Taxpayer Advocate Identifies 'Most Serious' Problems for Taxpayers

NEW YORK (TheStreet) -- The most serious problem facing taxpayers -- and the IRS -- is the complexity of the Internal Revenue code, National Taxpayer Advocate Nina E. Olson says in her annual report to Congress.

The Internal Revenue Code requires the advocate to submit a report to Congress each year to, among other things, identify at least 20 of the most serious problems encountered by taxpayers and to make administrative and legislative recommendations to correct those problems.

Topping the list this year: Since 2001, Congress has made nearly 5,000 changes to the tax code, an average of more than one a day, and the number of words in the code appears to have reached nearly 4 million.

"Tax law complexity leads to perverse results," the Wednesday report says. "On the one hand, taxpayers who honestly seek to comply with the law often make inadvertent errors, causing them to either overpay their tax or become subject to IRS enforcement action for mistaken underpayments. On the other hand, sophisticated taxpayers often find loopholes that enable them to reduce or eliminate their tax liabilities."

The solution:

"To reduce taxpayer burden and enhance public confidence in the integrity of the tax system, the National Taxpayer Advocate urges Congress to vastly simplify the tax code. In general, this means paring back the number of income exclusions, exemptions, deductions and credits (generally known as 'tax expenditures)."

The advocate recommends that Congress take several steps, including: consider holding meetings with constituents to discuss the complexity of the existing tax code and the tradeoffs between tax rates and tax breaks tax reform will require; employ a 'zero-based budgeting' approach to comprehensive tax reform that starts out with the assumption that all tax benefits will be eliminated and adds tax benefits back only if members conclude that the public policy benefits of running the provision or program through the tax code outweigh the complexity burden; and direct the IRS to provide each taxpayer with a "taxpayer receipt" in conjunction with the filing of a tax return that shows how the taxpayer's tax payments will be spent.

In releasing the report, Olsen suggested how to determine which "tax expenditures" should be added back:

"In performing this analysis we should look at each provision in the code and ask questions like: 'Does this government incentive make sense?'; 'If it does, is it better administered through the tax code or as a direct spending program?'; 'However well intentioned, is it doing what it was intended to do?'; and, if yes, 'Can it be administered without imposing unreasonable burdens on taxpayers or the IRS?' At the same time, Congress can separately consider how much revenue it wants to raise, and it can then marry up our optimally designed tax system with our revenue needs by setting tax rates accordingly."

Other serious problems identified in the report include:

• The Alternative Minimum Tax "corrodes" the tax system and democratic process.
• The IRS Is significantly underfunded to serve taxpayers and collect tax.
• The IRS has failed to provide effective and timely assistance to victims of identity theft.

The Office of the Taxpayer Advocate is an independent office within the Internal Revenue Service. The advocate is appointed by, and reports directly to, the Commissioner of Internal Revenue. The office, which replaced the IRS Office of the Ombudsman, was created under the Taxpayer Bill of Rights 2, which became law in July 1996. Olsen has been the advocate since January 2001.

Robert Flach has more than 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.