Olson recommends that Congress substantially simplify the tax code. The report includes a series of recommendations, including recommendations to repeal the Alternative Minimum Tax; streamline education and retirement savings tax incentives; simplify the family status provisions of the tax code; simplify the rules under which workers are classified as employees or independent contractors; reduce sunset and phase-out provisions and revise the overall penalty structure. More broadly, Olson recommends six core principles on which fundamental tax reform should be based. (For details, see Most Serious Problem: The Complexity of the Tax Code and corresponding items in the Legislative Recommendations section of the report.)
Working with Taxpayers Who Are Experiencing Financial Difficulties
The report makes three principal recommendations to reduce burden on financially struggling taxpayers:
1. Make greater use of collection alternatives when economic hardship is present. While enforced collection actions like levy and seizure authority are important collection tools that allow the IRS to address serious incidents of noncompliance, a review of IRS historical enforcement data show that more enforcement actions do not translate into commensurate increases in revenue collection. One example: The number of levies issued by the IRS increased by 1,608 percent from FY 2000 to FY 2007 — from 220,000 levies to about 3.76 million levies — yet the increase in the total collection yield during the period was slightly less than 45 percent. By contrast, historical enforcement data indicate that collection alternatives, such as offers in compromise and partial-payment installment agreements, may be more effective at collecting liabilities from taxpayers having difficulty paying their tax debts. (For details, see Most Serious Problem: The IRS Needs to More Fully Consider the Impact of Collection Enforcement Actions on Taxpayers Experiencing Economic Difficulties.)
2. Simplify the “cancellation of debt” minefield that many taxpayers who default on debts must navigate. Most financially distressed individuals who lose their homes to foreclosure or cannot pay off their car loans, credit card balances, student loans, or medical bills probably do not realize that their delinquency may increase their tax liabilities, but it often does. If a creditor writes off a debt, the tax code generally treats the amount of the canceled debt as taxable income to the debtor. Congress has carved out a number of exclusions, including an exclusion for “insolvency” and a recently enacted exclusion to help some (but not all) homeowners whose mortgage debts are canceled when their houses are foreclosed upon and sold or whose loan balances are reduced as part of a mortgage loan modification. However, taxpayers do not receive the benefit of these exclusions automatically. A taxpayer must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to claim an exclusion. Form 982 is extremely complex, and very few taxpayers or preparers are familiar with it.
IRS data show that approximately two million Forms 1099-C, Cancellation of Debt, are issued to taxpayers and the IRS each year reporting canceled debts. In an economic downturn, the number of taxpayers defaulting on credit card bills, car loans, home mortgages and other debts can be expected to rise. Olson estimates that tens of thousands and possibly hundreds of thousands of taxpayers who qualify to exclude canceled debts from gross income do not file Form 982 to claim allowable exclusions. Instead, some of these taxpayers unnecessarily include the amount of the canceled debt in gross income, and other taxpayers who fail to include it unnecessarily face IRS examinations and tax assessments.
Olson recommends that Congress change the law to remove taxpayers with modest amounts of debt cancellation from the cancellation of debt income regime, and she recommends that the IRS develop an insolvency worksheet that taxpayers can file with their returns and create a centralized unit dedicated to handling cancellation of debt issues. (For details, see Legislative Recommendation: Simplify the Tax Treatment of Cancellation of Debt Income, and Most Serious Problem: Understanding and Reporting the Tax Consequences of Cancellation of Debt Income.)
3. Implement a “screen” to protect low income Social Security recipients from continuous, automated tax levies. Under the Federal Payment Levy Program, the IRS is authorized to “levy” (or withhold) 15 percent of any federal payment made to a delinquent taxpayer. Using this authority, the IRS levied against 1.8 million payments to Social Security recipients in 2008. TAS estimates that more than 25 percent of these taxpayers had incomes below the poverty level and more than one-third would likely be classified by the IRS as unable to pay if their cases were subject to human review. However, the automated levy system does not use built-in screens to identify and shield these taxpayers. The report contains a research study recommending the implementation of such a screen. (For details, see Research Study: Building a Better Filter: Protecting Lower Income Social Security Recipients from the Federal Payment Levy Program.)