IRS destroyed 30M paper information returns due to backlog

The Internal Revenue Service destroyed an estimated 30 million paper-filed information return documents in March 2021 because of its inability to process its backlog of paper tax returns, according to a report by the Treasury Inspector General for Tax Administration.

The report, released May 4th, noted that the IRS typically uses information return documents for post-processing compliance matches to identify taxpayers who don’t accurately report their income. The report focuses on how the IRS should be doing more to encourage electronic filing of business tax returns and reduce paper filing. TIGTA reported that, while e-filing of business tax returns has continued to increase, the e-filing rate still lags behind that of individual tax returns.

“Repeated efforts to modernize paper tax return processing have been unsuccessful,” said the report.

During the pandemic, millions of paper tax returns and other documents accumulated at IRS facilities and the agency has been working overtime to catch up on the backlog. 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 Senate oversight hearing last week, IRS Commissioner Chuck Rettig testified that the number of unprocessed tax returns from 2021, as of April 21, had been reduced to 1.8 million (read more here).

The IRS continues to receive large volumes of paper-filed tax and information returns, leading to significant costs to process them every year, according to the new TIGTA report. In fiscal year 2020, the IRS spent more than $226 million on processing paper-filed tax returns.

The report acknowledged that the IRS has taken a number of actions and developed initiatives to increase e-filing. On top of that, legislative requirements have resulted and will continue to lead to increases in e-filing. But TIGTA believes the IRS needs an overall strategy.

“The backlogs of paper tax and information returns to be processed along with the inability to ship paper tax returns and/or retrieve paper tax returns from Federal Records Centers due to the pandemic demonstrate the need for the IRS to develop a Service-wide strategy to further increase e-filing,” said the report. “However, the IRS does not have a Service-wide strategy that identifies, prioritizes and provides a timeline for the addition of tax forms for e-filing nor an accurate and comprehensive list of tax forms not available to e-file.”

The problems led to the wholesale destruction of millions of information returns. The report does not explain exactly why the IRS destroyed millions of information returns, but it seems to be part of an effort to expedite the processing of the backlogged business tax returns.

“This audit was initiated because the IRS’s continued inability to process backlogs of paper-filed tax returns contributed to management’s decision to destroy an estimated 30 million paper-filed information return documents in March 2021,” said the report. “The IRS uses these documents to conduct post-processing compliance matches to identify taxpayers who do not accurately report their income.”

The documents help the IRS’s Automated Underreporter Program identify taxpayers who are not accurately reporting their income, but IRS officials told TIGTA that once the tax year ends, the information returns, such as Forms 1099-MISC, Miscellaneous Information, can no longer be processed due to system limitations. That’s because the system used to process the information returns is taken offline for programming updates in preparation for the following filing season.

Since 2014, the overall percentage of business tax returns e-filed has increased from 41% to 63%. Employment tax returns continue to provide the most significant opportunity for growth in business e-filing, TIGTA noted. The IRS has yet to establish processes and procedures to identify and address corporate, employer and Heavy Highway Vehicle Use Tax filers that do not comply with e-file mandates. TIGTA’s analysis of tax return filings identified 15,108 filers that paper-filed 22,569 tax year 2018 returns that were required to be e-filed. TIGTA estimates that the processing of these returns cost the IRS $30,196 in comparison to the $3,405 to process the required e-filed tax returns.

TIGTA recommended the IRS develop a Service-wide strategy to prioritize and incorporate all forms for e-filing; develop processes and procedures to identify and address potentially non-compliant corporate filers; and develop processes and procedures to ensure that penalties are consistently assessed against business filers that are non-compliant with e-filing requirements.

The IRS agreed with the first recommendation to develop a Service-wide strategy to incorporate all forms for e-filing, but didn’t agree with the report’s other two recommendations. IRS officials said they didn’t need to develop processes and procedures to identify non-compliant corporate filers because all requirements needed to assess penalties are not known at the time of filing.

The IRS also has systemic processes in place for e-filed partnership returns, which were found to be working as intended. Other types of business returns have differing criteria for e-filing requirements and exceptions to the requirements, which prevent the implementation of a standard process for all business filers.

TIGTA, for its part, said it believes that IRS management’s justification for taking no action on two recommendations is insufficient. “In view of the backlogs of paper tax returns, the IRS should take additional steps in an effort to continue to reduce paper return filings,” said the report.

The IRS pointed out that it’s facing a tight budget but is continuing to pursue more ways to encourage e-filing of various types of business tax returns. “Constrained funding is the foremost obstacle we face in implementing our modernization strategies,” said Kenneth Corbin, commissioner of the IRS’s Wage and Investment Division, in response to the report. “In 2015, we developed business tax return strategies for the employment tax family of returns (forms 94x), Form 990, Return of Organization Exempt from Income Tax, and Form 2290, Heavy Highway Vehicle Use Tax Return. Each of the strategies provided a framework of opportunities to increase the business return e-file rates.”