IRS blasted for destroying millions of information returns

The Internal Revenue Service is coming under criticism from Congress and the American Institute of CPAs for destroying an estimated 30 million paper-filed information returns to cope with its backlog last year, with one lawmaker even calling for the IRS commissioner to be replaced immediately.

On Monday, the Treasury Inspector General for Tax Administration released a report on the processing of business tax returns, noting that the IRS decided in March 2021 to destroy millions of paper information returns because of its inability to process all the paper returns it was receiving (see story). The IRS typically uses information returns such as Form 1099-MISC to verify the accuracy of the income tax returns filed by taxpayers. IRS officials noted that once the tax year ends, the information returns can no longer be processed anyway due to system limitations. The system used to process the information returns is taken offline for programming updates in preparation for the following filing season.

The IRS has taken steps to hire thousands more employees to help with processing returns after it was recently granted direct authority by Congress. The recent reduction in the backlog perhaps had begun to mollify lawmakers who had been hearing complaints from constituents about long waits for refunds and stimulus payments, alarming notices in the mail, and the difficulty of reaching anyone at the IRS by phone. But the new reports of wholesale destruction of paper documents, whether or not they were needed anymore by the IRS, provoked fresh consternation this week.

On Friday, Rep. Bill Pascrell, D-New Jersey, chairman of the House Ways and Means Oversight Subcommittee, called for Rettig to be replaced immediately by the Biden administration, even though Rettig’s term is nearing an end in November.

“The manner by which we are learning about the destruction of unprocessed paperwork is just the latest example of the lackadaisical attitude from Mr. Rettig,” Pascrell said in a statement. “This latest revelation adds to the public’s plummeting confidence in our unfair two-tier tax system. That confidence cannot recover if all the American people see at the IRS is incompetence and catastrophe. Mr. Rettig has had plenty of time and plenty of cooperation to begin the crucial work of fixing the IRS. There needs to be real accountability. President Biden must replace Mr. Rettig immediately and also nominate a chief counsel for IRS.”

Many tax and accounting professionals were also upset to learn that millions of the information returns they had laboriously prepared and filed for clients were being destroyed by the IRS, although the IRS is apparently preserving electronically filed forms and documents. 

“Considering the struggles the IRS has faced in keeping up with returns’ processing the last two years, the recent TIGTA report highlighting the revelation of the IRS’s destruction of 30 million documents last year has been concerning,” said AICPA vice president of taxation Edward Karl in a statement Friday. “IRS management’s decision to destroy information return documents due to the processing backlog raised numerous questions regarding IRS’s decision-making and risk assessment process. The IRS’s recent statement provided some of the answers, but American taxpayers deserve to know why this decision was made and how it might impact them. The IRS should continue to operate with transparency on this issue. For months, the AICPA has urged the IRS to implement specific recommendations that would help them reduce their backlog more quickly and provide relief to taxpayers, several of which are related to pandemic penalty relief. We are encouraged that the IRS statement indicated that taxpayers and payors have and will not be subject to penalties. However, the AICPA believes that the IRS should be transparent with their remediation strategy to ensure that taxpayers who attempt to be in compliance, and payors who have been compliant with the information reporting requirements, do not have penalties imposed on them in the future.”

The IRS tried to alleviate the controversy with a statement Thursday. “We processed 3.2 billion information returns in 2020,” it announced. “Information returns are not tax returns, and they are documents submitted to the IRS by third-party payors, not taxpayers. Ninety-nine percent of the information returns we used were matched to corresponding tax returns and processed. The remaining 1% of those documents were destroyed due to a software limitation and to make room for new documents relevant to the pending 2021 filing season. There were no negative taxpayer consequences as a result of this action. Taxpayers or payers have not been and will not be subject to penalties resulting from this action.”

The agency blamed the problem on its antiquated technology. “Broadly, this situation reflects the significant issues posed by antiquated IRS technology,” it said. “In 2020, the IRS prioritized the processing of backlogged tax returns to get taxpayers their refunds and support other COVID-related relief over inputting the less than 1% of information documents — mostly Form 1099s — that were submitted on paper.”

System constraints require the IRS to process the paper information return forms by the end of the calendar year in which they were received. “This meant that these returns could no longer be processed once filing season 2021 began,” said the IRS. “Not processing these information returns did not impact original return filing by taxpayers in any way as taxpayers received their own copy to use in filing an accurate return. The IRS processed all paper information returns received in 2021 and plans to process those received in 2022.”

The IRS has come under fire in recent months for its backlog of unprocessed tax returns, millions of which date back to last year. Another recent TIGTA report noted that more than 16.4 million individual tax returns, transactions, and accounts management cases remained in inventory as of the end of 2021. During a recent Senate oversight hearing, however, IRS Commissioner Chuck Rettig testified that the number of unprocessed tax returns from 2021 had been reduced to 1.8 million as of April 21 (see story).