Managing client expectations for IRS refunds

In fiscal year 2017, the IRS issued $437 billion in refunds. Almost all of these refunds (98%) were issued to individual taxpayers, and this amount does not include overpayments credited to subsequent years' tax liabilities (Internal Revenue Service Data Book, Tables 7 and 8 (2017)). To facilitate this volume of refund payments, the IRS has devoted a significant amount of resources to improving and maintaining its electronic filing and refund direct deposit systems. Indeed, from 2010 through 2016, the IRS spent on average $4 billion annually on operations support, including infrastructure and information systems, to ensure returns are processed efficiently and refunds are issued in a timely manner (Internal Revenue Service Data Book, Table 28 (2010-2016)).

When these resources work as planned, a taxpayer's refund can be issued in as little as 10 days, with most refunds paid within 21 days, and tools such as "Where's My Refund?" and e-Services provide important feedback to the taxpayer to accurately set expectations for processing times. While these processes work well for many taxpayers, they do not work for all refund claims. The purpose of this column is to describe reasons for delayed refunds and the actions practitioners can take when a client is experiencing a delay.

One explanation for a delayed refund is increased scrutiny of returns that include certain refundable tax credits. The Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, included a provision (Section 201) that prevents the IRS from issuing a refund for a tax return including the earned income tax credit (EITC) or the additional child tax credit (ACTC) until Feb. 15. The effective date for this policy change was Jan. 1, 2017. Under these new provisions, the IRS may not issue the entire refund until Feb. 15 even if the refund is only partially attributable to the EITC or the ACTC.

As these refundable credits are a rich target for individuals attempting to file fraudulent returns, this mandatory delay gives the IRS more time to evaluate taxpayers' eligibility for the credit(s) before issuing the refund. During the first year of this new process, the IRS did not update "Where's My Refund?" until Feb. 18. While some taxpayers who filed their returns before this date received a projected payment date for their refunds before the Feb. 18 update, many others received only a message that the IRS was processing their returns with no expected payment date for the refund. Once the IRS released the refunds, many taxpayers did not receive their payments until the week of Feb. 27. According to the IRS, many factors contributed to the delay, including increased processing times needed by banks and financial institutions receiving the refunds (see IRS News Release IR-2016-152).

Beyond the PATH Act policy change for certain refundable credits, another explanation for a delayed refund is IRS fraud and identity theft prevention procedures. These efforts predate the PATH Act and include security filters in tax return processing to stop suspicious refund claims. As the IRS continually evaluates and updates its processes, these procedures have become more successful. For example, between 2015 and 2016, these procedures reduced new identity theft claims by 50%, representing a reduction of 275,000 claims in one year (see IRS News Release IR-2016-152).

The effectiveness of these security filters means they will be maintained and likely expanded in upcoming years. Indeed, two of the six strategic themes described in the IRS Future State initiative relate to these efforts. These themes are: (1) facilitate voluntary compliance by empowering taxpayers with secure innovative tools and support; and (2) understand noncompliant taxpayer behavior and develop approaches to deter and change it (IRS, "Future State" (2016)). In an ideal system, only fraudulent returns would be caught by the filters, and legitimate refund claims would not. However, an ideal system is an aspirational goal, and the implementation of the filters has delayed refunds for legitimate returns.

When the filters have selected a return for further review and the IRS needs additional information from the taxpayer, a notice is sent to the taxpayer identifying the information the taxpayer must provide to resolve the concerns that triggered the filters. Examples of these notices include Letter 5071C and Letter 5447C. If clients attempt to fulfill these information requests on their own, the frustration prompted by the delayed refund can be exacerbated by the complex and confusing IRS identity verification process. In addition, failure to fully comply with the information request can further delay the refund. Practitioners can help clients avoid the added frustration by describing the security features to their clients before their returns are filed and instructing clients to notify the practitioner if they receive a notice.

The practitioner can access e-Services and obtain an account transcript to determine the status of the client's account. This initial action will require obtaining a Form 2848, Power of Attorney and Declaration of Representative, from the client. The transcript will include the dates of filing, assessment, payments, and other activity on the account. In addition, various transaction codes will be listed on the transcript. Knowledge of these transaction codes is often the key to quickly diagnosing the cause for the delayed refund.

Prior to the introduction of online tools such as e-Services, revenue agents conducting field audits would visit practitioners' offices with paper printouts of the taxpayer's account and then refer to a fold-out document to determine the various transaction codes on the account. With the introduction of online resources, these codes can now be found on the IRS website in two places: (1) IRS Document 11734, Transaction Codes Pocket Guide, available at www.irs.gov; and (2) IRS Document 6209, IRS Processing Codes and Information, available at www.irs.gov. The second document provides more detail on transaction codes than the first document.

Most accounts with delayed refunds will have a transaction code 570, referred to as a "hard freeze." As identity thieves developed ever more sophisticated schemes to steal tax refunds during the late 2000s, the IRS placed an increasing number of hard freezes on accounts to slow refund payments to potential criminals.

Removing the hard freeze is a two-step process that can create an added layer of frustration. Step one is the removal of the hard freeze, and step two is the approval for the payment of the refund. The key to successfully navigating the first step, when a notice has been issued, is to fully comply with the information request to address the concerns identified by the system filters. The IRS will evaluate the information provided and, if acceptable, authorize the removal of the hard freeze.

The removal of the hard freeze may not result in the payment of the refund, as the authorization to release the hard freeze is a separate process from the approval of the payment. The approval of the payment requires a separate transaction code to be entered into the client's account. That is, transaction code 570 needs to be removed from the client's account to remove the hard freeze, and then transaction code 571 needs to be entered into the account to authorize the payment of the refund. Completion of step one does not automatically result in the completion of step two. Consequently, it is not advisable that a client attempt to navigate this process without a practitioner's help.

After step one is completed and the hard freeze is no longer in the client's account, the practitioner will often have to contact the IRS a second time to secure the approval for the payment of the refund. Knowledge of the transaction codes can make this process easier than merely describing the issue without the code to an IRS employee. A practitioner may pursue a few other avenues for completing this second step. The first option is to contact the IRS through the Practitioner Priority Service. Alternatively, if the delay of the refund is creating a demonstrable economic hardship for the client, the Taxpayer Advocate Service (TAS) may be able to take the case. As the TAS has limited resources, recent changes in its guidelines require that it only accept cases where the taxpayer is facing an economic hardship from the issue requiring its assistance.

Refunds delayed through system filters that result in a hard freeze on a client's account can be a frustrating experience for both the client and the practitioner. Expansion of hard freezes stopped more criminal schemes but also snared more legitimate returns in the system. The false positives from filters catching legitimate returns appeared to hit its peak in 2012. Nina Olson, the national taxpayer advocate, described hard freezes in her 2012 Annual Report as "one of the most significant problems requiring improvement" and warned "that the IRS continues to harm taxpayers by unreasonably delaying the processing of valid refund claims" (National Taxpayer Advocate 2012 Annual Report to Congress, p. 95). The context of this problem is provided by the following data from the report:

• In 2012, 240,000 accounts received permanent hard freezes.
• In the second quarter of fiscal year (FY) 2012, the IRS reported that the Questionable Refund Program (QRP) inventory had increased threefold over the previous year. As a result, the IRS was not able to work this increased inventory within 70 calendar days. This delay violated an agreement between the TAS and IRS Criminal Investigation made in 2006 when the IRS began applying hard freezes on taxpayer accounts as part of the QRP.
• In FY 2012, the IRS Accounts Management Taxpayer Assurance Program(AMTAP) imposed a hard freeze on more than 142,000 returns because it could not complete the verification processes within the allotted time, not because the returns showed "badges of fraud." In other words, AMTAP was using hard freezes out of an abundance of caution as an inventory management tool to prevent refund payments for returns that could not be verified, not because the returns were suspicious filings.
• Referrals of cases to the TAS from the AMTAP freezes increased by approximately 468% from FY 2010 to FY 2012, or from 3,171 cases in 2010 to 18,012 in 2012. By 2012, AMTAP cases constituted 8.2% of all TAS cases and were the second most common issue in TAS casework.
• Seventy percent of all taxpayers who sought TAS help with the refund freezes in 2012 were experiencing some kind of financial harm as a result of IRS actions, compared with 38% in 2010.
• A representative sample of TAS wage verification cases closed in 2012 found that 86% of these taxpayers were facing potential adverse impacts.
• Seventy percent of these taxpayers with hardships received full relief, and another 2% received partial relief.
• In the same representative sample of TAS prerefund cases, 53% of the taxpayers claimed and received the EITC. These taxpayers waited more than three months for a median refund of $5,175. The refunds comprised, on average, 38% of their adjusted gross income.

The large number of hard freezes described for only one tax year in the report indicates most practitioners either have experienced or will experience this issue with their clients. While hard freezes can result from a wide variety of amounts reported on a return, returns with an EITC or an ACTC will receive special scrutiny. These returns will not receive refunds before Feb. 15, and special filters are designed to prevent fraud in these specific refund claims.

To reduce the frustration of a delayed refund, practitioners can set expectations with their clients by describing IRS processes that can slow the payment of a refund before returns are filed, advise clients to immediately notify the practitioner upon receipt of information requests, and obtain Forms 2848 that allow the practitioner to access clients' transcripts. With knowledge of the process for removing hard freezes from client accounts, including the transaction codes that identify the reason for the freeze, practitioners can more efficiently navigate the IRS system and reduce the time for securing refunds for their clients.