IRS Backlog Forces Destruction of 30M Paper Information Returns

According to a recent report released by the Treasury Inspector General for Tax Administration (TIGTA), 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. The IRS typically uses information return documents for post-processing compliance matches to identify taxpayers who do not accurately report their income. 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.

During a Senate oversight hearing at the start of May, 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 from the 16.4 million at the end of 2021. The IRS receives large volumes of paper-filed tax and information returns, leading to high processing costs every year. 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 several actions and developed initiatives to increase e-filing. On top of that, legislative requirements have resulted and will continue to increase e-filing. 

The report noted that the IRS does not have a Service-wide strategy that identifies, prioritizes, and provides a timeline for adding tax forms for e-filing nor an accurate and comprehensive list of tax forms not available to e-file. Without a proper strategy and a list of forms not available for e-file, individuals will be unsure of e-filing, thus deciding to paper file and creating an even more significant backlog. These issues led to the wholesale destruction of millions of information returns as a part of an effort to expedite the processing of the backlogged business tax returns. The documents help the IRS’s Automated Underreporter Program identify taxpayers who are not accurately reporting their income. Still, 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 is because the system used to process the information returns is taken offline for programming updates in preparation for the following filing season.

The TIGTA recommended that the IRS develops 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 establish a Service-wide strategy to incorporate all forms for e-filing but did not agree with the report’s other two recommendations. IRS officials said they did not need to develop processes and procedures to identify non-compliant corporate filers because all requirements to assess penalties are unknown at the filing time. 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 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 is facing a tight budget but continues to pursue more ways to spur the e-filing of various types of business tax returns.

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