Audit Shows IRS Owes Taxpayers $360 Million

By Cheryl K. Chumley | July 7, 2008 | 8:26 PM EDT

( - An Internal Revenue Service regulation that mandates filers must claim their refunds within three years is not only hypocritical, one tax reform advocate said, but also a contributing factor to the agency's $360 million debt to payers.

A Treasury Inspector General audit of the IRS completed and released in June found that an estimated $25 million in the excess collections account should be "immediately credited" to taxpayers, and another $335 million "could have been refunded" if the taxpayer's three-year window of opportunity for claims matched the IRS's own seven- year window for chasing down unpaid taxes.

IRS codes require taxpayers to claim credits and refunds within three years of the filing dates. The agency, however, is allowed seven years to issue liabilities uncovered during records searches - and impose interest and penalty payments under certain circumstances.

An IRS spokesperson declined to comment on the report, citing the agency's current preference of referring all questioners to the Treasury's Internet site, where the document was posted.

A tax reform supporter, however, described the IRS system of computing liabilities and excess funds as based in hypocrisy.

"I really think that if the IRS is going to go back seven years, then you and I should be able to go back seven," said Grover Norquist, the president of Americans for Tax Reform. "The IRS does not take that point of view ... we can go back three."

The $360 million IRS liability arose from computer problems, the Treasury report indicated.

Each taxpayer is given an account that is stored on the agency's primary computer system, called the Masterfile, which maintains records of payments and returns. If a taxpayer neglects to file a return, or if IRS agents cannot immediately match a taxpayer with his or her payment, the liabilities assessed filers are transferred to an "excess collections account."

Funds are not transferred automatically from the excess collections account to the Masterfile; taxpayers must contact the IRS and request such action. Late filers, then, are subject to the agency's manual search system, and inaccuracies develop within the various records departments - which are maintained separately from the excess collections files.

The Treasury report found that "computer systems limitations and processing procedures" within the IRS "made it appear that these taxpayers (who delayed filing) had not made payments."

The result, the study continued, was that taxpayers received "erroneous balance due notices" - which they often paid.

Since the IRS will not issue refunds to taxpayers owed from more than three years ago, the funds remain within the excess collections account.

"The IRS is a monopoly, and they have not put in the effort (to fix this)," Norquist said. "People program computers, and they shouldn't have screwed up. People ought to get their refunds ... in a timely basis, and they shouldn't be given a three year cutoff unless the government is going to take a three year cutoff, too."

The Treasury report suggested the IRS "immediately credit taxpayers' accounts where appropriate" and "develop a coordinated, cross-functional strategy" of maintaining excess collections accounts. The Treasury also recommended that the IRS use the results from the audit to aid with the development of statutes regarding the refund and credit processes.