Published: | Last Updated: February 8, 2024
The IRS May Consult a Ten-Year-Old Tax Return to Decide Whether to Exclude Your Account From Its Private Debt Collection Program
Since 2015, Congress has required the IRS to enter into contracts with private debt collection agencies (PCAs) to collect unpaid tax liabilities from taxpayers the IRS does not have the resources to collect. In 2019, as part of the Taxpayer First Act (TFA), Congress amended the law to bar the IRS from assigning the tax debts of low-income taxpayers to PCAs. Specifically, the TFA directs the IRS to exclude the debts of taxpayers with adjusted gross incomes (AGIs) at or below 200 percent of the federal poverty level from PCA assignment. This requirement took effect on January 1, 2021, and its intent to protect low-income taxpayers was straightforward and set forth in the accompanying House Ways and Means Committee report. The provision aimed “to protect such taxpayers from entering into payment plans they cannot afford.”
This provision is consistent with other parts of the tax code that balance the government’s interest in collecting tax against the government’s interest in ensuring that individuals and families have enough resources to meet their basic living expenses. For example, IRC § 6343(a)(1)(D) requires the IRS to release a levy if it determines that the levy “is creating an economic hardship due to the financial condition of the taxpayer.” Similarly, IRC § 7122(d)(2)(A) provides that in evaluating offers in compromise, the IRS must perform certain financial analyses designed to ensure that taxpayers are left with “adequate means to provide for basic living expenses.”
The TFA provision provides analogous taxpayer protections from collection attempts by PCAs. However, the statute does not instruct the IRS how to measure whether a taxpayer’s AGI is at or below 200 percent of the federal poverty level or as of what date the measurement should be made. We believe the IRS is measuring AGI in a manner that fails to identify low-income taxpayers accurately, is inconsistent with the intent of the statute, and the IRS should consider a more accurate approach.
The IRS approach fails to accurately protect low-income taxpayers
To determine a taxpayer’s AGI, the IRS has decided to use the taxpayer’s last-filed tax return — and if there is no recent return, it will reach back up to ten years to locate one. If there is no return filed within the last ten years, the IRS will assume the taxpayer’s AGI exceeded 200 percent of the federal poverty level and will not exclude it from assignment to a PCA. Under this approach, the results will be both underinclusive and overinclusive of the population the provision is designed to protect. Liability determinations and collectability determinations are made at different points in time. For example, if a taxpayer files a tax return for tax year 2012, the liability determination is based on the taxpayer’s income, deductions, and credits for that year. By contrast, if a taxpayer still has an unpaid 2012 tax liability today, the collectability determination is based on the taxpayer’s current financial condition (in 2021 or as recently as possible).
A taxpayer who could afford to pay tax in 2012 may not be able to do so today — and these are the taxpayers Congress intended to exclude from assignment to PCAs. Conversely, a taxpayer who could not afford to pay tax in 2012 might have earned additional income or acquired additional assets and be able to make payments currently. The IRS has not provided a persuasive justification for its approach of going back ten years and not considering other approaches. We believe our recommended approach would yield greater protections for low-income taxpayers facing current economic challenges.
The IRS approach is inconsistent with the statute and there is another approach that would be more accurate
The TFA provision directs the IRS to determine an individual’s AGI “for the most recent taxable year for which such information is available.” If filed tax returns were the only option available, then going back ten years might meet the statutory requirement. But there is another option which we contend better satisfies Congressional intent as set forth in the TFA.
TAS’s recommendation in determining appropriate cases to forward to PCAs
Every year, the IRS receives third-party information reporting documents (Forms W-2, Wage and Tax Statement, and Forms 1099 reporting income from various sources) and can construct or approximate a taxpayer’s gross income from those. When the IRS seeks to collect tax from individuals who have not filed tax returns, this is exactly the approach the IRS takes — it creates a tax return, including AGI, based on third-party information reporting documents under the authority provided in IRC § 6020(b), making a Substitute for Return (SFR). There is no reason the IRS cannot follow the same approach here. To ensure that collectability determinations are made based on current data, TAS has recommended that the IRS determine AGI under a three-part approach: (i) use information on a tax return if one has been filed in the last two years; (ii) if no return has been filed in the last two years, use recent third-party information reporting documents, if available, to create an SFR; and (iii) if no return was filed in the last two years and there are no third-party reporting documents, assume AGI was zero and exclude the account from assignment to a PCA.
TAS’s results with proposed approach
According to the IRS’s analysis of 2,311,294 cases in PCA inventory as of November 2019, the TAS method and the IRS method would exclude roughly the same number of cases. But we believe the TAS approach better protects those low-income taxpayers the TFA statute was designed to protect.
I acknowledge that no method is perfect, but the TAS approach is more effective in protecting taxpayers from entering into payment arrangements they cannot afford. Information reporting documents allow the IRS to compute gross income, but they do not identify “adjustments” and they do not tell the IRS whether the taxpayer is single or married. In these cases, we have suggested it would be reasonable to make assumptions “against” the taxpayer — i.e., assuming there are no adjustments and computing AGI on the basis of “single” filing status. If the IRS uses third-party information reporting documents to make collectability determinations, income not reported on those documents, such as self-employment income, will not be considered. But that is likely to be true even when the IRS relies on filed tax returns, as tax gap studies show most income not reported to the IRS on third-party documents is not reported on tax returns, either.
In our view, this is a situation where we should not make the perfect the enemy of the good. In a tax system where taxpayers file about 160 million individual income tax returns, no methodology will get the right answer in every case, but we should adopt the approach more likely to yield the intended protections. We believe basing collectability determinations on recent information will be far more accurate than reaching back for filed tax returns up to ten years old. In a recent audit report, the Treasury Inspector General for Tax Administration (TIGTA) reached a similar conclusion and similarly recommended that the IRS consider using “both last return filed information and third-party income information in its methodology to exclude low-income taxpayers from PCA inventory.”
TAS’s recommendation for PCA assignments
We encourage the IRS to reassess its approach. However, the IRS has rejected the use of third-party information reporting documents in informal discussions with us and in its formal response to TIGTA. As such, we have recommended in the National Taxpayer Advocate’s 2021 Purple Book that Congress amend IRC § 6306(d)(3)(F) to direct the IRS to determine an individual’s adjusted gross income “for the most recent taxable year for which such information is available” by reference to the individual’s most recently filed tax return if one has been filed in the preceding two years or, if not, by reference to third-party information reporting documents described in part III of subchapter A of chapter 61 of the IRC.
In the meantime, the best advice to taxpayers is this: If your tax debt is assigned to a PCA and you cannot pay, tell the PCA you want to work directly with the IRS. The IRS — not PCAs — can determine whether you should be placed into currently not collectible due to hardship status or approved for a collection alternative such as an offer in compromise or a partial-payment installment agreement. IRS Collection employees arrive at the appropriate resolution on the basis of your financial information (which PCA employees do not collect).
The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.