan during the hearing process to fully pay the liabilities owed.

In addition, in about another 11 percent of all CDP cases, taxpayers withdrew from the CDP process after their cases reached Appeals, so Appeals neither upheld nor overturned the liens or levies. For example, one taxpayer continued to work with Collection while the case was transferred to Appeals. Collection negotiated an IA with the taxpayer, and then the taxpayer withdrew the CDP request from Appeals. We did not track the final outcome of cases after taxpayers withdrew from the CDP hearing process.

Of all CDP cases, approximately 6 percent of taxpayers negotiated a collection alternative while in Collection but failed to formally withdraw from the CDP program, resulting in their cases being forwarded to Appeals. According to Appeals officials, in these situations Appeals will generally agree with the proposed collection alternatives unless the taxpayers’ situations change so much that they can no longer comply with the agreements reached with Collection. Appeals officials also said that some professional representatives advise clients not to withdraw from CDP even though they resolved the issue at the Collection level because they want to preserve their clients’ right to judicial review.

Appeals Upheld the Majority of Liens and Levies, Often Because of Taxpayer Noncompliance

In an estimated 60 percent of cases where Appeals determined the lien or levy was appropriate, Appeals upheld the lien filing or levy 46 percent of the time because Appeals determined that taxpayers did not comply with filing requirements, did not pay their liabilities for certain tax periods, or both, as shown in table 1. For example, to be eligible for an OIC, a business taxpayer must file all required federal tax returns, file and pay any required employment taxes on time for the two quarters prior to filing the OIC, be current with deposits for the quarter in which the OIC was submitted, pay any required estimated tax for the current period, and not be a debtor in a bankruptcy case. To be eligible for an IA, an individual taxpayer must file all required tax returns currently due and make all required estimated tax payments on the current period prior to the commencement of the IA.

In addition to noncompliant taxpayers, Appeals upheld the lien filing or levy for a variety of other reasons, including when taxpayers questioned the amount of the tax liability but Appeals determined the liability to be correct (an estimated 38 percent) and when taxpayers did not respond to Appeals (an estimated 30 percent). With respect to nonresponsive taxpayers, Appeals officials stated that they attempt to communicate with taxpayers at least twice by correspondence before issuing determination letters.

About 2 percent of all taxpayers that requested CDP appeal hearings contested the Appeals determination in the U.S. Tax Court or U.S. District Court. Officials in IRS’s Office of Chief Counsel said that based on their experience with docketed cases, Appeals is upheld a majority of the time. When the courts overturn the Appeals determination, IRS Chief Counsel officials said that it does not necessarily mean that Appeals erred. Some taxpayers provide additional or new information considered by the courts but not presented to Appeals, leading to reversed decisions.

The Majority of Taxpayers Raised the Same Arguments with Both Collection and Appeals, Received the Same Determination, and Had Multiple Contacts with IRS

During fiscal year 2004, most taxpayers raised arguments permitted by statute to Appeals, while we estimated that 5 percent of taxpayers raised arguments considered frivolous under IRS guidance with either Collection or Appeals. When a taxpayer raised the same argument in both Collection and Appeals, in an estimated 81 percent of the cases Appeals agreed with Collection on the merits of the taxpayer’s argument. During the CDP process, Collection and Appeals initiated multiple communications with the taxpayer, including letters, telephone discussions, and face-to-face meetings.

Most Taxpayers Raised Permissible Arguments, but Some Presented Frivolous Arguments

Taxpayers raised various arguments permitted by the Restructuring Act in more than an estimated 90 percent of CDP cases. After their cases were transferred to Appeals, about 41 percent of taxpayers requested an OIC and about 37 percent of taxpayers requested an IA. Less than 3 percent of taxpayers requested innocent spouse relief as permitted under the Restructuring Act during their CDP hearings in Appeals.

Approximately 38 percent of taxpayers questioned the existence of the tax liability. Under the Restructuring Act, a taxpayer may challenge the existence or dollar amount of the tax liability at the CDP hearing if the taxpayer did not receive a statutory notice of deficiency for the liability or did not otherwise have an opportunity to dispute the tax liability. Seven out of the 80 taxpayers in our sample challenging the existence of a liability claimed they did not receive the statutory notice of deficiency. The remaining 73 out of the 80 taxpayers raised existence of the liability for a variety of other reasons, including contesting the amount of the liability. One Appeals official suggested that some taxpayers without professional representation (pro se) may not understand the definition of questioning “the existence or amount of the liability” under the Restructuring Act. IRS has drafted a revised CDP appeal hearing request form in an effort to assist taxpayers in determining what types of collection alternatives are available and what types of arguments are allowed. The revised hearing request form is intended to more clearly explain what it means to dispute the existence or amount of the liability and the taxpayer’s ability to question the liability under CDP.

While their cases were in Appeals, an estimated 38 percent of taxpayers questioned the appropriateness of the lien filing or levy and presented hardship arguments. According to guidance issued by IRS Counsel, taxpayers may argue that a lien or levy is inappropriate because payment would cause hardship, for example, if the taxpayer has no disposable income or assets. The primary hardship issue taxpayers cited during the CDP process was illness (about 11 percent). Other hardship issues taxpayers reported included bankruptcy, unemployment, and death in the family.

An estimated 5 percent of taxpayers requesting a CDP appeal presented a frivolous argument to either Collection or Appeals. According to IRS, taxpayers raising frivolous issues consume a disproportionately large amount of time because Appeals personnel must often read lengthy frivolous submissions in search of any substantive issue that might be contained within the case file. In addition, according to IRS, delays result when taxpayers use face-to-face meetings as a venue for frivolous oration and harassment of Appeals personnel. IRS has proposed changes to the CDP regulations, which clarify that Appeals will not offer face-to-face meetings if the taxpayers or their representatives raise only frivolous arguments. However, representatives from an external stakeholder group expressed concerns that IRS may misclassify cases as frivolous and deny face-to-face meetings although the taxpayer is raising arguments permitted under the Restructuring Act. For example, one stakeholder suggested that a pro se taxpayer’s argument may be misclassified as frivolous if the taxpayer uses the word protest on the CDP request form. Prior to the Restructuring Act IRS could designate certain taxpayers, such as those using arguments that had been repeatedly rejected by the courts, as “illegal tax protesters.” As a result, taxpayers using the term protest might be equated with taxpayers offering frivolous arguments. The act prohibited IRS from using this or any similar designation.

In Cases Where Taxpayers Raised the Same Arguments in Appeals as in Collection, Appeals Agreed with Collection the Majority of the Time

Nearly 90 percent of taxpayers raised the same argument permitted by the Restructuring Act with both Collection and Appeals. IRS encourages taxpayers to discuss the issues they want to appeal with Collection because the matter may be resolved without the need for Appeals’ involvement. As shown in table 2, Appeals agreed with Collection that a taxpayer’s argument lacked merit in more than an estimated 80 percent of the cases where taxpayers raised the same argument in both Collection and Appeals. For example, taxpayers argued that they qualified for collection alternatives but were not in compliance with requirements for filing tax returns for prior periods, paying taxes for certain periods, or both.

More than half of the taxpayers that requested an IA (about 61 percent) or OIC (about 56 percent) in Appeals were not compliant for tax periods in addition to the period under CDP review. Appeals officials added that when a taxpayer requests an OIC in Appeals, Appeals staff often spend a lot of time developing the case by requesting and reviewing documentation needed to determine the taxpayer’s compliance and eligibility. Our review of the case files for the estimated 31 percent of taxpayers that asked both Collection and Appeals for an OIC indicated that Appeals staff spend time building cases. Appeals requested the OIC form from an estimated 33 percent of these taxpayers, and an estimated 24 percent provided the form. Appeals also requested supporting financial documents from an estimated 37 percent of these taxpayers, and an estimated 24 percent of taxpayers that requested an OIC in both Collection and Appeals provided the requested information. IRS voiced concerns that many taxpayers are raising the same issues with Appeals that were rejected by Collection in what appeared to be efforts to delay collection of the liabilities.

In an approximately 19 percent of the cases where taxpayers raised arguments permitted by the Restructuring Act, Appeals reached a different conclusion than Collection on the merits of the taxpayer’s argument, but may have upheld the lien filing or levy. For example, in one case Appeals approved an IA rejected by Collection but upheld the lien to protect the government’s interests in case the taxpayer defaulted. Appeals differed from Collection on the merits of the taxpayer’s arguments for a variety of reasons, including a change in the taxpayer’s circumstances or information. When Appeals differed from Collection on the merits of the taxpayer’s argument, in an estimated 20 percent of these cases the taxpayer provided different information to Appeals than to Collection. In addition, in an estimated 11 percent of the cases when Appeals reached a different conclusion than Collection it was because the taxpayer did not provide requested information to Collection, but provided the information to Appeals.

IRS Initiated Communication with CDP Taxpayers Multiple Times, Primarily by Telephone and Letter

After sending the lien or levy notice, IRS (Collection and Appeals) contacted the taxpayer multiple times using different methods. The range of communication between IRS and the taxpayers in our sample varied. For example, the maximum number of phone calls in a single case was 34 and the maximum number of letters was 17. The estimated median number of letters IRS sent to the taxpayers was 3.6 and the estimated median number of phone calls was 3.2. As shown in table 3, in general the median number of IRS-initiated contacts with taxpayers—letters, telephone conversations, and formal meetings—was twice as high as the median number of taxpayer-initiated contacts with IRS.

After IRS sent the lien or levy notice, about 28 percent of taxpayers had at least one face-to-face contact, including meetings and drop-in visits, with Collection or Appeals. Most external stakeholders we interviewed stated that face-to-face CDP hearings were preferable, although a few representatives favored telephone conferences. Members of the National Association of Enrolled Agents, for example, said they preferred face-to- face meetings because they could review all documents and reach agreement in writing. In contrast, members of the American Institute of Certified Public Accountants stated that teleconferences were the most efficient way to handle CDP hearings.

The September 2005 proposed changes to the CDP regulations describe specific circumstances under which Appeals will not offer a face-to-face conference to taxpayers or their representatives because it determines that a conference will not serve a useful purpose. Under the proposed changes, a face-to-face conference will not be granted if the taxpayer does not provide the required information in the written request for a CDP hearing or if the taxpayer proposes collection alternatives that would not be available to other taxpayers in similar circumstances. For example, because IRS does not consider OICs from taxpayers that have not filed required returns or made certain required deposits of tax, face-to-face conferences will not be offered to taxpayers that request an OIC but have not fulfilled those obligations. In addition, a face-to-face conference will not be held at the location closest to the taxpayer’s residence or principal place of business if all Appeals officers or employees at that location are considered to have prior involvement with the taxpayer.

The National Taxpayer Advocate (Advocate) and American Bar Association (ABA) expressed concern about the potential reduction in face-to-face hearings that may result from the proposed changes in the CDP regulations. The Advocate noted that certain taxpayers may need a face-to-face meeting with an Appeals officer who is familiar with local economic conditions, such as a business’s payroll provider that went bankrupt. In our sample, an estimated 2 percent of taxpayers requested that Appeals transfer the CDP hearing to another location and Appeals accommodated all of these requests. However, we did not collect data on whether the relocation was to accommodate a face-to-face hearing. The Advocate also expressed concern that the centralization of Appeals activities to IRS campuses will result in only certain taxpayers receiving face-to-face hearings, such as those with representation. ABA representatives stated that the proposed regulations will grant Appeals more ability to deny face-to-face hearings, which would adversely affect pro se CDP taxpayers. They also said that Appeals cases can be more quickly resolved in person than through correspondence and phone hearings.

Both Individuals and Businesses Used CDP, but Case Characteristics Varied

Individuals constituted the majority of taxpayers that requested a CDP appeal hearing, although business entities also exercised their right to request an appeal hearing. When compared to individual taxpayers with income tax liabilities, businesses with employment taxes liabilities had more delinquent periods. The majority of individuals requesting a CDP appeal were lower-income taxpayers.

Most Taxpayers That Requested CDP Appeal Were Individuals, although Businesses Also Used the Program

Individuals constituted about 87 percent of all taxpayers that exercised CDP appeal rights. Of these individuals, approximately 79 percent filed a CDP appeal related to individual income tax liability. Business entities constituted the remaining 13 percent of all taxpayers that requested CDP appeals, with business-related liabilities such as employment and unemployment tax. See table 4 for more detail on the types of taxpayers requesting CDP appeal.

Both the ACS and Field Collection areas of IRS generate lien and levy notices, which may lead to eventual CDP appeals. ACS issued the vast majority of notices related to individual cases, about 88 percent. Our sample data suggest that Field Collection issued the majority of notices related to business cases, about 78 percent. However, because of a small sample size we cannot conclude that this observed level of notice issuance is statistically different from the level of notices issued to individuals. IRS procedures specify that simpler cases are usually handled by ACS. Field Collection handles complex, high-risk, high-dollar, and certain other types of collection cases.

Although taxpayers are afforded CDP appeal rights for lien and levy notices, about 64 percent of all CDP appeals resulted from a levy notice. ACS issued levy notices for an estimated 49 percent of all cases, while Field Collection issued levy notices for about 15 percent of all CDP cases. Lien notices, which may be issued by either ACS or Field Collection, accounted for about 29 percent of all cases. For the remaining estimated 7 percent of cases, taxpayers either received both a lien and levy notice on the same liability amount and tax periods or a different type of levy notice, such as SITLP or FPLP.

Businesses with Employment Tax Liabilities Had More Delinquent Periods Than Individuals with Income Tax Liabilities

Business entities that appealed proposed collection of quarterly employment tax liabilities had on average over twice as many delinquent periods included in their appeals as individual taxpayers with income tax liabilities. As shown in table 5, these businesses had on average nearly 6 delinquent periods included in their appeals. In calendar terms, this means that on average businesses that requested a CDP appeal for failure to pay employment tax liabilities were delinquent for nearly 1-½ years. The number of delinquent periods included in the CDP appeal for these taxpayers ranged from a low of 1 to a high of 26 quarters, or in calendar terms, from 3 months to 6-½ years. In contrast, individuals who appealed the lien filing or levy on income tax liabilities in CDP had on average 2.6 delinquent periods, or years, included in their appeals. For individual income tax liabilities the number of multiple periods involved ranged from a low of 1 to as many as 9 years per case.

Similarly, the estimated amount of the tax liability associated with CDP appeals varied widely and was associated with the type of tax liability involved. The highest median tax liability was associated with trust fund recovery penalty cases, followed by employment tax liabilities, as shown in table 6.

In general, taxpayers represented themselves more than half of the time in CDP appeal cases, an estimated 56 percent of the time. Individual taxpayers represented themselves even more frequently, about 61 percent of the time. Individuals engaged the services of a professional representative, such as a tax attorney, certified public accountant (CPA), or enrolled agent, during CDP about 30 percent of the time. Our sample data suggest that 50 percent of businesses retained professional representation; however, because of our small sample size we cannot conclude that this observed level of representation is statistically different from the level of professional representation for individuals.

Most Individuals Were Lower-Income Taxpayers with Varied Liability Amounts

More than an estimated 50 percent of individual taxpayers who requested a CDP appeal had most recently reported an adjusted gross income (AGI) of less than or equal to $50,000 prior to their CDP appeals. The estimated median tax liability associated with these cases varied somewhat when compared to income level, as shown in table 7.

Appeals Devoted Many Staff Hours to Resolving CDP Cases That May Not Be Consistent with Goals of the Program or an Efficient Use of Resources

The results of our case file review and interviews with IRS officials have raised concerns that certain types of taxpayers have used CDP in a manner that may be inconsistent with the goal of the Restructuring Act to ensure due process. IRS also raised concerns that taxpayers have used CDP in a manner that resulted in an inefficient use of Appeals’ resources. Our case file review enabled us to develop quantitative estimates of the extent to which cases with selected characteristics of concern were present among cases closed by Appeals during fiscal year 2004. IRS devotes a significant amount of its resources to resolving CDP appeals cases. Changing the CDP process could release a significant amount of Appeals’ resources for other purposes. In operating the CDP program, IRS must balance efficient resource utilization against the goal of protecting taxpayer rights.

Concerns about Certain Types of CDP Cases

The Restructuring Act permits any taxpayer who receives a lien or levy notice to request a CDP appeal hearing. The act makes no distinction with respect to the type of taxpayer, type of tax liability, or whether the liability is self-reported or asserted by IRS. According to the legislative history, the Senate Committee on Finance believed that following procedures designed to afford taxpayers due process in collections would increase fairness to taxpayers. However, the results of our case file review and interviews with IRS officials raised concerns that certain taxpayers are using CDP in ways that may be inconsistent with the goal of the Restructuring Act to ensure due process. These would include the following: Frivolous arguments: As discussed earlier, an estimated 5 percent of taxpayers requesting a CDP appeal presented a frivolous argument to either Collection or Appeals. An estimated 4 percent of CDP taxpayers raised a frivolous argument to Appeals alone. IRS has publicized those arguments that are considered frivolous and that will not be considered as a basis for contesting tax liabilities. IRS officials said that taxpayers that submit frivolous arguments may simply be delaying collection efforts. In the budget submissions for fiscal years 2005 to 2007, the administration submitted a legislative proposal that would increase the penalty for filing frivolous income tax returns from $500 to $5,000. The proposal would permit IRS to dismiss requests for CDP hearings (as well as IAs and OICs) if they are based on frivolous arguments or are intended to delay or impede tax administration. In 2005, IRS’s Office of Chief Counsel also issued guidance encouraging Counsel staff to coordinate with Collection staff in order to file a motion to levy during CDP proceedings where a taxpayer raises solely frivolous arguments.

Nonresponsive taxpayers: About an estimated 20 percent of taxpayers requesting a CDP hearing in fiscal year 2004 did not respond at all or responded initially and then became nonresponsive to attempts by Appeals to contact them for additional information. IRS officials questioned whether taxpayers that requested CDP hearings but did not respond to Appeals’ efforts to contact them were serious about resolving a lien or levy. According to Appeals’ procedures, taxpayers are provided at least two opportunities by correspondence to schedule the CDP hearing or discuss the case. While it is possible that nonresponsive taxpayers may no longer reside at the most recent address on file with IRS, Appeals makes efforts to contact the taxpayers using the most recent information it has available. In addition, the taxpayer can initiate contact with IRS to inform it of a new address and continue the CDP hearing. If the taxpayer does not respond, Appeals will issue a final determination on the lien or levy. For cases closed during fiscal year 2004, nonresponsive taxpayers that requested a CDP hearing experienced an estimated average cycle time of 314 calendar days from the time they requested a CDP hearing until the time the final determination was issued by Appeals. As previously discussed, IRS generally suspends all collection efforts during CDP until the final determination is issued.

Basis for questioning the existence of the liability: As discussed earlier, taxpayers challenged the existence or amount of the liability with both Collection and Appeals about 37 percent of the time. An estimated 38 percent of taxpayers raised the issue with Appeals alone. In addition, Appeals agreed with Collection’s evaluation of the merits of the argument an estimated 89 percent of the time. However, as discussed earlier, in only 7 of 80 cases in our sample where the taxpayer raised the existence of the liability with Appeals during CDP was the taxpayer claiming not to have received a statutory notice of deficiency from IRS. The remaining 73 out of the 80 taxpayers raised existence of the liability for a variety of other reasons, including contesting the amount of the liability. IRS intends to clarify the circumstances under which a taxpayer may appropriately dispute the existence or amount of the liability in CDP when it revises the hearing request form.

Self-reported liabilities: Taxpayers that self-reported their liabilities accounted for nearly an estimated 50 percent of Appeals’ total CDP caseload for cases closed during fiscal year 2004. Of these taxpayers, nearly one-quarter raised the existence of the liability issue during their CDP appeals. The Restructuring Act states that taxpayers can use the CDP process to appeal the underlying tax liability in limited circumstances. IRS initially interpreted the language as meaning an additional tax assessment by IRS, not a liability reported by the taxpayer on the return. In 2004, the U.S. Tax Court rejected this interpretation and concluded that the term underlying tax liability referred to self-assessed amounts as well as amounts assessed under deficiency procedures. The U.S. Tax Court held that petitioners generally could dispute their self- reported tax liability because they had not received a notice of deficiency and had no other opportunity to challenge the merits of the disputed tax liability.

Employment and unemployment taxes: In previous reports GAO has discussed the unique problems associated with ensuring business taxpayers comply with their employment tax deposit requirements. IRS also expressed concern about business taxpayers who use CDP to appeal collection action for employment and unemployment taxes because many of them continue to incur additional liabilities by not filing subsequent returns or paying related taxes, often referred to as “pyramiding.” As previously discussed, businesses that requested CDP appeal for employment taxes were on average delinquent for 6 quarterly periods, or behind on their payments for 1-½ years. For example, in one case the business requested a CDP appeal hearing to contest collection of employment taxes dating back over 26 quarterly periods, or 6-½ years. The administration has submitted a legislative proposal with its fiscal year 2007 budget to amend CDP procedures for employment tax liabilities. In contrast to most other CDP cases, the proposal would allow IRS to levy businesses with delinquent employment tax liabilities first, and then provide the taxpayer with the opportunity for a postlevy CDP appeal hearing within a reasonable period of time. This proposal is similar to the postlevy hearing established by the Restructuring Act for levies issued to collect a federal tax liability from state tax refunds under SITLP and for levies where IRS has made a finding that the collection of tax is in jeopardy.

IRS also raised concerns that other types of cases result in an inefficient use of Appeals’ resources. These include the following: Offers-in-compromise: In 2001, IRS established two centralized OIC processing centers to reduce inventory, processing times, and costs. IRS officials said that some taxpayers fail to work with these specialized units and instead go directly to Appeals to seek OICs. In addition, when making its determination about the acceptability of an OIC, Appeals in most cases does not refer the OIC to the specialized processing units or a Field Collection offer specialist for investigation or for a recommendation on acceptance or rejection. In contrast, Appeals refers CDP cases involving innocent spouse issues to either IRS’s Centralized Innocent Spouse Operation (CISO) or a field examination office for investigation and evaluation. Appeals will delay its ruling on any other issues or collection alternatives until the CISO or field examination area issues a preliminary determination on the innocent spouse issue. As a result of taxpayers that seek OICs directly from Appeals instead of working with the specialized processing centers, Appeals deviates from its mission of settling disputes between taxpayers and Collection and instead spends time doing original case-building work, such as trying to get taxpayers to file overdue returns for prior periods, an important eligibility criterion for OICs.

IRS also said that many taxpayers who apply for a collection alternative do not (1) meet the basic requirement of having filed all necessary tax returns or (2) provide with their CDP requests the necessary supporting documentation or a completed OIC application for Appeals to consider, causing further delay and consuming more staff resources. As discussed earlier, for those taxpayers that asked both Collection and Appeals for an OIC, Appeals requested the OIC application form and other supporting financial documentation from about an estimated one-third of the taxpayers.

One option for ensuring that taxpayers timely provide overdue tax returns, supporting financial information, or a completed OIC application with their requests for a collection alternative would be to require taxpayers to provide this information before IRS accepts the request for a CDP hearing. However, according to officials from IRS’s Office of Chief Counsel, under the current statute IRS may not deny a taxpayer’s request for a CDP hearing even if the taxpayer only wants a collection alternative and has not met basic filing compliance requirements. Similarly, IRS said that it also lacks authority to deny a request for a CDP hearing to taxpayers seeking an alternative that fail to submit the supporting financial information or OIC application form. IRS also stated that most taxpayers would be unable to provide this information within the 30 days they have to request a CDP hearing.

Another option would be to require taxpayers to provide the information within a reasonable time following the request for the CDP hearing and for IRS to proceed to make a final determination at that time on the basis of whatever information the taxpayer had provided. This would be similar to IRS’s current practice of proceeding to make a final determination when taxpayers have not been responsive to IRS’s request for information. At the time we completed our review, however, IRS had not determined whether it could do this without a statutory change.

Installment agreements: As with OIC cases, IRS also said that many taxpayers do not provide the necessary documentation for Appeals to even consider an IA with their CDP requests. Instead of concentrating on dispute resolution, Appeals officers instead must attempt to bring noncompliant taxpayers into filing compliance in order to meet the basic eligibility criteria for the alternative, and then develop the IAs, including requesting application forms and the necessary financial information from the taxpayers.

Low liability cases: For cases closed during fiscal year 2004, about 3 percent of the taxpayers, or approximately 1,100, requested a CDP hearing for liabilities totaling less than $500. One Appeals official stated that small liability cases may not be the most efficient use of Appeals’ resources. However, establishing a dollar threshold would deny some taxpayers the right to appeal the lien filing or levy at the judicial level while taxpayers with perhaps slightly higher liabilities would retain that right. In addition, for some lower-income taxpayers, an improperly assessed liability of $500 may represent a significant amount of money. The median for the most recently reported AGI for taxpayers in our sample with a liability of less than $500 was estimated at approximately $36,000, with a range from as low as about $11,000 a year to a high of more than $200,000 a year.

Changing the CDP Process Could Free Up a Significant Amount of Appeals’ Resources

Restricting CDP appeals rights for certain kinds of taxpayers or implementing other processing changes, such as requiring taxpayers to submit documentation for collection alternatives following the CDP hearing request, could release a significant amount of Appeals’ resources for other purposes. According to IRS records, in fiscal year 2004, Appeals allocated more than 285,000 direct staff hours, or about 23 percent of all direct case time charges, to resolve about 32,000 CDP cases. We estimate that this cost was approximately $8.2 million.

Table 8 shows the resources devoted to selected types of CDP cases. However, the data on direct case time charges and salary costs for each type of CDP cases may overstate the potential resource savings of changing the CDP process. First, the table represents the resources devoted to cases that exhibited the specific characteristic, but other characteristics could also be present, so the categories are not mutually exclusive. A case with a self-reported liability may also be an employment/unemployment tax case, and the resources devoted to that case would be included in each category. As a result, the potential staff hour savings to be realized from excluding more than one category of cases from CDP cannot be estimated by totaling the salary costs associated with each category. For example, suppose taxpayers with self- reported liabilities and employment/unemployment taxes were deemed ineligible for the CDP process. The table shows that Appeals devoted about 135,000 staff hours to cases with self-reported taxes and about 34,000 hours to cases with employment/unemployment taxes. However, the total staff hours that would be released by deeming both categories ineligible would not be the sum of those two categories (169,000 staff hours) because some of employment/unemployment taxes are also self- reported. The actual total would be less. Second, although we obtained the total direct time charges involved in resolving each case in our sample, we could not isolate the amount of direct time Appeals expended in requesting and obtaining documentation in order to develop collection alternatives. (For more detail on the confidence intervals associated with the estimated hours and salary costs shown in table 8, see app. I.)

IRS Has Taken Some Steps to Improve the CDP Program

IRS has taken some steps to improve the CDP program. IRS has drafted a revised CDP hearing request form in an effort to assist taxpayers in determining what types of collection alternatives are available. In addition, in 2005, IRS issued proposed revisions to the CDP program regulations intended to allow Appeals to effectively and fairly handle the cases of taxpayers that raise issues of substance. Included in these proposed changes is a provision stating that Appeals will not offer a face-to-face meeting with a taxpayer when Appeals staff determine that the conference would not serve a useful purpose, such as with a taxpayer that offers only frivolous arguments. Further, the proposed changes state that a face-to- face conference need not be granted if a taxpayer does not provide the reasons for disagreeing with the lien filing or levy on the written CDP request. As previously discussed, stakeholder groups, including the Advocate and the ABA, voiced concerns about whether Appeals would have the ability under the proposed revised regulations to deny face-to- face hearings to taxpayers in need of assistance and thereby adversely affect taxpayer rights.

In issuing the proposed regulatory changes for the CDP program, IRS asserted as its goal to increase efficiency without compromising the quality and fairness of review. Appeals anticipates collecting detailed information on CDP case outcomes as a result of planned enhancements to its information management system. IRS guidance lays out a seven-step process for data collection and analysis, the last of which is that managers should use data to follow up and monitor the effectiveness of a course of action. However, we found that IRS has not clearly assigned responsibility for analyzing future CDP outcome data to assess whether the revised hearing request form or updated program regulations achieve their objectives or whether further corrective actions will be necessary.

Conclusions

Providing taxpayers with the ability to appeal unfair lien filings or levies is an important consideration in ensuring IRS continues to respect taxpayer rights as it collects tax revenue. However, Appeals devotes a significant amount of resources to CDP cases and decision makers need to weigh the value of the existing program against the value of potentially redirecting those resources to serve other taxpayers better.

The results of our case file review and interviews with IRS officials raised concerns about whether Appeals is devoting a large share of its resources to providing temporary relief from collection action to taxpayers that Congress may not have intended to benefit from the CDP process. The statute currently affords all taxpayers the protection of due process appeal, even those that raise frivolous arguments or that do not respond to Appeals after requesting a hearing and may not be serious about working with IRS. For those taxpayers, which collectively may represent as much as approximately 24 percent of the total CDP workload, the delay in collection activity until Appeals issues its final determination may be an incentive to request an appeal, even though penalties and interest continue to accrue during the time the case is with Appeals. Other types of CDP cases represent those that may involve an inefficient use of Appeals’ resources, such as taxpayers that are seeking OICs or IAs but are not in compliance with basic tax return filing requirements.

IRS has taken some steps that may improve CDP program operations. Appeals anticipates collecting more detailed CDP case outcome data as a result of planned enhancements to its information system. However, IRS has not established responsibility for analyzing future program outcome data to determine if these changes will be effective. Given the significant share of Appeals staff resources dedicated to resolving CDP cases, balancing the need to employ these resources efficiently versus the goal of protecting taxpayer rights as required by the Restructuring Act has been, and will likely continue to be, a challenge for IRS.

Recommendations for Executive Action

We are making three recommendations to the Commissioner of Internal Revenue to ensure that Appeals uses its resources in line with its mission as well as more efficiently. Specifically, we recommend that the Commissioner determine—for taxpayers seeking only a collection alternative—a reasonable amount of additional time beyond the current 30-day period for requesting a CDP hearing for these taxpayers to submit the required supporting financial information necessary for Appeals to consider the alternative of choice, and if seeking an OIC, to submit the OIC application form; instruct Appeals to transfer CDP cases where taxpayers seek an OIC as a collection alternative and raise no liability issues to IRS’s specialized processing units for investigation and evaluation of OICs before consideration by Appeals; and establish responsibility for analyzing future CDP appeal case outcome data in order to determine whether revisions to the hearing request form and program regulations will result in meeting their objectives.

Matters for Congressional Consideration

Since the Restructuring Act permits any taxpayer who receives a lien or levy notice to request a CDP hearing, Congress should consider amending the statute to remove eligibility for CDP appeal for selected categories of taxpayers or types of cases if it judges that they have characteristics that are inconsistent with the Restructuring Act’s goal of ensuring due process. These categories may include self-reported tax liabilities, including employment and unemployment taxes, or other categories deemed inconsistent with the goal of the Restructuring Act provisions. In order to leverage IRS resources more efficiently, Congress should consider requiring taxpayers that seek collection alternatives, such as OICs or IAs, and that raise no other allowable issues to comply with the basic eligibility criteria, that is, file all required tax returns before Appeals reviews their cases. In addition, Congress should consider requiring taxpayers that raise only collection alternatives to submit the supporting financial information needed to consider the alternative of choice, and if seeking an OIC without raising any liability issues, to submit the OIC application form within a reasonable time following their CDP request.

Agency Comments and Our Evaluation

The Commissioner of Internal Revenue provided written comments on a draft of this report in a September 20, 2006, letter, which is reprinted in appendix II. The Commissioner agreed that our findings would assist IRS in its effort to improve CDP program operations, and provided technical comments and clarifications that we have incorporated throughout this report where appropriate.

With regard to our recommendation on transferring cases where taxpayers request OICs as a collection alternative to one of IRS’s specialized processing units for consideration before Appeals considers the cases, IRS agreed that our recommendation merited consideration, although IRS concluded that additional study is needed to assess the advantages and disadvantages of such a change in order to achieve the proper balance between agency resource allocation and imposing unnecessary delays in processing OICs. IRS also agreed with our recommendation regarding establishing responsibility for evaluating CDP outcome data in order to determine if the changes to the hearing request form and proposed regulatory changes will achieve desired objectives. IRS expressed support for our matter for congressional consideration related to suggesting that Congress consider amending the statute to remove eligibility for CDP appeal for selected categories of taxpayers or types of cases, noting that IRS has submitted several legislative proposals in past years aimed at limiting taxpayer access to CDP.

In our draft report we recommended that IRS require taxpayers seeking a collection alternative to submit supporting financial information with their requests for a CDP hearing in order to consider the alternative of choice. We also recommended that IRS require each taxpayer seeking an OIC that raises no liability issues to submit the OIC application form with the hearing request. IRS disagreed with both of these recommendations. While IRS agreed that having this information would be desirable to facilitate consideration of taxpayers’ requests for collection alternatives, IRS believes that most taxpayers would be unable to provide this information within the 30-day period taxpayers are provided to request a CDP appeal hearing. Further, IRS stated that it does not currently have statutory authority to deny CDP hearings to taxpayers who fail to submit financial information forms or the OIC application form. IRS believes that congressional action would be required to enable it to impose these requirements on taxpayers. We incorporated this information into the body of our report. Given IRS’s concerns, we revised our report to say that taxpayers should be given a reasonable amount of time after filing a CDP request to provide supporting financial information and OIC applications. If taxpayers do not provide the materials within that time, IRS would proceed to make a final determination on the basis of available information. Further, because at the time we completed our review IRS had not decided if this could be done without a statutory change, we made this a matter for congressional consideration. Finally, we also added a recommendation that IRS should determine what a reasonable amount of additional time would be for taxpayers to assemble and submit this information since IRS would be in a position to make this determination.

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If you or your staff have any questions, please contact me at (202) 512- 9110. I can also be reached by e-mail at brostekm@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Key contributors to this report are listed in appendix III.

Appendix I: Objectives, Scope, and Methodology

Our objectives were to provide information on (1) the extent to which the Internal Revenue Service’s (IRS) Office of Appeals (Appeals) found the IRS Collection function (Collection) had made errors in processing liens and levies and how often Collection Due Process (CDP) case results changed after a taxpayer requested a CDP appeal hearing; (2) the nature of the arguments presented by taxpayers seeking relief from a lien filing or levy and the amount of communication between IRS and taxpayers; (3) the characteristics of the taxpayers that availed themselves of the CDP appeal process, such as the amount of their total liability; and (4) whether opportunities exist to improve the operations of the CDP program while protecting taxpayer rights.

To develop information addressing our objectives, we interviewed stakeholder groups with an interest in CDP, both within and outside of IRS. Within IRS we interviewed officials in Appeals as well as from the Collection area of the compliance divisions where CDP appeal cases originate. We also interviewed officials in the Office of Chief Counsel and the Office of the National Taxpayer Advocate. Outside of IRS, we met with representatives from organizations whose members provide professional representation to taxpayers during CDP appeals, including the American Institute of Certified Public Accountants, the American Bar Association, and the National Association of Enrolled Agents.

We reviewed the Appeals Centralized Database System (ACDS) to determine whether it contained sufficient case results information to address our objectives. In conjunction with another GAO study addressing the operations of IRS Appeals, we tested the reliability of the data in ACDS. Based on this assessment, we found that data in ACDS were not sufficiently reliable for our use. Therefore, we collected data through a random probability sample of CDP cases closed by Appeals during fiscal year 2004 using IRS case files. The sample of 208 cases was drawn from a population of 32,241 cases. Results from this sample are generalizable to all cases closed in the CDP program in fiscal year 2004.

For each of the cases in our sample, we requested the Appeals closed office file and reviewed the documentation in the files to determine case characteristics, such as the ultimate outcome of the CDP appeal process, including whether a case was “sustained” or “not sustained.” We reviewed documents available in the file, including the taxpayer’s Request for CDP Hearing, the Case Activity Record (documented notes on the case history recorded by the Appeals officer), and the Appeals Case Memorandum (a summary memorandum outlining the Appeals officer’s findings at the conclusion of the hearing process). Based on the documents available, we determined the nature of the arguments raised by each taxpayer, including whether the taxpayer sought a collection alternative, such as an offer-in- compromise (OIC) or installment agreement (IA).

Through our case file review we also determined whether Appeals identified any evidence of improper procedures or errors that occurred during the Collection phase of the case. Based on the Internal Revenue Service Restructuring and Reform Act of 1998, as part of each case determination, Appeals is legally required to verify that the requirements of any applicable law or administrative procedure have been met. Specifically, Appeals will verify that Collection met legal and procedural requirements by reviewing whether (1) an assessment was made in accordance with the Internal Revenue Code, which requires IRS to make inquiries, determinations, and assessments of taxes; (2) a notice and demand for payment was issued to the taxpayer; and (3) the taxpayer had a balance due at the time the notice of lien or levy was issued. In addition to reviewing cases to determine if Appeals found any instances where Collection did not comply with these requirements, we also identified cases where all of these legal conditions may have been met, but Appeals identified some other type of procedural error or problem. We used this broader, more inclusive definition of improper procedures when compiling and reporting our results.

We also requested access to the Collection administrative file associated with each of our sample CDP cases in order to assess what transpired between the taxpayer and IRS during the collection phase of the case prior to the CDP appeal. We sought access to these files so we could develop additional case characteristics, such as the nature of the arguments raised by the taxpayer with IRS Collection, as well as the extent to which the taxpayer and the IRS employee working the collection case actively initiated communication with each other to resolve the collection dispute. Of the 208 cases in our sample, 162 originated from the Automated Collection System (ACS) area. When documents were missing from the Collection administrative files for ACS cases, we supplemented the file information by reviewing the ACS history transcript for the case. The remaining 46 cases in our sample originated in the Field Collection area of IRS. IRS Field Collection officials were concerned that providing GAO with access to the complete case file for our sample cases would be burdensome and potentially disruptive in cases where collection enforcement was ongoing. In response to this concern, we agreed to consider using case history information stored in the Integrated Collection System (ICS). We tested the reliability of ACS and ICS history transcripts by comparing the information on issues raised and communication contacts documented in the collection administrative file to the information in ICS for a subsample of cases. We found that the information in both systems generally agreed with the administrative case file data and was therefore sufficient for our data-gathering purposes. While we relied on ACS transcripts as a supplement to the collection case file documentation, for CDP cases that originated in the Field Collection area, we relied exclusively on reviewing the detailed ICS case history transcript.

To record the descriptive data obtained from case file review for our sample cases, we developed a detailed data collection instrument (DCI). We refined this DCI through extensive pretesting, and also shared an interim draft of the instrument with officials from both IRS Appeals and Office of Chief Counsel to ensure that it was technically accurate. To ensure that the data entered on the DCI conformed to GAO’s data quality standards, each completed DCI was subject to secondary review by at least one other GAO analyst. Reviewers compared the data recorded on the DCI to the data in the case files to determine whether they concurred with the interpretation of the case files and the way the data were recorded on the DCI. When there were differing perspectives, the analysts met and reconciled them.

We input the data recorded on the DCIs into a computer data collection program. To ensure the accuracy of the transcribed data, each electronic DCI entry was compared to its corresponding paper DCI by analysts other than those who electronically entered the data. If the reviewers found any errors, changes were made to the electronic entries, and the entries were reviewed again to ensure that all data were transcribed accurately.

To tabulate and analyze the results of the compiled DCI information, we used a standardized statistical software package. All cross-tabulation analyses of case file characteristic data were based on computer programs that were reviewed by a second independent data analyst.

Because we followed a probability procedure based on random selection, our sample is only one of a large number of samples that we might have drawn. Since each sample could have provided different estimates, we express our confidence in the precision of our particular sample’s results as a 95 percent confidence interval, less than plus or minus 8 percentage points unless otherwise noted. This is the interval that would contain the actual population value for 95 percent of the samples we could have drawn. In some instances, we report our sample estimates as medians. The median, or midpoint in a series of numbers, was selected in certain instances because the total number of observations for a given characteristic varied greatly across the population. To determine the reliability of median estimates, we calculated the relative standard error associated with each estimate by dividing the standard error of the median by the median and multiplied by 100 to get a percentage. All medians based upon the results of our sample have a relative standard error of less than 30 percent unless otherwise stated. In instances where our sample estimate included a fraction, we rounded the estimate up if the fraction was greater than or equal to 0.50.

To estimate the salary costs associated with selected types of CDP cases with specific characteristics shown in table 8, we estimated the total direct hourly time charges based on the sample cases that had the characteristic of interest. We multiplied direct hourly time charges by a weighted hourly salary rate that was based on Appeals data for time charged to working CDP cases during fiscal year 2004. Each of the figures for direct hours worked and salary costs, as well as the average number of additional case characteristics present for each category, have their own confidence intervals, which are shown in tables 9, 10, and 11.

Appendix II: Comments from the Internal Revenue Service

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Acknowledgments

In addition to the contact named above, Jonda Van Pelt, Assistant Director; Carl Barden; Keira Dembowski; Evan Gilman; Shirley Jones; Laurie King; Edward Nannenhorn; Bryan Rogowski; Ellen Rominger; Susan Sato; Sam Scrutchins; and Michael Trujillo made key contributions to this report.