Systemic delays by the IRS in processing forms

Brief history and background

The IRS has historically faced significant challenges in processing tax returns, issuing refunds, and responding to taxpayer correspondence. These challenges are attributed to a combination of factors, including budget constraints and a diminishing workforce.

Budget constraints have limited the IRS’s ability to invest in technology and upgrade infrastructure. The IRS’s budget, adjusted for inflation, fell by 20% between 2010 and last year (IRS Fact Sheet 2022-18 (March 2022)). Without sufficient funding, the IRS was unable to hire and retain qualified employees. Retirements and hiring freezes further diminished the Service’s workforce and reduced its ability to operate efficiently.

The COVID-19 pandemic presented additional challenges to the IRS’s operations. Besides adjusting to new work procedures, the IRS had to administer a complex series of new pieces of legislation when Congress passed four laws containing major tax-related provisions aimed at providing economic relief to taxpayers and businesses affected by the pandemic (the Families First Coronavirus Response Act, P.L. 116-127; Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136; Coronavirus Response and Relief Supplemental Appropriations Act (Division M of the Consolidated Appropriations Act, 2021, P.L. 116-260); and the American Rescue Plan Act of 2021, P.L. 117-2).

This column provides a state-of-the-practice discussion with respect to more common areas of IRS procedural delay and recommendations as to what practitioners can do to help their clients should they find themselves in one of these difficulties.

Systemic delays

Before the pandemic, the IRS took an average of four to six weeks to process returns and issue refunds to taxpayers who paper-filed their returns. During the pandemic, the Service took more than 10 months on average to process paper returns and issue refunds.

While the IRS has poured extensive resources into improving operations in the past year, numerous significant systemic delays remain. According to a report by the Taxpayer Advocate Service, the IRS reduced its backlog of unprocessed paper-filed original tax returns from 13.3 million at the end of the 2022 filing season to 2.6 million at the end of the 2023 filing season (National Taxpayer Advocate, Objectives Report to Congress, Fiscal Year 2024, “Review of the 2023 Filing Season,” p. 4). These numbers represent an 80% reduction and mark a return to prepandemic levels. Additionally, while the IRS is answering more telephone calls — 35%, compared to 11% during the pandemic — the Service is far from answering even half of call inquiries (id., p. 7). Systemic delays that persist include those concerning:

• Amended returns, other refunds, and taxpayer correspondence;
• Forms 1045, Application for Tentative Refund, and 1139, Corporation Application for Tentative Refund;
• Entity elections/entity status issues;
• Name changes; and
• Repatriation tax payment issues under the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.

Amended returns, other refunds, and taxpayer correspondence

Traditionally, the IRS takes more time to process paper-filed returns compared to electronically filed returns. Paper-filed returns and applications generally require significantly more time and resources to process because the IRS must manually process each one.

Although the IRS works to increase electronic filing options to minimize processing time, certain forms must still be paper-filed due to technical limitations, statutory requirements, or the need for additional documentation. IRS forms that require paper submissions include those specifically designed to request refunds or claim specific tax credits or deductions. Amended returns for tax years prior to 2020 must also be paper-filed.

During the 2023 filing season, the IRS reallocated customer service representatives (CSRs) to answer phone calls in an attempt to reduce long wait times and increase efficiency in operations. This reallocation created new issues. CSRs, who normally process amended returns and taxpayer correspondence, were now answering calls. Consequently, the number of unprocessed returns and items of correspondence grew because fewer people were available to process them.

On top of the IRS’s reduced workforce, the new tax relief provisions generated a surge of paper-filed amended returns, refund applications, and taxpayer correspondence as more taxpayers filed returns and applications to take advantage of the relief. The volume of mail that the IRS received and the lack of people to process it led to an unprecedented backlog of unprocessed amended returns and correspondence and significant delays in refund payments.

To compound matters, a rise in identity theft since the start of the pandemic further increased delays in issuing refunds to taxpayers. Taxpayers must, in many cases, contact the IRS Taxpayer Protection Program (TPP) to resolve their identity-theft issue. However, taxpayers have experienced long wait times to reach an agent on the TPP phone line.

Furthermore, some taxpayers who successfully verify their identity over the phone continue to encounter issues with the issuance of their refunds when the system does not register the identity update. To add to taxpayers’ frustration, the IRS then requires taxpayers to make estimated tax payments for the current tax year while they wait for the Service to post refunds owed them for a previous tax year.

Forms 1045 and 1139

The CARES Act significantly revised the treatment of net operating losses (NOLs). Under it, taxpayers were allowed to carry back any NOL arising in a tax year beginning after Dec. 31, 2017, and before Jan. 1, 2021, to each of the five tax years preceding the tax year of such loss (Sec. 172(b)(1)(D)). To claim these refunds, a taxpayer must either paper-file an amended income tax return or paper-file a form requesting a refund. Specifically, many individual taxpayers file Form 1045, and many corporate taxpayers file Form 1139.

The expanded use of NOL carrybacks provided substantial tax incentives for taxpayers. As a result, the IRS received a significant increase in NOL refund filings. According to the U.S. Government Accountability Office (GAO), the IRS received 276% more applications for carryback refunds for fiscal year 2021 compared to fiscal 2020 (GAO, COVID-19: Significant Improvements Are Needed for Overseeing Relief Funds and Leading Responses to Public Health Emergencies, Rep’t No. GAO-22-105291, p. 27 (January 2022)). Because the IRS lacks the infrastructure to support the processing of such a high volume of paper filings, the IRS was taking up to 165 days on average to issue an NOL refund, although it is required under Sec. 6411(b) to process them within 90 days (id.).

Entity elections/entity status issues

Taxpayers are encountering issues with the processing of their requests for an entity change. Specifically, it has become increasingly common for the IRS to process entity elections incorrectly or reject an entity election form when a taxpayer’s answer deviates from the norm.

One such client, an S corporation about to become a partnership, experienced issues when it filed a Form 8832, Entity Classification Election, to elect to be a partnership. The IRS rejected the taxpayer’s request to be a partnership and sent the taxpayer a letter revoking its S corporation status. In the letter, the IRS notified the taxpayer that it had reclassified the taxpayer to a C corporation. According to the IRS, the taxpayer did not meet the requirements to be a partnership. The taxpayer never made an election to be a C corporation and never made a voluntary revocation of its S election by filing a formal revocation statement.

Name changes

To make a name change, an entity must send a letter to an IRS service center notifying the IRS of the change. In the last few years, taxpayers have experienced extreme delays in the processing of these letters. Taxpayers must then expend resources to follow up with the IRS and send additional correspondence to confirm name changes.

The long delays in getting the IRS to process a name change affect some taxpayers’ ability to carry out their business operations, as their name does not match their employer identification number.

TCJA repatriation tax payment issues

The TCJA introduced a one-time repatriation tax on certain accumulated foreign earnings of U.S. companies. Also known as the “repatriation tax,” this provision was passed to encourage companies to bring offshore profits to the United States and invest them domestically.

The repatriation tax is complex, leading to various issues and challenges for taxpayers and the IRS. Taxpayers can elect to pay the tax on foreign earnings deemed repatriated in installments over eight years as opposed to making a one-time payment. However, due to the complexity and uncertainty around certain aspects of the tax, the IRS is not timely or correctly processing taxpayers’ requests to pay in installments (see Marchand and Hahn,“Sec. 965 Transition Tax: Installment Payments Causing Processing Errors,” 54-6 The Tax Adviser 18 (June 2023)).

What you can do

Tax practitioners can take the initiative in dealing with these administrative issues and protecting their clients’ rights by obtaining a power of attorney (POA) and getting to know the IRS. Provide a copy of your POA with every document that you send to the IRS. Send all documents by U.S. Postal Service (USPS) certified mail, return receipt requested. Yes, there are other IRS-approved delivery services (UPS, FedEx, and DHL), but if you use these services, you must go online to the service provider’s website to obtain proof of delivery. Note on the white and green USPS receipt and the green proof-of-delivery card the tax period and type of document included in the mailer.

Three weeks after submitting the documents to the IRS, begin to call the service center or other office to which the documents were sent. Persistently, periodically call the IRS until it has found your documents. If the Service cannot find your documents, refiling is generally the best option.

Let the IRS know your contact information and the importance of contacting you with any questions. Let the Service know what you want. Be specific. The IRS professional whom you are talking to may not be able to help you, but if you communicate the right way, you can make progress.

Work on finding the professionals at the IRS who might go the extra mile to help you. How can you identify these professionals? Look for cues such as words of concern or caring. Build your IRS directory. The best way to solve an IRS problem? Know someone at the Service. Build your network of practitioners who deal regularly with the IRS so that you can gain knowledge from the network.

Work on your approach with the IRS. You want the Service to help you and your clients. You have to have a story, and your story has to generate empathy. With respect to taxpayers with delayed NOL carryback refund claims, the issue is not that it is a shame that your client has to make a $4 million estimated tax payment because the IRS has not processed the claim; it is a shame that, because the payment has depleted the client’s assets, they cannot get a line of credit to make an investment in a new facility that will generate another 100 jobs. With respect to taxpayers with entity status issues, identify real economic consequences that will result from the failure to correct the entity status.

Be persistent. Dogged. Do not give up. Many seasoned tax controversy professionals know that if you keep trying regularly and periodically, you will achieve success.

New IRS services from increased funding cannot get here soon enough. Some of the expected services include enhanced online services such as online tax preparation tools, real-time status updates on returns, and interactive resources for common tax-related inquiries. Another example of improvements headed your way: real-time error notifications during the filing process that will enable taxpayers to rectify mistakes promptly and reduce the need for additional processing and potential delays.

An attentive follow-through

The IRS processes a vast number of tax returns each year; its workload is substantial. Furthermore, tax returns involve a range of complexities, including various deductions, credits, and reporting requirements. Entity elections, name changes, and the repatriation tax are three of the more confounding areas for tax practitioners. Increased IRS funding from the Inflation Reduction Act, P.L. 117-169, holds much promise. Benefits from the funding, however, will take time. In the meantime, you serve your clients best when you stay on top of submissions to the IRS and see them through.

Contributors

Mark Heroux, J.D., is a partner in the Tax Advocacy and Controversy Services practice at Baker Tilly US LLP in Chicago and a member of the AICPA IRS Advocacy and Relations Committee. Mai Chao Thao, J.D., is a senior associate with Baker Tilly US LLP in Madison, Wis. For more information on this column, contact thetaxadviser@aicpa.org.