Report: IRS failed to use law that assesses penalties on bad tax returns

The Internal Revenue Service has limited its ability to assess and collect penalties on a growing number of erroneous tax returns by misinterpreting federal law, according to a report released Tuesday.

The Treasury inspector general for tax administration (OIG) report found that the IRS’s mistake significantly reduced the amount of money it could have collected since 2007 on those improperly filed claims.  

Under current law, the IRS can penalize individual taxpayers who claim excessive tax credits or refunds up to 20 percent of the improper tax credit or refund claim.

While the IRS revised its interpretation in May 2012, the agency has failed to put the procedures in place to properly assess penalties where needed. 

“I am troubled that even though the IRS has revised its interpretation of this law, it has still failed to establish processes to assess penalties on the majority of disallowed tax credit claims,” said J. Russell George, Treasury inspector general for tax administration.

“Taxpayers who seek refunds or credit claims that have no reasonable basis in law must be penalized, for they create unnecessary burden on both the IRS and the American people by straining resources and impeding tax administration,” George said. 

In the five year period between May 2007, when the law went into place, until May of last year, the IRS assessed only 84 erroneous refund penalties totaling $1.9 million.

In the year after the IRS revised its interpretation of the law — June 3, 2012, through May 25, 2013 — there were 709,123 individual tax credits disallowed for which the IRS could have potentially assessed erroneous refund penalties totaling more than $1.5 billion.

The report noted that IRS management raised concerns about the costs and benefits of establishing the process to assess the refund penalties but has not provided any documentation and analysis to support them.

The IRS agreed with the OIG’s recommendation that it properly implemented the law.