IRS Failed to Refund $4 Billion in Improper Taxes

By Randy Hall | July 7, 2008 | 8:23 PM EDT

( - The Internal Revenue Service has failed to refund about $4 billion in improperly collected taxes, according to a Treasury Department audit.

The IRS collected $8 billion while an outdated tax on long-distance telephone calls was being challenged in court, according to a federal report that states "a significant amount" of the tax "may never be refunded." As of August, only about half of the $8 billion had been returned to taxpayers.

Further, evidence shows that many people opted to take a refund for less money than they were owed because the IRS paperwork necessary to get a full deduction was too complicated.

"After several court decisions held that the excise tax the IRS was collecting on long-distance and bundled telephone service was inappropriate, the IRS implemented a major program for taxpayers to receive refunds for the portion of their excise taxes paid on these services," the 28-page document notes.

The Treasury Inspector General for Tax Administration (TIGTA) report estimated that up to 165 million taxpayers became eligible for a share of the approximately $8 billion gathered by the IRS after Feb. 28, 2003, and before Aug. 1, 2006, once the Telephone Excise Tax was invalidated in the courts.

The tax, which was put in place in 1898 to help fund the Spanish-American War, originally applied to all telephone use. It was later revised to apply to long-distance charges that factored both duration and distance into the cost of the call.

But in recent decades, telecommunications companies began billing only for call duration. As a result, the courts found, these charges were not subject to the tax.

The IRS was ordered to develop strategies to inform taxpayers about the availability of refunds for $8 billion in improperly collected telephone taxes and to produce forms for tax year 2006 that would advise people to claim either a standard refund of between $30 and $60 or the actual amount owed to them as documented by 41 months of phone bills.

While acknowledging that this project "was the most wide-reaching tax refund in the history of the IRS," the report notes that "as of June 9, 2007, about 87.6 million (71.5 percent) of the approximately 122.6 million taxpayers" that had filed their returns made a claim for the excise tax refund.

In addition, "the refunds associated with these claims totaled only $3.8 billion, or 48 percent of the $8 billion collected," the report states. "We believe a significant amount of the telephone excise tax collected by the IRS may never be refunded."

The TIGTA document lists two reasons for its findings: The IRS underestimated the number of people who would take the standard refund instead of itemizing, and many people never even realized they were owed a refund.

The IRS estimated that 74 percent of individual taxpayers would choose the standard refund. In fact, more than 99 percent did. The audit report concluded that this "indicates taxpayers preferred to accept potentially lower refunds in exchange for much less paperwork and burden."

The report also said that a significant number of claims that were obviously either incorrect or potentially abusive were processed and refunded without being challenged.

TIGTA officers conducted an analysis of more than 52,000 tax forms filed through June 2, 2007, which contained claims for amounts they considered highly questionable. The investigators found that the average claim in those cases was $826, for a total of more than $43 million.

"Taxpayers would have to have spend more than $27,000 on long-distance fees over a 41-month period to qualify for claims of that amount," the document says.

'Really, really basic'

Eric Smith, a spokesman for the Internal Revenue Service, told Cybercast News Service on Friday that while his agency agreed with the report's findings in its official response to the audit report, the IRS has made a tremendous effort to make the Telephone Excise Tax refund available to everyone.

"There was the opportunity for people who did not need to file a return because they have low income to file a really, really basic return asking for the telephone tax refund and nothing else," Smith said.

"We called it a 1040 EZT because it's just a one-line form," he stated. "You put down the amount of the refund. You put your name, address and Social Security number on it, you sign it, and that's pretty much it."

Smith further noted that if you've filed your income tax forms for 2006, it's still not too late to receive the refund.

"Even it it's a one-shot deal, it's a deal you haven't missed," he said. "For the same reason that pencils have erasers, we have amended return forms. You can file what we call a 1040 X anytime there's something on your return that needs to be changed, whether or not it's in your favor, for the next several years."

In addition, the IRS will include reminders on the excise tax refund with its 2007 income tax materials.

"You put that all in a shaker and mix it up, and you get your refund," Smith said.

'Read the instructions'

However, Natasha Altamirano, communications manager for the National Taxpayers Union, told Cybercast News Service on Friday that the problems cited in the TIGTA report are "nothing new for taxpayers."

"For too long, taxpayers have had to navigate the impossible bureaucracy of the IRS in order to receive money that is theirs to begin with," she said. "This is just another example."

Altamirano also pointed to the fact that 99 percent of the people filing returns were willing to accept a smaller refund to avoid piles of paperwork.

"When taxpayers start choosing less money in order to avoid painstaking navigation of government bureaucracy, that tells me we have a problem," she said.

Ryan Ellis, tax policy director at Americans for Tax Reform, agreed that the situation would be less complicated "if you didn't have a lot of gunk cluttering up the tax code. This is probably line 68 of the 1040, not counting all of the schedules, forms and everything that go with that."

"If we had a simpler system without all these weird ins and outs but instead had lower rates and a broader base, we'd be much better off," he told Cybercast News Service.

Ellis also stated that the standard refund "should have been $10 higher. A lot of this honestly was just guesswork on their part" because the IRS "had a very short amount of time to slap that together, and they missed by $4 billion."

Nevertheless, "at some point, if you don't read the instructions, I've only got so much pity for you," he said, stating that the excise tax refund was listed clearly even on the 1040 EZ, "which is about as close to a post card flat tax form as you're going to get with our current code."

"There are just a lot of people out there who either don't know what they're doing or couldn't be bothered," he said, but "at some point, you have to be a grown-up and read the fine print."

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